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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
Commission File Number: 1-1511
FEDERAL-MOGUL CORPORATION
(Exact name of Registrant as specified in its charter)
| Michigan | 38-0533580 | |
(State or other jurisdiction of incorporation or organization) | (IRS Employer I.D. No.) | |
26555 Northwestern Highway Southfield, Michigan | 48034 | |
| (Address of principal executive offices) | (Zip code) | |
Registrant’s telephone number including area code: (248) 354-7700
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered | |
Common Stock and Rights to Purchase Preferred Shares | Over-the-counter market |
Securities registered pursuant to Section 12(g) of the Act: None.
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.
Yesx No¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
Yes¨ Nox
The aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $25.3 million as of June 30, 2004 based on the reported last sale price as published for over-the-counter market for such date.
The Registrant had 89,057,696 shares of common stock outstanding as of February 22, 2005.
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Certain statements contained or incorporated in this Annual Report on Form 10-K which are not statements of historical fact constitute “Forward-Looking Statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Reform Act”).
Forward-looking statements give current expectations or forecasts of future events. Words such as “anticipate”, “expect”, “intend”, “plan”, “believe”, “seek”, “estimate” and other words and terms of similar meaning in connection with discussions of future operating or financial performance signify forward-looking statements. From time to time, Federal-Mogul Corporation (the “Company”) also may provide oral or written forward-looking statements in other materials released to the public. Such statements are made in good faith by the Company pursuant to the “Safe Harbor” provisions of the Reform Act.
Any or all forward-looking statements included in this report or in any other public statements may ultimately be incorrect. Forward-looking statements may involve known and unknown risks, uncertainties and other factors, which may cause the actual results, performance, experience or achievements of the Company to differ materially from any future results, performance, experience or achievements expressed or implied by such forward-looking statements. The Company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events, or otherwise.
These are some of the factors that could potentially cause actual results to differ materially from expected and historical results. Other factors besides those listed here could also materially affect the Company’s business.
Chapter 11 Filing
| • | Factors relating to Federal Mogul’s filing for Chapter 11 in the U.S. and the filing for Administration by certain of Federal-Mogul’s subsidiaries in the U.K. such as: the possible disruption of relationships with creditors, customers, and employees; the Company’s ability to implement its plan of reorganization in the U.S. and scheme of arrangement in the U.K.; the outcome of asbestos litigation proceedings; and the Company’s compliance with its existing debtor-in-possession credit facility. |
Legal and Environmental Proceedings
| • | Legal actions and claims of undetermined merit and amount involving, among other things, product liability, warranty, recalls of products manufactured or sold by the Company, and environmental and safety issues involving the Company’s products or facilities. |
| • | The merit and amount of claims to reinsurance carriers for asbestos related claims, and the financial viability of and resources available to the reinsurance carriers to meet these claims. |
Business Environment and Economic Conditions
| • | The Company’s ability to generate cost savings or manufacturing efficiencies to offset or exceed contractually or competitively required price reductions or price reductions to obtain new business. |
| • | Variations in the financial or operational condition of the Company’s significant customers, particularly the world’s original equipment manufacturers of commercial and personal vehicles. |
| • | Fluctuations in the price and availability of raw materials and other supplies used in the manufacturing and distribution of the Company’s products. |
| • | Material shortages, transportation system delays, or other difficulties in markets where the Company purchases supplies for the manufacturing of its products. |
| • | Significant work stoppages, disputes, or any other difficulties in labor markets where the Company obtains materials necessary for the manufacturing of its products or where its products are manufactured, distributed or sold. |
| • | Increased development of fuel cells, hybrid-electric or other non-combustion engine technologies. |
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| • | The Company’s ability to obtain cash adequate to fund its needs, including the borrowings available under its debtor-in-possession credit facility and the availability of financing for the Company’s subsidiaries not included under the voluntary filing for Chapter 11 in the U.S. or Administration in the U.K. |
| • | Changes in actuarial assumptions, interest costs and discount rates, and fluctuations in the global securities markets which directly impact the valuation of assets and liabilities associated with the Company’s pension and other postemployment benefit plans. |
Other Factors
| • | Various worldwide economic, political and social factors, changes in economic conditions, currency fluctuations and devaluations, credit risks in emerging markets, or political instability in foreign countries where the Company has significant manufacturing operations, customers or suppliers. |
| • | Physical damage to or loss of significant manufacturing or distribution property, plant and equipment due to fire, weather or other factors beyond the Company’s control. |
| • | New or expanded litigation activity regarding alleged asbestos claims against subsidiaries of the Company not included in either the U.S. Chapter 11 or the U.K. Administration Proceedings. |
| • | Legislative activities of governments, agencies, and similar organizations, both in the United States and in foreign countries, that may affect the operations of the Company. |
| • | Possible terrorist attacks or acts of aggression or war, that could exacerbate other risks such as slowed vehicle production or the availability of supplies for the manufacturing of the Company’s products. |
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PART I
| ITEM 1. | BUSINESS |
Proceedings under Chapter 11 and Administration of the Bankruptcy Code
On October 1, 2001 (the “Petition Date”), Federal-Mogul Corporation, (“Federal-Mogul” or the “Company”) and all of its wholly-owned United States subsidiaries filed voluntary petitions for reorganization (the “U.S. Restructuring”) under Chapter 11 of the United States Bankruptcy Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”). Also on October 1, 2001, certain of the Company’s United Kingdom subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the Bankruptcy Code and petitions for Administration (the “U.K. Restructuring”) under the United Kingdom Insolvency Act of 1986 (the “Act”) in the High Court of Justice, Chancery division in London, England (the “High Court”). The Company and its U.S. and U.K. subsidiaries included in the U.S. Restructuring or the U.K. Restructuring are herein referred to as the “Debtors”. The U.S. Restructuring and U.K. Restructuring are herein referred to as the “Restructuring Proceedings”. The Chapter 11 cases of the Debtors (collectively, the “Chapter 11 Cases”) have been consolidated for purposes of joint administration asIn re: Federal-Mogul Global Inc., T&N Limited, et al(Case No. 01-10578(RTL)). Subsidiaries outside of the aforementioned U.S. and U.K. subsidiaries are not party to the Chapter 11 Cases and, therefore, are not currently provided protection from creditors by any bankruptcy court and are operating in the normal course. The Chapter 11 Cases are discussed in Note 2 to the consolidated financial statements.
The Restructuring Proceedings were initiated in response to a sharply increasing number of asbestos-related claims and their demand on the Company’s cash flows and liquidity. Under the Restructuring Proceedings, the Debtors expect to develop and implement a plan for addressing the asbestos-related claims against them.
Business Overview
The Company is a leading global supplier of vehicular parts, components, modules and systems to customers in the automotive, small engine, heavy-duty and industrial markets. Federal-Mogul has established an expansive global presence and conducts its operations through various manufacturing, distribution and technical centers that are wholly-owned subsidiaries or partially-owned joint ventures, organized into five primary reporting segments; Powertrain, Sealing Systems and Systems Protection, Friction, Aftermarket and Corporate. Federal-Mogul offers its customers a diverse array of market-leading products for original equipment (“OE”) and parts replacement (“aftermarket”) applications, including engine bearings, pistons, piston pins, rings, cylinder liners, valve train and transmission products, connecting rods, sealing systems, element resistant systems protection sleeving products, electrical connectors and sockets, disc pads and brake shoes, and ignition, lighting, fuel, wiper and chassis products. The Company’s principal customers include many of the world’s original equipment manufacturers (“OEM”) of vehicles and industrial products and aftermarket retailers and wholesalers.
Federal-Mogul has operations in 31 countries and, accordingly, all of the Company’s reporting segments derive sales from both domestic and international markets. The attendant risks of the Company’s international operations are primarily related to currency fluctuations, changes in local economic and political conditions, and changes in
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laws and regulations. The following tables set forth the Company’s net sales and net property, plant and equipment by geographic region as a percentage of total net sales and total net property, plant and equipment, respectively:
| Net sales | Net property, plant and equipment | ||||||||||||||
| Year ended December 31 | December 31 | ||||||||||||||
| 2004 | 2003 | 2002 | 2004 | 2003 | |||||||||||
Net sales by geographic region: | |||||||||||||||
United States | 47 | % | 49 | % | 55 | % | 36 | % | 38 | % | |||||
Mexico | 3 | % | 3 | % | 3 | % | 5 | % | 4 | % | |||||
Canada | 2 | % | 3 | % | 2 | % | 1 | % | 1 | % | |||||
Total North America | 52 | % | 55 | % | 60 | % | 42 | % | 43 | % | |||||
Germany | 16 | % | 15 | % | 12 | % | 24 | % | 23 | % | |||||
France | 9 | % | 8 | % | 7 | % | 8 | % | 9 | % | |||||
United Kingdom | 8 | % | 8 | % | 8 | % | 8 | % | 9 | % | |||||
Switzerland | 4 | % | 4 | % | 4 | % | — | — | |||||||
Italy | 3 | % | 3 | % | 3 | % | 5 | % | 4 | % | |||||
Other Europe | 5 | % | 4 | % | 4 | % | 10 | % | 11 | % | |||||
Total Europe | 45 | % | 42 | % | 38 | % | 55 | % | 56 | % | |||||
Rest of World | 3 | % | 3 | % | 2 | % | 3 | % | 1 | % | |||||
| 100 | % | 100 | % | 100 | % | 100 | % | 100 | % | ||||||
The following table sets forth the Company’s net sales by reporting segment as a percentage of total net sales. Segment information for the years ended December 31, 2003 and 2002 has been reclassified to include the operating results of Asia Pacific operations within the product group reporting segments. Previously, the Asia Pacific segment information was included within the Corporate reporting segment. This reclassification is consistent with organizational changes implemented during the second quarter of 2004.
| Year Ended December 31 | |||||||||
| 2004 | 2003 | 2002 | |||||||
Net sales by reporting segment: | |||||||||
Powertrain | 35 | % | 34 | % | 33 | % | |||
Sealing Systems and Systems Protection | 11 | % | 11 | % | 12 | % | |||
Friction | 8 | % | 8 | % | 7 | % | |||
Aftermarket | 46 | % | 47 | % | 48 | % | |||
| 100 | % | 100 | % | 100 | % | ||||
As set forth in the above table, the Company maintains a balance of sales derived from the original equipment market and the aftermarket. The Company seeks to participate in both of these markets by leveraging its original equipment product engineering and development capability, manufacturing know-how, and expertise in managing a broad and deep range of replacement parts to service the aftermarket. The Company believes that it is uniquely positioned to effectively manage the life cycle of a broad range of products to a diverse customer base.
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Strategy
The Company’s strategy is designed to enhance profitability by leveraging existing and developing new sustainable competitive advantages. This strategy consists of the following primary elements:
| • | Focus on core business segments to provide market share, earnings and cash flow growth. |
| • | Provide innovative, value-added components, modules and systems to customers in markets served. |
| • | Extend the Company’s global reach to support its OEM customers, penetrate new markets and acquire new customers. The Company is particularly focused on furthering its relationships with the Asian OEMs. |
| • | Leverage the strength of the Company’s aftermarket brand positions, product portfolio and range, marketing and selling expertise, and distribution and logistics capabilities. |
| • | Utilize the Company’s technological resources to develop advanced and innovative products, processes and manufacturing capabilities. |
| • | Aggressively pursue low cost operations in all business segments by continuing to consolidate and relocate manufacturing operations to low cost countries, utilizing the Company’s strategic joint ventures and alliances, and consolidation and rationalization of business resources and infrastructure. |
The Company’s strategy is designed to capitalize on certain trends occurring in the original equipment and aftermarket replacement markets. The Company assesses individual opportunities to execute its strategy based upon estimated sales and margin growth, cost reduction potential, internal investment returns, and other criteria, and makes investment decisions on a case-by-case basis. Opportunities meeting or exceeding these criteria are generally undertaken through acquisitions and investments, divestitures, restructuring activities, strategic joint ventures and alliances, and research and development activities.
Acquisitions and Investments.In connection with its strategic planning process, the Company assesses opportunities for sales and earnings growth through product line expansion, technological advancements, geographic expansion, penetration of new markets and acquisition of new customers, and other opportunities consistent with the Company’s strategy that will provide a sustainable competitive advantage.
Divestitures. In connection with its strategic planning process, the Company assesses its operations for market position, product technology and capability, and profitability. Those businesses determined by management not to have a sustainable competitive advantage are considered non-core and may be considered for divestiture or other exit activities. Over the past several years, the Company has divested numerous non-core businesses. The elimination of these non-core businesses has freed up both human and capital resources, which have been devoted to the Company’s core businesses.
During 2004, the Company completed the following divestitures of non-core businesses:
| • | During July 2004, the Company completed the divestitures of its large bearing operations in Pinetown, South Africa and Uslar, Germany. |
| • | During December 2004, the Company divested its transmission operations located in Dayton, Ohio. |
During 2003, the Company completed the following divestitures of non-core businesses:
| • | During April 2003, the Company completed the divestitures of its U.S. camshaft operations and the majority of its original equipment lighting operations. The divested U.S. camshaft operations include manufacturing operations in Grand Haven, Michigan and Orland, Indiana, as well as the Company’s share of an assembled camshaft joint venture operation in Grand Haven. The original equipment lighting divestitures include operations in Matamoros, Mexico; Brownsville, Texas; and Toledo, Ohio. |
| • | During September 2003, the Company divested operations located in Hampton, Virginia and Solon, Ohio. |
During 2002, the Company completed the following divestitures of non-core businesses:
| • | In March 2002, the Company completed the divestiture of its Signal-Stat Lighting Products business (“Signal-Stat”). Signal-Stat produces exterior lighting and power distribution products primarily for the heavy-duty and commercial vehicle markets. |
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| • | In July 2002, the Company completed the divestiture of its automotive camshaft manufacturing plant in Jackson, Michigan, under the terms of a management buyout. The Company also entered into a three-year supply agreement to market and sell aftermarket camshafts produced at the Jackson facility through its aftermarket business. |
| • | In November 2002, the Company completed the divestiture of Federal-Mogul Camshafts de Mexico S. de R.L. de C.V. (“Camshafts de Mexico”). Camshafts de Mexico manufactures camshafts for the North American original equipment market. |
These divestitures have been presented as discontinued operations for the fiscal years ended December 31, 2004, 2003, and 2002. At December 31, 2004, no assets were held for sale in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” Additional financial information related to these divestitures is included in Note 7 to the consolidated financial statements, “Discontinued Operations” included in Item 8 of this report.
Restructuring Activities.The Company has undertaken various restructuring activities to streamline its operations, consolidate and take advantage of available capacity and resources, and ultimately achieve cost reductions. These restructuring activities include efforts to integrate and rationalize the Company’s businesses and to relocate manufacturing operations to lower cost markets.
The Company defines restructuring expense to include charges incurred with exit or disposal activities accounted for in accordance with Statement of Financial Accounting Standard (“SFAS”) No. 146, employee severance costs incurred as a result of an exit or disposal activity accounted for in accordance with SFAS Nos. 88 and 112, and pension and other postemployment benefit costs incurred as a result of an exit or disposal activity accounted for in accordance with SFAS Nos. 87 and 106.
An overview by reporting segment of the Company’s restructuring activities completed during 2004 is provided below.
| • | Powertrain restructuring efforts relate to the closure of one U.S. plant and one European plant with transfer of related production activities to existing facilities primarily in Mexico and Turkey. Production transfers were also completed at one European plant with the related production moving to an existing facility in Poland. |
| • | Aftermarket restructuring efforts have resulted in the closure of one European ignition facility with relocation of related production activities to existing facilities in the U.S. and Italy. |
Various programs, which are similar in nature to those discussed above, are currently in progress and are scheduled for completion during 2005. The Company’s restructuring activities are further discussed in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 4 to the consolidated financial statements, “Restructuring.”
Joint Ventures and Other Strategic Alliances. Joint ventures and other strategic alliances represent an important element of the Company’s business strategy. The Company forms joint ventures and strategic alliances to gain entry into new markets, facilitate the exchange of technical information and development of new products, extend current product offerings, provide low cost manufacturing operations, and broaden its customer base. The Company believes that certain of its joint ventures have provided, and will continue to provide, opportunities to expand business relationships with Asian OEMs. The Company is currently involved in 36 joint ventures located in 12 different countries throughout the world, including China, India, Korea and Turkey. Of these joint ventures, the Company maintains a controlling interest in 15 entities and, accordingly, the financial results of these entities are included in the consolidated financial statements of the Company. The Company has a non-controlling interest in 21 of its joint ventures, of which 18 are accounted for under the equity method and three are accounted for under the cost method. The Company does not hold a controlling interest in an entity based on exposure to economic risks and potential rewards (variable interests) for which it is the primary beneficiary. Further, the Company’s joint ventures are businesses established and maintained in connection with its operating strategy and are not special purpose entities.
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Net sales for consolidated joint ventures were approximately 9% of consolidated net sales for the year ended December 31, 2004. The Company’s investment in unconsolidated joint ventures totaled $160 million as of December 31, 2004, while the Company’s equity in earnings of such affiliates amounted to $36 million for the year ended December 31, 2004.
Research and Development. The Company maintains technical centers throughout the world designed to develop advanced products and processes, to provide manufacturing support for all of the Company’s manufacturing sites, and to provide technological expertise in engineering and design development providing solutions for customers and bringing new, innovative products to market. Federal-Mogul’s research and development activities are conducted at the Company’s major research centers in Burscheid, Germany; Nuremberg, Germany; Wiesbaden, Germany; Bad Camberg, Germany; Plymouth, Michigan; Skokie, Illinois, Ann Arbor, Michigan and Yokohama, Japan.
Each of the Company’s business units is engaged in various engineering, research and development efforts working closely with customers to develop custom solutions unique to their needs. Total expenditures from continuing operations for research and development activities were $137 million, $123 million and $107 million for the years ended December 31, 2004, 2003 and 2002, respectively.
The Company’s Products
The following provides an overview of products manufactured and distributed by the Company’s reporting segments.
Powertrain. Powertrain products are used primarily in automotive, light truck, heavy-duty, industrial, marine, agricultural, power generation and small air-cooled engine applications. The primary products of this segment include engine bearings, pistons, piston pins, rings, cylinder liners, valve train and transmission products and connecting rods. These products are offered under the Federal-Mogul, AE, Glyco, Goetze and Nural brand names. These products are either sold as individual components or, increasingly, offered to automotive manufacturers assembled in a power cylinder system. This strategic product offering adds value to the customer by simplifying the assembly process, lowering costs and reducing vehicle development time. Powertrain operates 46 manufacturing facilities in 12 countries, serving a large number of major automotive, heavy-duty and industrial customers worldwide. Powertrain derived 28% of its 2004 sales in the Americas and 72% in Europe and the rest of world.
In North America, Powertrain products are expected to benefit from increased out-sourcing of piston machining and power cylinder systems from OEMs. Additionally, the Company is well positioned to benefit from expected growth opportunities in heavy-duty markets. In Europe, Powertrain products will continue to benefit from its existing high market share in diesel engine applications in pistons, rings, and engine bearings, and the expected continuing increase in production of diesel engines in comparison to gasoline applications.
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The following provides a description of the various products manufactured by Powertrain:
Product | Description | |
| Pistons | The main task of the piston is to convert combustion energy into mechanical energy. In this process substantial pressures are exerted on the piston, imposing high demands on it in terms of rigidity and temperature resistance. | |
| Rings | The three main tasks of piston rings in internal combustion engines include (1) sealing the combustion chamber, (2) supporting heat transfer from the piston to the cylinder wall, and (3) regulating oil consumption. | |
| Cylinder Liners | Cylinder liners, or sleeves, work in tandem with the piston and ring, forming the chamber in which the thermal energy of the combustion process is converted into mechanical energy. | |
| Piston Pins | Piston pins attach the piston to the end of the connecting rod, allowing the combustion force to be transferred to the crankshaft. | |
| Connecting Rods | The connecting rod is the link between the piston and the crankshaft, which enables the reciprocating motion of the piston to be converted into the rotary motion of the crankshaft. | |
| Engine Bearings | Engine bearings ensure low friction rotation and guidance between the connecting rod and the crankshaft to facilitate the transmission of full combustion power from the piston. | |
| Valve Train and Transmission Products | Federal-Mogul designs and manufactures a wide variety of powdered metal components for engines, transmissions, general industrial applications and special materials to meet particular customer requirements. | |
Sealing Systems and Systems Protection. The Sealing Systems and Systems Protection reporting segment serves the complete drive train with sealing systems comprised of a wide array of seal and gasket technologies and innovative products focused primarily on protecting sensitive components from the harsh environment within engine compartments. Sealing Systems and Systems Protection products are used in automotive, light truck, heavy-duty, agricultural, off-highway, marine, railroad, high performance and industrial applications. The primary products include dynamic seals, gaskets (static seals) and element resistant systems protection sleeving products. The products within this group are marketed under the brand names of Federal-Mogul, Goetze, National, Fel-Pro, Payen and Glockler. Sealing Systems and Systems Protection operates 30 manufacturing facilities in 12 countries, serving many major automotive, heavy-duty and industrial customers worldwide. Sealing Systems and Systems Protection derived 76% of its 2004 sales in the Americas and 24% in Europe and the rest of world.
OEM customers are increasingly demanding total engine sealing solutions and Federal-Mogul is poised to take advantage of these opportunities as Sealing Systems possesses the ability to supply total engine, transmission and axle sealing applications. Joint venture partnerships with Japanese automotive suppliers provide the Company commercial relationships with Honda and Toyota in the United States.
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The following provides a description of the various products manufactured by Sealing Systems and Systems Protection:
Product | Description | |
| Dynamic Seals | Dynamic seals are used to create a barrier between a rotating and a stationary surface and function to retain or separate lubricants or fluids, keep out contamination, and contain pressure. Dynamic seals include rotary shaft seals, bonded unipistons and valve stem seals. | |
| Cold Static Gaskets and Seals | Cold static gaskets provide a barrier between two mating surfaces, resulting in the prevention of leaks, while cold static seals provide a high integrity seal that performs over an extended life, functioning to maintain a static environment free of surprises and/or troubles. Cold static gaskets and seals must be able to maintain a seal under pressure and under relatively low temperatures. The most common applications include transmission and timing covers, intake manifolds, water pumps and oil pans. | |
| Hot Static Gaskets and Seals | Hot static gaskets provide a barrier between two mating surfaces, resulting in the prevention of leaks, while hot static seals provide a high integrity seal that performs over an extended life, functioning to maintain a static environment free of surprises and/or troubles. Hot static gaskets and seals operate in conditions of relatively high temperatures, such as cylinder head and exhaust manifold applications. | |
| Heat Shields | Metallic heat shields are designed to provide thermal and/or acoustic optimization. These products encompass full vehicle capability, from manifold to tail pipe and include a mixture of offerings, such as plain/embossed aluminum, and proprietary specialist products. | |
| Element Resistant Sleeving | Element resistant sleeving products provide under-hood and under-car protection of wires, hoses, sensors, and mechanical components and assemblies from heat, dirt, vibration, and moisture. Element resistant sleeving products include :
• Automotive wire harnesses and hoses
• Abrasion protection and wire management of cable assemblies
• Dielectric protection of electrical leads
• Thermal and mechanical protection of hose assemblies
• Acoustic insulating and sound-dampening materials | |
Friction. Federal-Mogul is one of the world’s largest independent suppliers of friction materials for the automotive, heavy-duty, and railway markets. The primary products of this segment include brake disc pads, brake shoes, and brake linings and blocks. Federal-Mogul offers a portfolio of world-class brand names, including Abex, Beral, Wagner and Ferodo. Federal-Mogul supplies friction products to all major customers in the light vehicle, commercial vehicle and railway sectors and is also very active in the aftermarket. Friction operates 15 manufacturing facilities in 10 countries, serving many major automotive, railroad and industrial customers worldwide. Friction derived 26% of its 2004 sales in the Americas and 74% in Europe and the rest of world.
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The following provides a description of the various products manufactured by Friction:
Product | Description | |
| Light Vehicle Disc Pads | A light vehicle disc pad assembly consists of:
• Friction material, which dissipates forward momentum by converting energy to heat
• Underlayer, which is a layer of different friction material placed between the backplate and friction material to improve strength, thermal barrier, corrosion resistance, noise performance or a combination of these characteristics
• Backplate, to support and locate the friction material in the caliper
• Shim, which is a rubber/metal laminate developed to suppress noise | |
| Commercial Vehicle Disc Pads | Commercial vehicle disc brake pads are a growing segment of the friction market, superseding drum brakes on trucks, busses, tractor units and trailers. The basic construction of a commercial vehicle disc pad is the same as a light vehicle disc pad. | |
| Light Vehicle Drum Brake Linings | Drum brake linings are friction material affixed to a brake shoe and fitted on rear service brake, rear parking brake and transmission brake applications. | |
| Commercial Vehicle Full Length Linings | Full-length linings are the commercial vehicle equivalent of light vehicle drum brake linings. | |
| Commercial Vehicle Half-Blocks | Half blocks are segments of friction material made to be riveted onto drum brake shoes. They are used on heavier vehicle applications where discs are not used (e.g. due to the age of the vehicle). | |
| Railway Brake Blocks | Railway brake blocks work by acting on the circumference of the wheel. They are lighter and quieter in operation than cast iron blocks. However, friction performance is designed to replicate that of cast iron blocks. | |
| Railway Disc Pads | Railway disc pads are produced in single pad or paired pad format. Federal-Mogul produces sintered metal pads for high duty applications. | |
Aftermarket. Aftermarket distributes products manufactured within the above segments, or purchased, to the independent automotive, heavy-duty and industrial aftermarkets. The segment also includes manufacturing operations for brake, chassis, ignition, lighting, fuel and wiper products. Federal-Mogul is a leader in several key aftermarket product lines. These products are marketed under various brand names, including Champion, Fel-Pro, Carter, ANCO, Moog, Wagner, Ferodo, Glyco and Sealed Power. Aftermarket operates 22 manufacturing facilities and 29 distribution centers in 19 countries, serving a diverse base of distributors and retail customers around the world. Aftermarket derived 73% of its 2004 sales in the Americas and 27% in Europe and the rest of world.
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The following provides a description of the various products manufactured and/or distributed by Aftermarket:
Product | Description | |
| Engine | Domestic – Sealed Power is Federal-Mogul’s premier brand of internal engine components, for use in automotive, light truck or heavy-duty engines. The Sealed Power product line includes pistons, piston rings, engine bearings, camshafts, oil pumps, timing components and valvetrain products. Similar products are offered to the heavy-duty market, including construction, marine, agricultural, mining, gas compression, trucking and industrial customers under the Company’s FP Diesel brand.
International – The Glyco brand offers a wide range of engine bearings and materials. Nüral products include pistons and cylinder liners and are fitted with Goetze rings. The Goetze brand is among the market leaders in the global automotive, agricultural, marine and industrial markets providing customers with products including pistons, piston rings, cylinder liners, oil seals, gaskets, valve stem seals and head bolts. | |
| Gaskets | Domestic – The Company’s Fel-Pro brand is among the most recognized brands in the aftermarket. Fel-Pro gaskets are engineered to deliver a perfect seal on every engine. That’s why many NASCAR and NHRA racing teams, as well as a vast majority of professional engine rebuilders and vehicle service technicians, choose Fel-Pro over other gasket brands.
International – Federal-Mogul’s Payen and Goetze brands are recognized among the industry’s leaders. These components include cylinder head gaskets, head sets, full sets, conversion sets, head bolt sets, liner sealing ring kits, manifold joints and sets, exhaust pipe joints, valve cover joints, sump joints and sets, valve stem seals, carburetor joints, timing case joints and sets, water pump joints, thermostat joints, and oil seals. | |
| Antifriction Bearings and Seals | Domestic – National hub assemblies include unitized bearing, seal and spindle assemblies. Our premium hub assemblies offer solutions for wheel end repair to provide safety, performance and reliability. National antifriction bearings are engineered to deliver performance and reliability in demanding applications, from automotive and heavy-duty axles, to agricultural and industrial equipment. National oil seals deliver exceptional performance and reliability in a wide variety of applications, including automotive and heavy-duty axles, gasoline and diesel crankshafts, and agricultural and industrial equipment.
International – Federal-Mogul offers seals in international markets under the aforementioned Payen and Goetze brands. | |
| Brake | Domestic – Wagner brake products include friction components (disc brake pads and linings), rotors and drums, hardware and hydraulic products, each engineered to deliver performance and reliability. Abex, among North America’s leading heavy-duty friction brands for more than 70 years, has brought exceptional braking power and durability to commercial fleets and OE customers. Abex brake blocks are used for commercial applications, from straight trucks and school and transit buses to van trailers and tankers.
International – Beral is a traditional German producer of brand name brake linings used by manufacturers of commercial vehicles, axles and brakes. Beral products include disc brake pads and drum brake pads for commercial vehicles and industrial linings. The Ferodo brand of friction products includes light vehicle and commercial vehicle disc pads, linings and related accessories. | |
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| Chassis | Domestic – Moog chassis parts is among the automotive industry’s premier brands of replacement steering and suspension components. Moog products are engineered to improve on original equipment technologies, solve real OE problems and make installation easy. Precision u-joints combine advanced engineering, superior materials and manufacturing quality for performance and durability. Precision u-joints are available for automotive, light truck and a full range of heavy-duty vehicles.
International – The Moog product offering includes ball joint housings, tie rods, center and drag links, forgings, idler and pitman arms, ball joints, coil springs and sway bar link kits. | |
| Wipers | Domestic – For more than 80 years, ANCO has been among the leaders in replacement wiper blades, refills, washer pumps and wiper arms. From passenger cars, light trucks and heavy-duty fleets, ANCO has comprehensive coverage to supply all types of drivers with necessary visibility.
International – Federal-Mogul offers wipers and related components under the Champion brand name. Champion wiper products are used in passenger cars, light trucks and heavy-duty fleets. | |
| Fuel Pumps | Domestic – Carter mechanical fuel pumps, electric pump sets and modular design applications deliver original equipment appearance, fit and performance in a full range of domestic and import passenger and light truck applications, recreational vehicles, commercial and agricultural vehicles and marine engines. | |
| Ignition | Champion spark plugs offer a complete line of standard and premium plugs for automotive, marine and small-engine applications. PowerPath wire sets, battery cables and accessories provide electrical connections in a full range of automotive, farm, fleet and marine vehicles. | |
| Lighting | Aftermarket lighting solutions for passenger and commercial vehicles are marketed under the Wagner brand name. | |
Reporting Segment Financial Information. Approximately 54% of the Company’s net sales are to the OE market and approximately 46% are to the aftermarket. The following tables summarize net sales, gross margin and total assets for each reporting segment for the periods indicated. Segment information for the years ended December 31, 2003 and 2002 has been reclassified to include the operating results of Asia Pacific operations within the product group reporting segments. Previously, the Asia Pacific segment information was included within the Corporate reporting segment. This reclassification is consistent with organizational changes implemented during the second quarter of 2004.
For information related to the Company’s reporting segments, refer to Note 21 to the consolidated financial statements included in Item 8 of this Form 10-K.
Net sales by reporting segment were:
| Year Ended December 31 | |||||||||
| 2004 | 2003 | 2002 | |||||||
| (Millions of Dollars) | |||||||||
Powertrain | $ | 2,146 | $ | 1,847 | $ | 1,651 | |||
Sealing Systems and Systems Protection | 682 | 622 | 641 | ||||||
Friction | 527 | 441 | 379 | ||||||
Aftermarket | 2,819 | 2,613 | 2,486 | ||||||
| $ | 6,174 | $ | 5,523 | $ | 5,157 | ||||
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Gross margin by reporting segment was:
| Year Ended December 31 | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| (Millions of Dollars) | ||||||||||||
Powertrain | $ | 316 | $ | 260 | $ | 263 | ||||||
Sealing Systems and Systems Protection | 114 | 104 | 124 | |||||||||
Friction | 112 | 119 | 99 | |||||||||
Aftermarket | 662 | 617 | 555 | |||||||||
Corporate | (27 | ) | (13 | ) | (19 | ) | ||||||
| $ | 1,177 | $ | 1,087 | $ | 1,022 | |||||||
Total assets by reporting segment were:
| December 31 | |||||||||
| 2004 | 2003 | 2002 | |||||||
| (Millions of Dollars) | |||||||||
Powertrain | $ | 2,032 | $ | 2,039 | $ | 1,861 | |||
Sealing Systems and Systems Protection | 1,039 | 1,255 | 1,237 | ||||||
Friction | 769 | 716 | 618 | ||||||
Aftermarket | 3,057 | 2,954 | 2,718 | ||||||
Corporate | 1,368 | 1,153 | 1,479 | ||||||
| $ | 8,265 | $ | 8,117 | $ | 7,913 | ||||
The Company’s Industry
The automotive supply industry is comprised of two primary markets; the OE market in which the Company’s products are used in the manufacture of new vehicles, and the aftermarket in which the Company’s products are used as replacement parts for current production and older vehicles.
The OE Market. The OE market is characterized by short-term volatility, with overall expected long-term growth of vehicle sales and production. Demand for automotive parts in the OE market is generally a function of the number of new vehicles produced, which is primarily driven by macro-economic factors such as interest rates, fuel prices, consumer confidence, employment and other trends. In 2004, the number of light vehicles produced, which is a substantial portion of the OE market, was 15.8 million in North America, 16.3 million in Western Europe, and 27.5 million in the rest of the world. Although OE demand is tied to planned vehicle production, parts suppliers also have the opportunity to grow through increasing their product content per vehicle, by further penetrating business with existing customers, and by gaining new customers and markets. Companies with a global presence and advanced technology, engineering, manufacturing and customer support capabilities are best positioned to take advantage of these opportunities.
There are currently several significant existing and emerging trends that are impacting the OE market, including the following:
| • | Globalization of Automotive Industry – OEMs are increasingly designing global platforms where the basic design of the vehicle is performed in one location but is produced and sold in numerous geographic markets to realize significant economies of scale by limiting variations across products. OEMs are increasingly focused on emerging markets for growth opportunities where suppliers must be prepared to provide product and technical resources in support of their customers. Furthermore, OEMs are moving their operations to lower cost geographies relative to the U.S. and European markets and, accordingly, OEMs are increasingly requiring suppliers to provide parts on a global basis. Finally, the Asian OEMs continue to expand their reach and market share in relation to traditional domestic manufacturers. As this trend is expected to continue into the foreseeable future, suppliers must be positioned to meet the needs of the Asian OEMs. |
| • | Increased Emphasis on Systems and Modules – To simplify the vehicle assembly process, lower costs and reduce vehicle development time, OEMs are increasingly rewarding suppliers possessing the capability of |
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providing fully-engineered systems and pre-assembled combinations of components rather than individual components. |
| • | Focus on Fuel Economy and Emissions – Increased fuel economy and decreased vehicle emissions are of great importance to OEMs as customers and legislators continue to demand more efficient and cleaner operating vehicles. In the United States, strict corporate average fuel economy (“CAFE”) standards and Environmental Protection Agency regulations are driving OEMs to focus on new technologies including diesel applications and hybrid engines, which allow the OEMs to achieve these increasingly stringent government regulations. Suppliers offering solutions to OEMs related to these issues posses a distinct competitive advantage, which is driving accelerated new product development cycles. |
| • | Focus on Vehicle Safety – Vehicle safety continues to gain increased industry attention and plays a critical role in consumer purchasing decisions. Accordingly, OEMs are seeking suppliers with new technologies, capabilities and products that have the ability to advance vehicle safety. Those suppliers able to enhance vehicle safety through innovative products and technologies have a distinct competitive advantage. |
| • | Pricing Pressures – In order to maintain sales levels of new vehicles and retain or gain market share, many OEMs continue to provide extensive pricing incentives and financing alternatives to consumers. These actions have placed pressures on the OEMs profits and, in turn, the OEMs expect certain recovery from their supply base. In order to retain current business as well as to be competitively positioned for future new business opportunities, suppliers must continually identify and implement product innovation and cost reduction activities to fund annual price concessions to their customers. |
| • | Automotive Supply Consolidation – Consolidation within the automotive supply base is expected to continue, while the entire automotive industry matures. Suppliers will seek opportunities to achieve synergies in their operations through consolidation, while striving to acquire complementary businesses to improve global competitiveness or to strategically enhance a product offering to provide customers with a more fully integrated module or system capability. |
The Aftermarket Business. Aftermarket products are sold as replacement parts for vehicles in current production and older vehicles to a wide range of wholesalers, retailers and installers. Demand for aftermarket products is driven by the quality of OE parts, the number of vehicles in operation, the average age of the vehicle fleet, and vehicle usage (measured by miles driven). Although the number of vehicles on the road and different models available continue to increase, the aftermarket has experienced weakness due to increases in average useful lives of automotive parts resulting from continued technological innovation and resulting quality and durability. Replacement demand for certain aftermarket products is also impacted by annual weather cycles. Generally, the relative severity of winter can significantly impact the short-term demand for products such as wiper blades, chassis components and fuel pumps. The aftermarket continues to experience consolidation of warehouse distributors and retailers, resulting in excess inventory throughout the supply chain that can adversely affect near-term sales to these customers.
There are currently several significant existing and emerging trends that are impacting the aftermarket business, including the following:
| • | Extended Automotive Part Product Life and New Car Warranties – The average useful life and quality of automotive parts, both OE and aftermarket, have been steadily increasing due to innovations in products and technologies. Longer product lives and better quality allow vehicle owners to replace parts on their vehicles less frequently. In addition, the OEMs have generally increased the extent of coverage and duration of new car warranties. Increased warranties have the effect of vehicle owners having repairs performed by the OEM dealership versus a traditional automotive installer. |
| • | Vehicle Complexity – Today’s vehicles are more complex in design, features, and integration of mechanical and electrical components. Ever increasing complexity adversely impacts the demand for replacement parts through the traditional independent aftermarket, as vehicle owners are less capable of performing repairs on their own vehicles. Similarly, independent repair shops and installers must increasingly invest capital in diagnostic equipment and technician training to service newer vehicles. Generally, the OEM dealerships are better equipped and capitalized to service the complexity of today’s vehicles. |
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| • | Globalization of Automotive Industry – As previously discussed, OEMs are increasingly focused on emerging markets for growth. This increased OEM focus on emerging geographic regions will ultimately drive the need for replacement parts for vehicles produced and in service, and provides further growth opportunities for the Company’s aftermarket business in these regions. |
The Company’s Customers
The Company supplies OE manufacturers with a wide variety of precision-engineered parts, essentially all of which are manufactured by the Company. The Company’s OE customers consist primarily of automotive and heavy-duty vehicle manufacturers as well as agricultural, off-highway, marine, railroad, high performance and industrial application manufacturers. The Company has well-established relationships with substantially all major North American, European and Asian automotive OE manufacturers.
Federal-Mogul’s aftermarket customers include independent warehouse distributors who redistribute products to local parts suppliers called jobbers, distributors of heavy-duty vehicular parts, engine rebuilders and retail parts stores. The breadth of Federal-Mogul’s product lines, the strength of its brand names, marketing expertise, and sizable sales force, and its distribution and logistics capability, are central to the Company’s aftermarket operations.
Among Federal-Mogul’s largest customers are the Aftermarket Autoparts Alliance, Autozone, BMW, CarQuest, Caterpillar, Cummins, DaimlerChrysler, Fiat, Ford/Jaguar/Volvo, General Motors, NAPA, Ozark/O’Reilly’s, PSA, Renault/Nissan and Volkswagen/Audi. This determination is based upon sales derived from these customers during the fiscal year ended December 31, 2004. No individual customer accounted for more than 10% of the Company’s sales during 2004.
The Company’s Competition
The global vehicular parts business is highly competitive. The Company competes with many of its customers that produce their own components as well as with independent manufacturers and distributors of component parts in the United States and abroad. In general, competition for such sales is based on price, product quality, technology, delivery, customer service and the breadth of products offered by a given supplier. The Company is meeting these competitive challenges by more efficiently integrating its manufacturing and distribution operations, expanding its product coverage within its core businesses, and utilizing its worldwide technical centers to develop and provide value-added solutions to its customers. A summary of the Company’s primary independent competitors by reporting segment is set forth below.
| • | Powertrain – In North America, primary competitors are Daido, Dana, GKN, Kolbenschmidt, Mahle, STI and Sumitomo. In Europe, primary competitors are Bleistahl, Dana, GKN, Kolbenschmidt, Mahle, Miba and NPR. |
| • | Friction – In North America, primary competitors are Akebono and Honeywell. In Europe, primary competitors are Galfer, Honeywell and TMD. |
| • | Sealing Systems and Systems Protection – In North America, primary competitors are Dana and Freudenberg NOK. In Europe, primary competitors are Elring Klinger, Freudenberg NOK and Dana/Reinz. |
| • | Aftermarket – In North America, primary competitors are Affinia, Airtex, Bosch, Honeywell and Trico. In Europe, primary competitors are Bosch, Elring Klinger, Kolbenschmidt, Mahle, NGK and Valeo. |
The Company’s Backlog
For OEM customers, the Company generally receives purchase orders for specific components supplied for particular vehicles. These supply relationships typically extend over the life of the related vehicle, subject to interim design and technical specification revisions, and do not require the customer to purchase a minimum quantity. In addition to customary commercial terms and conditions, purchase orders generally provide for annual price
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reductions based upon expected productivity improvements and other factors. Customers typically retain the right to terminate purchase orders, but the Company generally cannot terminate purchase orders. OEM order fulfillment is typically manufactured in response to customer purchase order releases, and the Company ships directly from a manufacturing location to the customer for use in vehicle production and assembly. Accordingly, the Company’s manufacturing locations do not typically maintain significant finished goods inventory, but rather produce from on-hand raw materials and work-in process inventory within relatively short manufacturing cycles. The primary risk to the Company is lower than expected vehicle production by one or more of its OEM customers or termination of the business based upon perceived or actual shortfalls in delivery, quality or value.
For its aftermarket customers, the Company generally establishes product line arrangements that encompass all components offered within a particular product line. These are typically multi-year arrangements, although they are subject to termination by either the Company or the customer upon relatively short notice. Pricing is market responsive and subject to adjustment based upon competitive pressures and other commercial factors. Aftermarket order fulfillment is largely performed from finished goods inventory stocked in the Company’s worldwide distribution network. Inventory stocking levels in the Company’s distribution centers are established based upon historical customer demand.
Although customer programs typically extend to future periods and, although there is an expectation that the Company will supply certain levels of OE production and aftermarket shipments over such periods, the Company believes that outstanding purchase orders and product line arrangements do not constitute firm orders. Firm orders are limited to specific and authorized customer purchase order releases placed with its manufacturing and distribution centers for actual production and order fulfillment. Firm orders are typically fulfilled as promptly as possible after receipt from the conversion of available raw materials and work-in-process inventory for OEM orders and from current on-hand finished goods inventory for aftermarket orders. The dollar amount of such purchase order releases on hand and not processed at any point in time is not believed to be significant based upon the timeframe involved.
The composition of the Company’s purchase orders and arrangements as measured by terms and conditions, pricing and other factors has remained largely unchanged during the last three years.
The Company’s Raw Materials and Suppliers
The Company purchases various raw materials for use in its manufacturing processes, including ferrous and non-ferrous metals, synthetic and natural rubber, graphite, fibers, stampings, castings and forgings. In addition, the Company purchases parts manufactured by other manufacturers for sale in the aftermarket. The Company has not experienced any shortages of raw materials or finished parts and normally does not carry inventories of raw materials or finished parts in excess of those reasonably required to meet its production and shipping schedules. For business and efficiency purposes, the Company has established single sourcing relationships with a small number of its suppliers. However, based upon market conditions and readily available alternative supply sources, the Company believes it could readily replace any single supply source without a material disruption to its business. In 2004, no outside supplier of the Company provided products that accounted for more than 10% of the Company’s net sales.
The Company experienced raw material inflation of approximately $50 million during 2004 concentrated in steel, non-ferrous metals and hydrocarbon based commodities. Through its centralized supply chain functions, the Company continues to work with its suppliers to reduce its global material costs. However, the Company expects raw material steel supply will continue to be constrained and the impact of increasing material costs or disruptions in supply will likely continue to pressure the Company’s operating results.
Seasonality of the Company’s Business
The Company’s business is moderately seasonal because many North American customers typically close assembly plants for two weeks in July for model year changeovers, and for an additional week during the December holiday season. Customers in Europe historically shut down vehicle production during a portion of August and one week in December. The aftermarket experiences seasonal fluctuations in sales due to demands caused by weather patterns.
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Historically, the Company’s sales and operating profits have been the strongest in the second quarter. Refer to Note 22, “Quarterly Financial Data”, to the consolidated financial statements included in Item 8 of this report.
The Company’s Employee Relations
As of December 31, 2004, the Company had approximately 44,700 full-time employees, of which approximately 17,200 were employed in the United States.
Various unions represent approximately 42% of the Company’s domestic hourly employees and approximately 60% of the Company’s international hourly employees. Most of the Company’s unionized manufacturing facilities have their own contract with its own expiration date, and as a result, no contract expiration date affects more than one facility.
Impact of Environmental Regulations on the Company
The Company’s operations, consistent with those of the manufacturing sector in general, are subject to numerous existing and proposed laws and governmental regulations designed to protect the environment, particularly regarding plant wastes and emissions and solid waste disposal. Capital expenditures for property, plant and equipment for environmental control activities did not have a material impact on the Company’s financial position or cash flows in 2004 and are not expected to have a material impact on the Company’s financial position or cash flows in 2005 or 2006.
The Company’s Intellectual Property
The Company holds in excess of 3,800 patents and patent applications on a worldwide basis, of which 762 have been filed in the United States. Of the 3,800 patents and patent applications, approximately 30% are in production use and/or are licensed to third parties, and the remaining 70% are being considered for future production use or provide a strategic technological benefit to the Company. These patents and patent applications expire over various periods through the year 2026.
The Company does not materially rely on any single patent, nor will the expiration of any single patent materially affect the Company’s business. Typically, new technology is introduced and patented by the Company replacing formerly patented technology before the expiration of the existing patent. In the aggregate, the Company’s worldwide patent portfolio is materially important to its business because it enables the Company to achieve technological differentiation from its competitors.
The Company also maintains more than 4,800 active trademark registrations and applications worldwide. In excess of 90% of these trademark registrations and applications are in commercial use by the Company or are licensed to third parties. All trademark registrations that are still in commercial use are routinely renewed by the Company prior to their expiration.
The Company’s Website and Access to Filed Reports
The Company maintains an internet website atwww.federal-mogul.com.The Company provides access to its annual and periodic reports filed with the SEC through this website. In addition, paper copies of annual and periodic reports filed with the SEC may be obtained by contacting the Company’s headquarters at the address located within the SEC Filings or under Investor Relations on the aforementioned website.
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| ITEM 2. | PROPERTIES |
Federal-Mogul’s world headquarters is located in Southfield, Michigan, which is a leased facility. At December 31, 2004, the Company had 196 manufacturing/technical centers, distribution and sales and administration office facilities worldwide. Approximately 35% of the facilities are leased; the majority of which are distribution, sales and administration offices. The Company owns the remainder of the facilities.
Type of Facility | North America | Europe | Rest of World | Total | ||||
Manufacturing/technical centers | 55 | 52 | 35 | 142 | ||||
Distribution centers and warehouses | 12 | 8 | 8 | 28 | ||||
Sales and administration offices | 9 | 5 | 12 | 26 | ||||
| 76 | 65 | 55 | 196 | |||||
The facilities range in size from approximately 1,700 square feet to 1,143,000 square feet. Management believes substantially all of the Company’s facilities are in good condition and that it has sufficient capacity to meet its current and expected manufacturing and distribution needs. No material facility is significantly underutilized, except for those being sold or closed in the normal course of business.
| ITEM 3. | LEGAL PROCEEDINGS |
On October 1, 2001 (the “Petition Date”), the Company and all of its wholly-owned United States subsidiaries filed voluntary petitions for reorganization (the “U.S. Restructuring”) under Chapter 11 of the United States Bankruptcy Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”). Also on October 1, 2001, certain of the Company’s United Kingdom subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the Bankruptcy Code and petitions for Administration (the “U.K. Restructuring”) under the United Kingdom Insolvency Act of 1986 (the “Act”) in the High Court of Justice, Chancery division in London, England (the “High Court”). The Company and its U.S. and U.K. subsidiaries included in the U.S. Restructuring and the U.K. Restructuring are herein referred to as the “Debtors”. The U.S. Restructuring and U.K. Restructuring are herein referred to as the “Restructuring Proceedings”. The Chapter 11 cases of the Debtors (collectively, the “Chapter 11 Cases”) have been consolidated for purposes of joint administration asIn re: Federal-Mogul Global Inc., T&N Limited, et al(Case No. 01-10578(RTL)). Subsidiaries outside of the aforementioned U.S. and U.K. subsidiaries are not party to the Chapter 11 Cases and, therefore, are not currently provided protection from creditors by any bankruptcy court and are operating in the normal course. The Chapter 11 Cases are further discussed in Note 2 to the consolidated financial statements.
The Restructuring Proceedings were entered into in response to a sharply increasing number of asbestos-related claims and their demand on the Company’s cash flows and liquidity. Under the Restructuring Proceedings, the Debtors expect to develop and implement a plan for addressing the asbestos-related claims against them.
Material pending legal proceedings, other than the Chapter 11 and Administration proceedings above and other than ordinary, routine litigation incidental to the business, to which the Company became or was a party during the year ended December 31, 2004, or subsequent thereto but before the filing of this report, are summarized below.
T&N Companies Asbestos Litigation
The Company’s U.K. subsidiary, T&N Ltd., and two U.S. subsidiaries (the “T&N Companies”) are among many defendants named in numerous court actions in the U.S. alleging personal injury resulting from exposure to asbestos or asbestos-containing products. T&N Ltd. is also subject to asbestos-disease litigation, to a lesser extent, in the United Kingdom and France. As of the Petition Date, T&N Ltd. was a defendant in approximately 115,000 pending personal injury claims. The two United States subsidiaries were defendants in approximately 199,000 pending personal injury claims. The Company includes as pending claims open served claims, settled but not documented claims, and settled but not paid claims. Notice of complaints continue to be received post-petition and are in violation of the automatic stay.
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The Company’s recorded liability for this litigation (approximately $1.4 billion as of December 31, 2004) represented the Company’s estimate prior to the Restructuring Proceedings for claims currently pending and those which were reasonably estimated to be asserted and paid through 2012. The Company did not provide a liability for claims that may be paid subsequent to this period as it could not reasonably estimate such claims. In estimating the liability prior to the Restructuring Proceedings, the Company made assumptions regarding the total number of claims anticipated to be received in a future period, the typical cost of settlement (which is sensitive to the industry in which the plaintiff claims exposure, the alleged disease type and the jurisdiction in which the action is being brought), the rate of receipt of claims, the settlement strategy in dealing with outstanding claims and the timing of settlements. As a result of the Restructuring Proceedings, pending asbestos-related litigation against the Company in the United States and the U.K. is stayed (subject to certain exceptions in the case of governmental authorities), and no party may take action to pursue or collect on such asbestos claims absent specific authorization of the Bankruptcy Court or the High Court. Since the Restructuring Proceedings, the Company has ceased making payments with respect to asbestos-related lawsuits. An asbestos creditors’ committee has been appointed in the U.S. representing asbestos claimants with pending claims against the Company, and the Bankruptcy Court has appointed a legal representative for the interests of potential future asbestos claimants. In the U.K. a creditors committee consisting in large part of representatives of asbestos claimants has been appointed. The Company’s obligations with respect to present and future claims could be determined through litigation in the Bankruptcy Court, the High Court, and/or through negotiations with each of the official committees appointed.
While the Company believes that the liability recorded as of October 1, 2001 was appropriate for anticipated losses arising from asbestos-related claims against the T&N Companies through 2012, it is the Company’s view that, as a result of the Restructuring Proceedings, there is even greater uncertainty in estimating the timing and amount of future asbestos liability and related insurance recovery for pending and future claims. There are significant differences in the treatment of asbestos claims in a bankruptcy proceeding as compared to the tort litigation system. Among other things, it is uncertain at this time as to the number of asbestos-related claims that will be filed in the Restructuring Proceedings, the number of future claims that will be included in a plan of reorganization, how claims for punitive damages and claims by persons with no asbestos-related physical impairment will be treated and whether such claims will be allowed, and the impact that historical settlement values for asbestos claims may have on the estimation of asbestos liability in the Restructuring Proceedings.
While the Restructuring Proceedings will impact the timing and amount of the asbestos claims and related insurance recoverable amounts, there has been no change, other than to reflect an insurance settlement and foreign exchange translation, to the recorded amounts since the Company initiated the Restructuring Proceedings. Accordingly, the recorded amounts for the asbestos claims and related insurance recoverable asset could change significantly based upon events that occur from the Restructuring Proceedings.
No assurance can be given that the T&N Companies will not be subject to material additional liabilities and significant additional litigation relating to asbestos matters through 2012 or thereafter. In the event that such liabilities exceed the amounts recorded by the Company or the remaining insurance coverage, the Company’s results of operations and financial condition could be materially affected.
In 1996, T&N Ltd. (formerly T&N, plc) purchased for itself and its then defined global subsidiaries a £500 million layer of insurance which will be triggered should the aggregate costs of claims made or brought after June 30, 1996, where the exposure occurred prior to that date, exceed £690 million. During 2000, the Company concluded that the aggregate cost of the claims filed after June 30, 1996 would exceed the trigger point and recorded an insurance recoverable asset under the T&N policy of $577 million. As of December 31, 2004, the recorded insurance recoverable was $687.7 million. In December 2001, one of the three reinsurers, European International Reinsurance Company Ltd. (“EIR”), filed suit in a London, England court to challenge the validity of its insurance contract with the T&N Companies. As a result of this lawsuit, a claim was made against the broker (Sedgwick) that assisted in procuring this policy for breach of its duties as a broker. This trial commenced in October 2003. Prior to the conclusion of the trial, the parties were able to reach a settlement. As a result of this settlement, the Company recorded a $38.9 million asbestos charge during 2003. Under the terms of the settlement, EIR would be liable for 65.5% of its one-third share of the reinsurance policy. By separate agreement, Sedgwick agreed to be liable for an additional 17.25% of the EIR share of the reinsurance policy. T&N Ltd. has also agreed to indemnify the insurer for sums paid under the policy for which the insurer is liable to T&N Ltd. for which the insurer has no recovery from the reinsurers or Sedgwick. The settlement agreements referenced above are being held in escrow pending approval
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by the Bankruptcy Court and the Administrators of T&N Ltd. of those portions of the above-described settlement agreements that affect the Debtors. A motion seeking the Bankruptcy Court’s approval of the settlement was filed on March 1, 2004.
Subsequent to this motion, the other two reinsurers, Munchener Ruckversicherungs-Gesellschaft AG (“Munich Re”) and Centre Reinsurance International Co. (“CRIC”), a subsidiary of the Zurich Financial Services Group, notified the Company of their belief that the settlements with EIR and Sedgwick may breach one or more provisions of the Reinsurance Agreement. The hearing to review the March 1, 2004 motion has been adjourned without date as the parties attempt to resolve the issues raised by the two reinsurers. However, these efforts have been unsuccessful, prompting the Administrators to file an action in the London High Court seeking a declaration that the settlements with EIR and Sedgwick do not breach provisions of the Reinsurance Agreement. At a hearing on February 14, 2005, the English High Court gave directions to set out an approximate 35 day timetable for the production of evidence for a substantive hearing in early April 2005. In addition, the English High Court gave a direction that Curzon Insurance Limited, (“Curzon”) the original insurer under the policy, should make a similar application to run in tandem with the Administrators’ application.
In October 2004, the other two reinsurers initiated an action against the Company in the High Court in London alleging that the Company’s proposed Plan of Reorganization may breach provisions of the applicable insurance policies, relieving the reinsurers of their obligations. On November 26, 2004, the court issued its judgement generally finding that the Plan as written does not provide any basis to relieve the reinsurers of their obligations. The court indicated that it could not address at this time issues arising from subsequent implementation of the Plan. This judgement has not been appealed.
Also in relation to the insurance in December 2002, Munich Re and CRIC sought certain declarations from the English High Court as to the meaning of certain terms contained in the policy and Reinsurance Agreement. These proceedings were adjourned; however, in August 2003, T&N’s Administrators issued their own applications for determinations of certain legal issues arising under the policy. These included, among other things, the seeking of declarations whether (i) the provision for the transfer of claims handling rights under the policy was not enforceable under the provisions of S1(3) of the Third Party (Rights Against Insurers) Act 1930; (ii) the Reinsurers must meet all expenses incurred in claims handling following the transfer of the right to handle claims, even if such expenses are incurred within the retention of the policy; (iii) such expenses incurred by the Reinsurers constitutes an administration expense payable in priority to other creditors.
On February 12, 2004 the English High Court held, among other thing, that (i) claims handling rights had been transferred; (ii) that claims handling rights did not rank as an administration expense; and (iii) that the Reinsurers could be obliged, in the proper exercise of claims handling to incur expenses, but only on the basis that they formed part of the ultimate net loss under the policy.
The English High Court of Appeal gave judgement on February 11, 2005. Curzon and T&N’s appeal was unsuccessful on all points. Munich Re and CRIC were successful only in relation to their appeal to the extent to which claims handling expenses incurred by the Reinsurers were administration expenses. The Court of Appeal held that the reimbursement of such expenses should be treated as sums payable in respect of liabilities incurred within Section 19(5) of the Insolvency Act of 1986. However, the Court of Appeal said that what claims handling expenses need to be incurred by the Reinsurers must remain a matter under the control of the Court. Curzon and T&N sought permission to appeal to the House of Lords in respect of this issue but leave was refused. T&N’s Administrators are considering whether to seek permission to appeal from the House of Lords.
The ultimate realization of insurance proceeds is directly related to the amount of related covered claims paid by the Company. If the ultimate asbestos claims are higher than the recorded liability, the Company expects the ultimate insurance recoverable to be higher than the recorded amount, up to the cap of the insurance layer. If the ultimate asbestos claims are lower than the recorded liability, the Company expects the ultimate insurance recoverable to be lower than the recorded amount. While the Restructuring Proceedings will impact the timing and amount of the asbestos claims and the insurance recoverable, there has been no change, other than to reflect the settlement discussed above and the effect of foreign currency, to the recorded amounts since the Company initiated the Restructuring Proceedings. Accordingly, the recorded amounts for this insurance recoverable asset could change significantly as a result of the Restructuring Proceedings.
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During the first quarter of 2004, the security rating of Centre Reinsurance International Co. was downgraded by several major credit rating providers. As a result of the downgrade, the Company obtained a guarantee of all CRIC’s obligations under the policy from Centre Reinsurance (US) Limited (“CRUS”), an affiliate of CRIC. The security rating of CRUS has not been affected by the downgrade of CRIC and remains unchanged since the inception of the policy. If the reinsurers and/or the related affiliate are not able to meet their obligations under the policy, the Company’s results of operations and financial condition could be materially affected.
The U.S. claims costs applied against this policy are converted at a fixed exchange rate of $1.69/£. As such, if the market exchange rate is greater than $1.69/£, the Company will effectively have a premium on 100% recovery on claims paid. As of December 31, 2004, the $688 million insurance recoverable asset includes an exchange rate premium of approximately $76 million.
Abex and Wagner Asbestos Litigation
Two of the Company’s businesses formerly owned by Cooper Industries, Inc., known as Abex and Wagner, are involved as defendants in numerous court actions in the U.S. alleging personal injury from exposure to asbestos or asbestos-containing products. These claims mainly involve friction products. As of the Petition Date, Abex and Wagner were defendants in approximately 66,000 and 33,000 pending claims, respectively. As a result of the Restructuring Proceedings, the Company includes as a pending claim open served claims, settled but not documented claims and settled but not paid claims. Notices of complaints continue to be received post-petition and are in violation of the automatic stay.
The liability of the Company with respect to claims alleging exposure to Wagner products arises from the 1998 stock purchase from Cooper Industries, Inc. of the corporate successor by merger to Wagner Electric Company; the purchased entity is now a wholly-owned subsidiary of the Company and one of the Debtors in the Restructuring Proceedings. As a consequence, all claims against the Debtors, including asbestos-related claims, have been stayed.
The liability of the Company with respect to claims alleging exposure to Abex products arises from a contractual liability entered into in 1994 by the predecessor to the Company whose stock the Company purchased in 1998. Pursuant to that contract, prior to the Restructuring Proceedings, the Company, through the relevant subsidiary, was liable for certain indemnity and defense payments incurred on behalf of an entity known as Pneumo Abex Corporation, the successor in interest to Abex Corporation. Effective as of the Petition Date, the Company has ceased making such payments and is currently considering whether to accept or reject the 1994 contractual liability.
As mentioned above, as of the Petition Date, pending asbestos litigation of Abex (as to the Company only) and Wagner is stayed (subject to certain exceptions in the case of governmental authorities), and no party may take action to pursue or collect on such asbestos claims absent specific authorization of the Bankruptcy Court or the High Court.
The Company’s recorded liability for this litigation (comprised of $129.5 million in Abex liabilities and $84.1 million in Wagner liabilities as of December 31, 2004) represented the Company’s estimate prior to the Restructuring Proceedings for claims currently pending and those which were reasonably estimated to be asserted and paid through 2012. The Company did not provide a liability for claims that may be brought subsequent to this period as it could not reasonably estimate such claims. In estimating the liability prior to the Restructuring Proceedings, the Company made assumptions regarding the total number of claims anticipated to be received in a future period, the typical cost of settlement (which is sensitive to the industry in which the plaintiff claims exposure, the alleged disease type and the jurisdiction in which the action is being brought), the rate of receipt of claims, the settlement strategy in dealing with outstanding claims and the timing of settlements.
As a result of the Restructuring Proceedings, pending asbestos-related litigation is stayed. The Company issued various letters of credit in connection with asbestos lawsuits that had resulted in verdicts against the Company or its subsidiaries prior to its filing for bankruptcy protection. The letters of credit were issued as security for judgments entered against the Company or its subsidiaries to permit the Company to pursue appeals to these judgments. The Bankruptcy Court has lifted the automatic stay with respect to one letter of credit for the Company where the letter of credit was in place to allow the appeal of a judgement against Wagner to proceed. During 2004, the final appeal in this case was denied and a draw was made upon this letter of credit of approximately $1 million.
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While the Company believes that the liability recorded as of October 1, 2001 was appropriate for anticipated losses arising from asbestos-related claims related to Abex and Wagner through 2012, it is the Company’s view that, as a result of the Restructuring Proceedings, there is even greater uncertainty in estimating the timing and amount of future asbestos liability and related insurance recovery for pending and future claims. There are significant differences in the treatment of asbestos claims in a bankruptcy proceeding as compared to the tort litigation system. Among other things, it is uncertain at this time as to the number of asbestos-related claims that will be filed in the proceeding, the number of future claims that will be included in a plan of reorganization, how claims for punitive damages and claims by persons with no asbestos-related physical impairment will be treated and whether such claims will be allowed, and the impact historical settlement values for asbestos claims may have on the estimation of asbestos liability in the Restructuring Proceedings.
While the Restructuring Proceedings will impact the timing and amount of the asbestos claims and related insurance recoverable amounts, there has been no change, other than cash payments and receipts and foreign exchange translation, to the recorded amounts since the Company initiated the Restructuring Proceedings. Accordingly, the recorded amounts for the asbestos claims could change significantly based upon events that occur from the Restructuring Proceedings.
No assurance can be given that the Company will not be subject to material additional liabilities and significant additional litigation relating to Abex and Wagner asbestos matters through 2012 or thereafter. In the event that such liabilities exceed the amounts recorded by the Company or the remaining insurance coverage, the Company’s results of operations and financial condition could be materially affected.
Federal-Mogul and Fel-Pro Asbestos Litigation
Prior to the Restructuring Proceedings, the Company was sued in its own name as one of a large number of defendants in multiple lawsuits brought by claimants alleging injury from exposure to asbestos due to its ownership of certain assets involved in gasket making. As of the Petition Date, the Company was a defendant in approximately 61,500 pre-petition pending claims. Over 40,000 of these claims were transferred to a federal court, where, prior to the Restructuring Proceedings, they were pending. Notices of complaints continue to be received post-petition and are in violation of the automatic stay.
Prior to the Restructuring Proceedings, the Company’s Fel-Pro subsidiary also was named as a defendant in a number of product liability cases involving asbestos, primarily involving gasket or packing products. Fel-Pro was a defendant in approximately 34,000 pending claims as of the Petition Date. Over 32,000 of these claims were transferred to a federal court where, prior to the Restructuring Proceedings, they were pending. The Company was defending all such claims vigorously and believed that it and Fel-Pro had substantial defenses to liability and insurance coverage for defense and indemnity. All claims alleging exposure to the products of the Company and of Fel-Pro have been stayed as a result of the Restructuring Proceedings.
Other Matters
In January 2005, the Company was notified by a customer that it experienced a quality problem with one of its products allegedly due to component parts supplied by the Company. The merits of this allegation are still under investigation by both the Company and its customer. Until further investigation is completed, any responsibility and related liability cannot be determined. However, based upon investigations performed to date, the Company believes its component parts are in accordance to customer specifications and are not the root cause of the quality problem. Accordingly, no reserve has been provided as of December 31, 2004.
The Company is involved in other legal actions and claims, directly and through its subsidiaries. After taking into consideration legal counsel’s evaluation of such actions, management is of the opinion that the outcomes are not likely to have a material adverse effect on the Company’s financial position, operating results, or cash flows.
Environmental Matters
The Company is a defendant in lawsuits filed, or the recipient of administrative orders issued, in various jurisdictions pursuant to the Federal Comprehensive Environmental Response Compensation and Liability Act of
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1980 (“CERCLA”) or other similar national or state environmental laws. These laws require responsible parties to pay for remediating contamination resulting from hazardous substances that were discharged into the environment by them, or by others to whom they sent such substances for treatment or other disposition. In addition, the Company has been notified by the United States Environmental Protection Agency, other national environmental agencies, and various state agencies that it may be a potentially responsible party (“PRP”) under such laws for the cost of remediating hazardous substances pursuant to CERCLA and other national and state or provincial environmental laws. PRP designation requires the funding of site investigations and subsequent remedial activities.
At most of the sites that are likely to be the costliest to remediate, which are often current or former commercial waste disposal facilities to which numerous companies sent waste, the Company’s exposure is expected to be limited. Despite the joint and several liability which might be imposed on the Company under CERCLA and some of the other laws pertaining to these sites, the Company’s share of the total waste has generally been small. The other companies, which also sent wastes, often numbering in the hundreds or more, generally include large, solvent publicly owned companies, and in most such situations the government agencies and courts have imposed liability in some reasonable relationship to contribution of waste.
The Company has identified certain present and former properties at which it may be responsible for cleaning up environmental contamination, in some cases as a result of contractual commitments. The Company is actively seeking to resolve these matters.
Although difficult to quantify based on the complexity of the issues, the Company has accrued amounts corresponding to its best estimate of the costs associated with such regulatory and contractual matters based upon information currently available from site investigations and consultants.
Recorded environmental reserves were $61 million and $66 million at December 31, 2004 and 2003, respectively. The decrease in the reserves during 2004 resulted primarily from expenditures against the reserves, downward adjustment of certain reserves based on new and more accurate estimates of remaining costs, sale of certain sites to purchasers who assumed the remaining environmental liabilities, court-approved settlement of certain contractual and governmental cleanup claims with creditors in the company’s pending Chapter 11 bankruptcy proceeding, and other factors. In the event that such liabilities were to significantly exceed the amounts recorded by the Company, the Company’s results of operations and financial condition could be materially affected. At December 31, 2004, management estimates that reasonably possible material additional losses above and beyond management’s best estimate of required remediation costs, as recorded approximate $40 million.
Legal proceedings are further discussed in Note 20 to the consolidated financial statements included in Item 8 of this report.
| ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
There were no matters submitted to a vote of security holders in the fourth quarter of fiscal year 2004.
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PART II
| ITEM 5. | MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
The Company’s common stock trades on the NASD over-the-counter bulletin board market under the ticker symbol “FDMLQ”.
The approximate number of shareholders of record of the Company’s common stock at February 22, 2005 was 7,090. The following table sets forth the high and low sales prices of the Company’s common stock for each calendar quarter for the last two years as reported on the over-the-counter market:
| 2004 | 2003 | |||||||||||
Quarter | High | Low | High | Low | ||||||||
First | $ | 0.46 | $ | 0.20 | $ | 0.47 | $ | 0.07 | ||||
Second | $ | 0.41 | $ | 0.24 | $ | 0.44 | $ | 0.12 | ||||
Third | $ | 0.29 | $ | 0.12 | $ | 0.36 | $ | 0.10 | ||||
Fourth | $ | 0.53 | $ | 0.15 | $ | 0.40 | $ | 0.07 | ||||
The closing price of the Company’s common stock as reported on the over-the-counter market on February 22, 2005 was $0.34.
The Company was prohibited in 2004, 2003 and 2002, under its Senior Credit Agreement and its debtor-in-possession credit facilities, from paying dividends on its common stock, and therefore did not declare any such dividends. The Company does not expect to declare a dividend in the foreseeable future.
On June 4, 2004, the Third Amended Joint Plan of Reorganization (the “Plan”) for the Company and the other U.S. and U.K. Debtors was filed with the Bankruptcy Court. The Plan was jointly proposed by the Company, the Unsecured Creditors Committee, the Asbestos Claimants Committee, the Future Asbestos Claimants Representative, the Agent for the Prepetition Bank Lenders and the Equity Security Holders Committee (collectively referred to as the “Plan Proponents”).
The Plan provides that asbestos personal injury claimants, both present and future, will be permanently channeled to a trust or series of trusts established pursuant to Section 524(g) of the Bankruptcy Code, thereby protecting Federal-Mogul and its affiliates in the Chapter 11 Cases from existing and future asbestos liability. Although certain issues remain to be resolved, the Plan provides that all currently outstanding stock of Federal-Mogul will be cancelled, and 50.1% of newly authorized and issued common stock of reorganized Federal-Mogul will be distributed to the asbestos trusts, and 49.9% of the newly authorized and issued common stock will be distributed pro rata to the noteholders. If the Bankruptcy Court finds that the classes of holders of common and preferred stock of Federal-Mogul have voted in favor of the Plan, the holders of currently outstanding common and preferred stock of Federal-Mogul will receive warrants that may be used to purchase shares of reorganized Federal-Mogul at a predetermined exercise price.
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| ITEM 6. | SELECTED FINANCIAL DATA |
The following table presents information from the Company’s consolidated financial statements for the five years ended December 31, 2004. This information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Financial Statements and Supplemental Data”. Information for the four years ended December 31, 2003 has been reclassified from that presented in prior reports to reflect the financial results of operations divested in 2004 as discontinued operations.
| 2004 | 2003 | 2002 | 2001 | 2000 | ||||||||||||||||
| (Millions of Dollars, Except Share and Per Share Amounts) | ||||||||||||||||||||
Consolidated Statement of Operations Data | ||||||||||||||||||||
Net sales | $ | 6,174.1 | $ | 5,522.9 | $ | 5,157.3 | $ | 5,062.9 | $ | 5,464.4 | ||||||||||
Costs and expenses | (6,048.0 | ) | (5,403.3 | ) | (5,072.6 | ) | (5,073.6 | ) | (5,188.8 | ) | ||||||||||
Amortization of intangible assets | (17.2 | ) | (16.9 | ) | (14.0 | ) | (106.0 | ) | (110.6 | ) | ||||||||||
Restructuring charges, net | (17.5 | ) | (32.7 | ) | (32.0 | ) | (36.7 | ) | (139.2 | ) | ||||||||||
Adjustment of assets to fair value | (276.4 | ) | (93.9 | ) | (62.6 | ) | (145.1 | ) | (64.0 | ) | ||||||||||
Asbestos charge | — | (38.9 | ) | — | — | (184.4 | ) | |||||||||||||
Chapter 11 and Administration related reorganization expenses | (99.7 | ) | (97.1 | ) | (107.4 | ) | (50.6 | ) | — | |||||||||||
Gain on involuntary conversion | 46.1 | — | — | — | — | |||||||||||||||
Gain on early retirement of debt | — | — | — | 72.2 | — | |||||||||||||||
Other income (expense), net | 49.2 | 43.8 | 25.5 | (27.8 | ) | (28.2 | ) | |||||||||||||
Income tax expense | (136.1 | ) | (52.5 | ) | (77.9 | ) | (229.6 | ) | (22.6 | ) | ||||||||||
Loss from continuing operations before cumulative effect of change in accounting principle | (325.5 | ) | (168.6 | ) | (183.7 | ) | (534.3 | ) | (273.4 | ) | ||||||||||
Loss from discontinued operations, net of income taxes | (8.5 | ) | (20.9 | ) | (33.0 | ) | (467.2 | ) | (8.1 | ) | ||||||||||
Cumulative effect of change in accounting principle, net of applicable income tax benefit | — | — | (1,412.2 | ) | — | — | ||||||||||||||
Net Loss | $ | (334.0 | ) | $ | (189.5 | ) | $ | (1,628.9 | ) | $ | (1,001.5 | ) | $ | (281.5 | ) | |||||
Common Share Summary (Diluted) | ||||||||||||||||||||
Average shares and equivalents outstanding (in thousands) | 87,318 | 87,129 | 83,022 | 75,598 | 70,573 | |||||||||||||||
Loss per share: | ||||||||||||||||||||
From continuing operations before cumulative effect of change in accounting principle | $ | (3.73 | ) | $ | (1.93 | ) | $ | (2.21 | ) | $ | (7.09 | ) | $ | (3.88 | ) | |||||
From discontinued operations, net of income taxes | (0.10 | ) | (0.24 | ) | (0.40 | ) | (6.18 | ) | (0.14 | ) | ||||||||||
Cumulative effect of change in accounting principle, net of applicable income tax benefit | — | — | (17.01 | ) | — | — | ||||||||||||||
Net loss per share | $ | (3.83 | ) | $ | (2.17 | ) | $ | (19.62 | ) | $ | (13.27 | ) | $ | (4.02 | ) | |||||
Dividends declared per common share | $ | — | $ | — | $ | — | $ | — | $ | 0.01 | ||||||||||
Consolidated Balance Sheet Data | ||||||||||||||||||||
Total assets | $ | 8,265.2 | $ | 8,116.7 | $ | 7,913.3 | $ | 9,053.2 | $ | 9,831.0 | ||||||||||
Short-term debt | 309.6 | 14.8 | 346.1 | 24.9 | 147.8 | |||||||||||||||
Long-term debt | 10.1 | 331.2 | 14.3 | 266.7 | 3,559.7 | |||||||||||||||
Liabilities subject to compromise | 6,018.5 | 6,087.8 | 6,053.2 | 6,256.6 | — | |||||||||||||||
Company-obligated mandatorily redeemable preferred securities of subsidiary trust holding solely convertible subordinated debentures of the Company | — | — | — | — | 575.0 | |||||||||||||||
Shareholders’ (deficit) equity | (1,925.7 | ) | (1,376.9 | ) | (1,403.6 | ) | 419.0 | 1,550.2 | ||||||||||||
Other Financial Information | ||||||||||||||||||||
Net cash provided from (used by) operating activities | $ | 465.5 | $ | 312.5 | $ | 256.5 | $ | 35.8 | $ | (154.5 | ) | |||||||||
Expenditures for property, plant, equipment | 267.5 | 300.9 | 339.1 | 313.8 | 315.5 | |||||||||||||||
Depreciation and amortization expense | 335.7 | 307.1 | 277.1 | 373.7 | 374.4 | |||||||||||||||
Payments against asbestos liability | — | — | (2.1 | ) | (234.7 | ) | (353.7 | ) | ||||||||||||
Receipts from asbestos insurance policies | 5.1 | 0.6 | 0.6 | 18.8 | 2.2 | |||||||||||||||
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| ITEM 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Overview
Federal-Mogul Corporation (“Federal-Mogul” or the “Company”) offers a broad range of vehicular parts, accessories, modules and systems to customers in both the original equipment market (“OE”) and the replacement market (“aftermarket”) on a worldwide basis. Management believes the Company’s sales of $6.2 billion are well balanced between original equipment and aftermarket as well as domestic and international. During 2004, the Company derived 54% of its sales from the OE market and 46% from the aftermarket. Prominent OE customers include the world’s largest automotive manufacturers such as General Motors, Ford/Jaguar/Volvo, DaimlerChrysler, BMW, PSA, Volkswagen/Audi and Renault/Nissan. Similarly, prominent aftermarket customers include the Aftermarket Auto Parts Alliance, Autozone, CarQuest, Advance Automotive, NAPA and Ozark/O’Reilly’s. Geographically, the Company derived 47% of its sales domestically and 53% internationally. The Company has operations in established markets including the United States, Germany, United Kingdom, France, Italy, Mexico and Canada, and emerging markets including China, Czech Republic, Hungary, India, Korea, Poland and Thailand. The attendant risks of the Company’s international operations are primarily related to currency fluctuations, changes in local economic and political conditions, and changes in laws and regulations.
The Company operates in an extremely competitive industry, driven by global vehicle production volumes and part replacement trends. Business is typically awarded to the supplier offering the most favorable combination of cost, quality, technology and service. In addition, customers continue to require periodic cost reductions which requires the Company to continually assess, redefine and improve its operations, products, and manufacturing capabilities to maintain and improve profitability. Management continues to develop and execute initiatives to meet the challenges of the industry and to achieve its strategy.
A number of initiatives commenced in 2001 and, while certain of these initiatives have been completed as of December 31, 2004, many are still in process and ongoing:
| • | Global Organization – Recognizing the ever-increasing globalization of the automotive industry, the Company organized its primary business units on a global basis – Powertrain, Sealing Systems and Systems Protection, Friction and Aftermarket. This allows each business to take advantage of best practices in product development, technology and innovation, manufacturing capability and capacity. Furthermore, the Company continues to develop and implement standardized processes and centralized systems to further the direction and performance of the business. |
| • | Productivity – Management implemented a series of initiatives targeted at leveraging the Company’s global scale and reducing total enterprise costs. These initiatives included implementation of a centralized supply chain function focused on the reduction of global material costs; headcount reduction programs to reduce selling, general and administrative costs; implementation of standard manufacturing methods across business segments to achieve operational efficiencies and decrease production costs; and modified capital expenditure processes to ensure capital funds are directed at the most strategically appropriate investments with the highest rates of return. |
| • | Low Cost Production – The Company has established and expanded manufacturing operations in low cost geographies to meet the cost pressures inherent in the industry. The Company has manufacturing operations or joint venture alliances in the Czech Republic, China, Korea, Thailand, Poland, Turkey, Hungary, and Mexico. |
| • | Exit “Non-Core” Businesses – Management identified certain businesses that were not consistent with the Company’s long-term strategy or were not expected to achieve certain performance targets. These businesses were deemed non-core and, during the course of the last three years, the Company has divested substantially all of these businesses. These activities have freed up both human and financial resources that are focused on improving the Company’s core businesses. |
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| • | North America Aftermarket Distribution Optimization – The Company commenced activities to streamline the North America aftermarket distribution network in order to improve both the efficiency of operations and customer order fulfillment and delivery performance. This distribution network consisted of 18 facilities at the end of 2000. Since then, the Company has completed the consolidation and closure of nine distribution centers. The Company now operates its North America aftermarket customer order processing and fulfillment from nine distribution centers. The Company has embarked upon a similar initiative for its Europe aftermarket operations. |
| • | Aftermarket Delivery Performance – In addition to the distribution network consolidation efforts in North America, the Company upgraded many of its remaining distribution centers with state-of-the-art warehouse management systems. Furthermore, the Company renewed its focus on internal logistics and execution of inventory “pull” systems throughout its manufacturing operations and suppliers to ensure prompt and accurate replenishment of its distribution network. These efforts have resulted in significantly improved order fulfillment to the Company’s aftermarket customers in North America and Europe. The Company believes that its current customer order fulfillment levels are best in class. |
| • | Expand Asia Pacific Presence – The Company has invested in manufacturing operations (both wholly-owned and joint venture relationships) in the Asia Pacific region and maintains a technical center in Yokohama, Japan to support the Company’s efforts in this region. The Company intends to use these operations and technical platform to strengthen its current, as well as to develop new, customer relationships in this important region. |
| • | Customer Valued Technology – The Company has significant engineering and technical resources throughout its businesses focused on addressing customer issues and problems with innovative solutions for both product applications and manufacturing processes. A recent example is the development and launch of the Company’s Wagner ThermoQuiet disc brake pad technology for the aftermarket. This technology employs patented shim technology which provides a one piece insulator and backing plate and provides exceptional stopping power, quiet performance, and enhanced durability. The Company was awarded the prestigious Automotive News PACE Award in 2003 for this new technology. |
| • | Settle Asbestos Obligation And Right Size Capital Structure – On October 1, 2001 the Company and all of its wholly-owned United States subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy. Also on October 1, 2001, certain of the Company’s United Kingdom subsidiaries filed for reorganization under Chapter 11 of the Bankruptcy Code and petitions for Administration under the United Kingdom Insolvency Act of 1986 in the High Court of Justice, Chancery division in London, England. These proceedings were initiated in response to a sharply increasing number of asbestos-related claims and their demand on the Company’s cash flows and liquidity. Management expects the Company to emerge from the Restructuring Proceedings free from its asbestos obligation and with an appropriate capital structure necessary to achieve the Company’s future objectives. |
Voluntary Reorganization under Chapter 11 and Administration
On October 1, 2001 (the “Petition Date”), the Company and all of its wholly-owned United States subsidiaries filed voluntary petitions for reorganization (the “U.S. Restructuring”) under Chapter 11 of the United States Bankruptcy Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”). Also on October 1, 2001, certain of the Company’s United Kingdom subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the Bankruptcy Code and petitions for Administration (the “U.K. Restructuring”) under the United Kingdom Insolvency Act of 1986 (the “Act”) in the High Court of Justice, Chancery division in London, England (the “High Court”). The Company and its U.S. and U.K. subsidiaries included in the U.S. Restructuring or the U.K. Restructuring are herein referred to as the “Debtors”. The U.S. Restructuring and U.K. Restructuring are herein referred to as the “Restructuring Proceedings”. The Chapter 11 cases of the Debtors (collectively, the “Chapter 11 Cases”) have been consolidated for purposes of joint administration asIn re: Federal-Mogul Global Inc., T&N Limited, et al(Case No. 01-10578(RTL)). Subsidiaries outside of the aforementioned U.S. and U.K. subsidiaries are not party to the Chapter 11 Cases and, therefore, are not currently provided protection from creditors by any bankruptcy court and are operating in the normal course. The Chapter 11 Cases are further discussed in Note 2 to the consolidated financial statements.
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The Restructuring Proceedings were initiated in response to a sharply increasing number of asbestos-related claims and their demand on the Company’s cash flows and liquidity. Under the Restructuring Proceedings, the Debtors expect to develop and implement a plan for addressing the asbestos-related claims against them.
Consequences of the Restructuring Proceedings
The U.S. Debtors are operating their businesses as debtors-in-possession subject to the provisions of the Bankruptcy Code. The U.K. Debtors are continuing to manage their operations under the supervision of Administrators approved by the High Court. All vendors are being paid for all goods furnished and services provided after the Petition Date. However, as a consequence of the Restructuring Proceedings, pending litigation against the Debtors as of the Petition Date is stayed (subject to certain exceptions in the case of governmental authorities), and no party may take any action to pursue or collect pre-petition claims except pursuant to an order of the Bankruptcy Court or the High Court as applicable. It is the Debtors’ intention to address all pending and future asbestos-related claims and all other pre-petition claims through a unified plan of reorganization under the Bankruptcy Code or schemes of arrangement or company voluntary arrangements under the Act.
In the U.S., four committees, representing asbestos claimants, asbestos property damage claimants, unsecured creditors and equity security holders (collectively, the “Committees”) have been appointed as official committees in the Chapter 11 Cases and, in accordance with the provisions of the Bankruptcy Code, have the right to be heard on all matters that come before the Bankruptcy Court. The Committees, together with the legal representative for the future asbestos claimants, play important roles in the Restructuring Proceedings. In the U.K., the Administrators have appointed creditors committees, representing both asbestos claimants and general unsecured creditors.
On June 4, 2004, the Third Amended Joint Plan of Reorganization (the “Plan”) for the Company and the other U.S. and U.K. Debtors was filed with the Bankruptcy Court. The Plan was jointly proposed by the Company, the Unsecured Creditors Committee, the Asbestos Claimants Committee, the Future Asbestos Claimants Representative, the Agent for the Prepetition Bank Lenders and the Equity Security Holders Committee (collectively referred to as the “Plan Proponents”). Also on June 4, 2004, a Disclosure Statement to be used in soliciting votes to accept or reject the Plan (the “Disclosure Statement”) was approved by the Bankruptcy Court and a December 2004 hearing was scheduled to determine whether the Bankruptcy Court should approve the Plan. On December 7, 2004, the Bankruptcy Court delayed this confirmation hearing pending a hearing to estimate asbestos personal injury claims against U.K. Debtors. Such estimation hearing has not yet been scheduled.
On July 12, 2004, solicitation packages containing the Plan and Disclosure Statement, various supporting documents and a ballot, if appropriate, were mailed to known creditors of the Company and holders of common and preferred stock interests in the Company. All votes were due by the close of business on November 3, 2004. Although the Plan Proponents have granted extensions of the November 3, 2004 voting deadline to a few significant claimants, the voting agent has confirmed that the overwhelming majority of the classes of claims and interests have voted to accept the Plan. For the few classes of claims that voted to reject the Plan, the Plan Proponents intend to either amend the Plan so as to obtain such classes’ accepting votes or seek to confirm the Plan over the objection of such classes.
The Plan provides that asbestos personal injury claimants, both present and future, will be permanently channeled to a trust or series of trusts established pursuant to Section 524(g) of the Bankruptcy Code, thereby protecting Federal-Mogul and its affiliates in the Chapter 11 Cases from existing and future asbestos liability. Although certain issues remain to be resolved, the Plan provides that all currently outstanding stock of Federal-Mogul will be cancelled, and 50.1% of newly authorized and issued common stock of reorganized Federal-Mogul will be distributed to the asbestos trusts, and 49.9% of the newly authorized and issued common stock will be distributed pro rata to the noteholders. If the classes of holders of common and preferred stock of Federal-Mogul vote in favor of the Plan, the holders of currently outstanding common and preferred stock of Federal-Mogul will receive warrants that may be used to purchase shares of reorganized Federal-Mogul at a predetermined exercise price.
Unsecured creditors, including trade creditors, of the U.S. Debtors are projected to receive cash distributions under the Plan equal to 35% of their allowed claims, payable in three annual installments, provided that the aggregate of all allowed unsecured claims against the U.S. Debtors does not exceed $258.0 million. Any excess above this amount could result in a reduction in the percentage distribution that the unsecured creditors of the U.S. Debtors ultimately receive. Unsecured creditors, including trade creditors, of the U.K. Debtors will receive distributions that vary according to terms specified within the Plan and Disclosure Statement.
There are two possible types of U.K. schemes of arrangements. The first is under Section 425 of the Companies Act of 1985, which may involve a scheme for the reconstruction of the Company. If a majority in number representing
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three-fourths in value of the creditors or members or any class of them agree to the compromise or arrangement, it is binding if sanctioned by the High Court. Section 425 may be invoked where there is an Administration order in force in relation to the Company. The other possible type of scheme arises under Section 1 of the Insolvency Act of 1986 in relation to Company Voluntary Arrangements (“CVAs”). If a majority in value representing more than three-fourths of the creditors agrees to the compromise or arrangement set out in the CVA proposal, it will be approved.
The Plan Proponents have prepared forms of Schemes of Arrangement and CVAs to be submitted for the U.K. Debtors in the U.K. Restructuring proceedings. These forms of Schemes of Arrangement and CVAs parallel the provisions of the Plan to the fullest extent possible under English and Scottish insolvency law. Under English and Scottish law, the Administrators are the only persons with authority to recommend and submit Schemes of Arrangement and/or CVAs. The Administrators have not yet agreed to recommend the Schemes of Arrangement and CVAs that parallel the Plan. The Plan Proponents are working toward an agreement with the Administrators to recommend parallel Schemes of Arrangement and CVAs. Alternatively, if such an agreement cannot be achieved, the Plan Proponents will work toward an agreement with the Administrators to retain the businesses of those U.K. Debtors that are valuable to Federal-Mogul and its customers and to jointly market those U.K. Debtors that are not valuable to Federal-Mogul and its customers. This process is consistent with the Company’s strategy to focus on core business segments, and to consider for divestiture or other exit activities those non-core operations determined by management not to have a sustainable competitive advantage.
In October 2004, the Administrators applied to the High Court for directions related to: 1) questions of fairness of the Plan; 2) the approach of the High Court to CVAs and schemes of arrangement designed to implement the Plan within the U.K.; 3) the compatibility with English pension laws of the proposals for the trustees of pension schemes of the U.K. debtors; and 4) the impact under English insolvency law should the Administrators not propose CVAs and schemes of arrangement. In response to the application for directions, the High Court directed the Administrators to not propose schemes of arrangement and CVAs consistent with the draft schemes and draft CVAs included within the currently filed Plan without further order of the High Court. In addition, the High Court directed the Administrators to not convene meetings of creditors of the U.K. Companies pursuant to any demands or requisitions made pursuant to the Plan. Additionally, the High Court granted the Administrators leave to modify their consent, if necessary, with the directors of the U.K. Debtors exercising their powers either to a) promote and/or confirm the Plan; or b) file or continue any motion in the Bankruptcy Court which seeks relief in relation to the Administrators or the U.K. Debtors.
If the Plan Proponents and the Administrators cannot reach an agreement regarding either Schemes of Arrangement and CVAs that parallel the Plan or the means by which the Federal-Mogul will retain the business of the U.K. Debtors that are valuable to Federal-Mogul and its customers, then one or more of the following may occur with respect to each U.K. Debtor: (a) the U.K. Debtors and the Plan Proponents may ask the High Court to approve the Plan with respect to the U.K. Debtors as a matter of comity; or (b) Federal-Mogul may bid for those businesses of the U.K. Debtors that are valuable to Federal-Mogul and its customers and any actual or deemed transfer of assets to Federal-Mogul in connection therewith shall be entitled to the benefits of the injunction pursuant to Section 524(g) of the Bankruptcy Code. If Federal-Mogul is not the successful bidder, the injunction pursuant to Section 524(g) of the Bankruptcy Code shall not apply to the transfer of any assets to any entity other than Federal-Mogul or its designee. The Company believes that, in the event the assets of the U.K. debtors are marketed for public sale, Federal-Mogul ultimately will be the successful bidder for those assets that are valuable to Federal-Mogul and its customers. Any remaining assets would be liquidated. The Company believes that such a non-consensual process with the Administrators is not in the best interest of the creditors of the U.K. Debtors, including pension creditors, and employees of the U.K. Debtors and that the failure to arrive at a consensual plan could be damaging to the interests of such parties.
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The Company is unable to predict with a high degree of certainty at this time what treatment will be accorded under any such plan of reorganization to claims against the U.K. Debtors arising from intercompany indebtedness, licenses, executory contracts, transfers of goods and services, and other intercompany arrangements, transactions and relationships that were entered into prior to the Petition Date. Various parties in the Chapter 11 Cases may challenge these arrangements, transactions, and relationships, and the outcome of those challenges, if any, may have an impact on the treatment of various claims under such plan of reorganization.
The Bankruptcy Court may confirm a plan of reorganization only upon making certain findings required by the Bankruptcy Code, and a plan may be confirmed over the dissent of non-accepting creditors and equity security holders if certain requirements of the Bankruptcy Code are met. The payment rights and other entitlements of pre-petition creditors and equity security holders may be substantially altered by any plan of reorganization confirmed in the Chapter 11 Cases. There is no assurance that there will be sufficient assets to satisfy the Debtors’ pre-petition liabilities in whole or in part, and the pre-petition creditors of some Debtors may be treated differently than those of other Debtors.
Accounting Impact
Pursuant to AICPA Statement of Position 90-7 (“SOP 90-7”), “Financial Reporting by Entities in Reorganization under the Bankruptcy Code”, the Company’s pre-petition liabilities that are subject to compromise are reported separately in the consolidated balance sheet at the expected amount of the allowed claims. Note 2, “Voluntary Reorganization under Chapter 11 and Administration”, includes the detail of “Liabilities subject to compromise” as of December 31, 2004. Obligations of the Company’s subsidiaries not covered by the Restructuring Proceedings will remain classified in the consolidated balance sheet based upon maturity dates or the expected dates of payment. SOP 90-7 also requires separate reporting of certain expenses, realized gains and losses, a portion of interest income and provisions for losses related to the Restructuring Proceedings as reorganization items. Accordingly, the Debtors recorded Chapter 11 and Administration related reorganization expenses of $99.7 million, $97.1 million and $107.4 million for the years ended December 31, 2004, 2003 and 2002, respectively. See Note 2 to the consolidated financial statements in Item 8 of this report for further information concerning the Restructuring Proceedings.
Critical Accounting Policies
The accompanying consolidated financial statements in Item 8 of this report have been prepared in conformity with United States generally accepted accounting principles and, accordingly, the Company’s accounting policies have been disclosed in Note 1 to the consolidated financial statements. The Company considers accounting estimates to be critical accounting policies when:
| • | The estimates involve matters that are highly uncertain at the time the accounting estimate is made; and |
| • | Different estimates or changes to estimates could have a material impact on the reported financial position, changes in financial condition, or results of operations. |
When more than one accounting principle, or the method of its application, is generally accepted, management selects the principle or method that it considers to be the most appropriate given the specific circumstances. Application of these accounting principles requires the Company’s management to make estimates about the future resolution of existing uncertainties. Estimates are typically based upon historical experience, current trends, contractual documentation, and other information, as appropriate. Due to the inherent uncertainty involving estimates, actual results reported in the future may differ from those estimates. In preparing these financial statements, management has made its best estimates and judgments of the amounts and disclosures included in the financial statements, giving due regard to materiality. The following summarizes the Company’s critical accounting policies.
Reorganization Under Chapter 11 and Administration
The accompanying consolidated financial statements have been prepared in accordance with SOP 90-7 and on a going concern basis, which contemplates continuity of operations and realization of assets and liquidation of
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liabilities in the ordinary course of business. However, as a result of the Restructuring Proceedings, such realization of assets and liquidation of liabilities, without substantial adjustments and/or changes of ownership, is highly uncertain. Given this uncertainty, there is substantial doubt about the ability of the Company to continue as a going concern. While operating as debtors-in-possession under the protection of Chapter 11 of the Bankruptcy Code and Administration under the Act, and subject to approval of the Bankruptcy Court, Administrators or the High Court or otherwise as permitted in the ordinary course of business, the Debtors, or some of them, may sell or otherwise dispose of assets and liquidate or settle liabilities for some amounts other than those reflected in the consolidated financial statements. Further, a plan of reorganization or scheme of arrangement could materially change the amounts and classifications in the historical consolidated financial statements.
Asbestos Liabilities and Asbestos-Related Insurance Recoverable
The Company’s United Kingdom subsidiary, T&N Ltd., two United States subsidiaries (“T&N Companies”), and two of the Company’s subsidiaries formerly owned by Cooper Industries, Inc., known as Abex and Wagner, are among many defendants named in numerous court actions in the United States alleging personal injury resulting from exposure to asbestos or asbestos-related products. T&N Ltd. is also subject to asbestos-disease litigation, to a lesser extent, in the United Kingdom and France. The recorded liability at December 31, 2004 represents the Company’s estimate, prior to the Restructuring Proceedings, for claims currently pending and those which were reasonably estimated to be asserted and paid through 2012. The Company did not provide a liability for claims that may be paid subsequent to this period as it could not reasonably estimate such claims. In estimating the asbestos liability prior to the Restructuring Proceedings, the Company made assumptions regarding the total number of claims anticipated to be received in a future period, the rate of receipt of claims, the typical cost of settlement, the settlement strategy in dealing with outstanding claims and the timing of settlements. While the Company believes that the liability recorded was appropriate for anticipated losses arising from asbestos-related claims through 2012, it is the Company’s view that, as a result of the Restructuring Proceedings, there is even greater uncertainty in estimating the asbestos liability for pending and future claims.
T&N Ltd. purchased for itself and its then defined global subsidiaries a £500 million layer of insurance which will be triggered should the aggregate costs of claims made or brought after June 30, 1996, where the exposure occurred prior to that date, exceed £690 million. During 2000, the Company concluded that the aggregate cost of the claims filed after June 30, 1996 would exceed the trigger point of certain asbestos policies and accordingly recorded an insurance recoverable asset.
The ultimate realization of insurance proceeds is directly related to the amount of related covered claims paid by the Company. If the ultimate asbestos claims are higher than the recorded liability, the Company expects the ultimate insurance recoverable to be higher than the recorded amount. If the ultimate asbestos claims are lower than the recorded liability, the Company expects the ultimate insurance recoverable to be lower than the recorded amount. While the Restructuring Proceedings will impact the timing and amount of the asbestos claims and the insurance recoverable, there has been no change to the recorded amounts, other than an insurance settlement described further below, and the impact of foreign currency, due to uncertainties created by the Restructuring Proceedings. Accordingly, these amounts could change significantly based upon events that occur from the Restructuring Proceedings and could materially affect the Company’s future financial statements.
Pension Plans and Other Postretirement Benefit Plans
Using appropriate actuarial methods and assumptions, the Company’s defined benefit pension plans are accounted for in accordance with SFAS No. 87, “Employers’ Accounting for Pensions;” Non-pension postretirement benefits are accounted for in accordance with SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions;” disability, early retirement and other postemployment benefits are accounted for in accordance with SFAS No. 112, “Employer Accounting for Postemployment Benefits.”
Actual results that differ from assumptions used are accumulated and amortized over future periods and, accordingly, generally affect recognized expense and the recorded obligation in future periods. Therefore, assumptions used to calculate benefit obligations as of the end of a fiscal year directly impact the expense to be recognized in future periods. The primary assumptions affecting the Company’s accounting for employee benefits under SFAS Nos. 87, 106 and 112 as of December 31, 2004 are as follows:
| • | Long-term rate of return on plan assets: The required use of the expected long-term rate of return on plan assets may result in recognized returns that are greater or less than the actual returns on those plan assets in any given year. Over time, however, the expected long-term rate of return on plan assets is designed to approximate actual earned long-term returns. The Company uses long-term historical actual return information, the mix of investments that comprise plan assets, and future estimates of long-term investment returns by reference to external sources to develop an assumption of the expected long-term rate of return on plan assets. The expected long-term rate of return is used to calculate net periodic pension cost. In determining its pension obligations, the Company used long-term rates of return on plan assets of 5.25-8.5%. |
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| • | Discount rate: The discount rate is used to calculate future pension and postretirement obligations. Discount rate assumptions used to account for pension and non-pension postretirement benefit plans reflect the rates available on high-quality, fixed-income debt instruments on December 31 of each year. In determining its pension and other benefit obligations, the Company used discount rates of 4.5-5.75%. |
| • | Health care cost trend: For postretirement health care plan accounting, the Company reviews external data and Company specific historical trends for health care costs to determine the health care cost trend rate assumptions. In determining its projected benefit obligation, the Company used health care cost trend rates of 8.0%, declining to an ultimate trend rate of 5.0% in 2010, for postretirement health care plans. |
The following table illustrates the sensitivity to a change in certain assumptions for pension and non-pension benefits. The changes in these assumptions have no impact on the Company’s 2005 funding requirements.
| United States Plans | International Plans | |||||||||||||||||||||||
| Pension Benefits | Other Plans | Pension Benefits | ||||||||||||||||||||||
Impact on Expense | Impact on PBO | Impact on Equity | Impact on Expense | Impact on APBO | Impact on Expense | Impact on PBO | Impact on Equity | |||||||||||||||||
| (Millions of dollars) | ||||||||||||||||||||||||
25 basis point (bp) decrease in discount rate | $ | + 2.4 | $ | + 24.1 | $ | - 23.2 | $ | + 1.9 | $ | + 14.1 | $ | + 4.5 | $ | + 62.2 | $ | - 62.0 | ||||||||
25 bp increase in discount rate | - 2.4 | - 23.6 | + 22.7 | - 1.9 | - 13.8 | - 4.4 | - 58.8 | + 58.4 | ||||||||||||||||
25 bp decrease in rate of return on assets | + 1.9 | — | — | — | — | + 2.5 | — | — | ||||||||||||||||
25 bp increase in rate of return on assets | - 1.9 | — | — | — | — | - 2.5 | — | — | ||||||||||||||||
The assumed health care trend rate has a significant impact on the amounts reported for non-pension plans. The following table illustrates the sensitivity to a change in the assumed health care trend rate:
Total Service and Interest Cost | APBO | |||||
| (Millions of Dollars) | ||||||
100 bp increase in health care trend rate | $ | + 5.1 | $ | + 68.2 | ||
100 bp decrease in health care trend rate | - 4.3 | - 58.1 | ||||
Environmental Matters
The Company is a defendant in lawsuits filed, or the recipient of administrative orders issued, in various jurisdictions pursuant to the Federal Comprehensive Environmental Response Compensation and Liability Act of 1980 (“CERCLA”) or other similar national or state environmental laws. These laws require responsible parties to pay for remediating contamination resulting from hazardous substances that were discharged into the environment by them, or by others to whom they sent such substances for treatment or other disposition. In addition, the Company has been notified by the United States Environmental Protection Agency, other national environmental agencies, and various state agencies that it may be a potentially responsible party (“PRP”) under such laws for the cost of remediating hazardous substances pursuant to CERCLA and other national and state environmental laws. PRP designation requires the funding of site investigations and subsequent remedial activities.
The Company has identified certain present and former properties at which it may be responsible for cleaning up environmental contamination, in some cases as a result of contractual commitments. The Company is actively seeking to resolve these matters. Although difficult to quantify based on the complexity of the issues, the Company
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has accrued amounts corresponding to its best estimate of the costs associated with such matters based upon current available information from site investigations and consultants.
Recorded environmental reserves were $61.0 million and $66.0 million at December 31, 2004 and 2003, respectively. These accruals are based upon management’s best estimates, which requires management to make assumptions regarding the costs for remediation activities, the extent to which costs may be reimbursed by other participating parties, the financial viability of such participating parties, the timeframes over which remediation activities will be completed, and other items. Although management believes its accruals will be adequate to cover the Company’s estimated liability for its exposure in respect to such environmental matters, any changes in the underlying assumptions could materially impact the Company’s future results of operations and financial condition. At December 31, 2004, management estimates that reasonably possible material additional losses above and beyond management’s best estimate of required remediation costs as recorded approximates $40 million.
Long-Lived Assets
Long-lived assets, such as property, plant and equipment and definite-lived intangible assets, are stated at cost. Depreciation and amortization is computed principally by the straight-line method for financial reporting purposes and by accelerated methods for income tax purposes. Definite-lived assets are periodically reviewed for impairment indicators. If impairment indicators exist, the Company performs the required analysis and records an impairment charge, as required, in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”.
Indefinite-lived intangible assets, such as goodwill and trademarks, are carried at historical value and not amortized. Indefinite-lived intangible assets are reviewed for impairment annually as of October 1, or more frequently if impairment indicators exist. In accordance with SFAS No. 142, “Accounting for Goodwill and Other Intangible Assets”, the impairment analysis compares the estimated fair value of these assets to the related carrying value, and an impairment charge is recorded for any excess of carrying value over estimated fair value. The estimated fair value is based upon considerations of various valuation methodologies, including guideline transaction multiples, multiples of current earnings, and projected future cash flows discounted at rates commensurate with the risk involved.
Estimating fair value for both long-lived and indefinite-lived assets requires management to make assumptions regarding future sales volumes and pricing, capital expenditures, useful lives and salvage values of related property, plant and equipment, the Company’s ability to develop and implement productivity improvements, discount rates, effective tax rates, market multiples, and other items. Any differences in actual results from management’s estimates could result in fair values different from estimated fair values, which could materially impact the Company’s future results of operations and financial condition.
Income Taxes
The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes”. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The Company records a valuation allowance on deferred tax assets by tax jurisdiction when it is more likely than not that such assets will not be realized. Management judgment is required in determining the Company’s valuation allowance on deferred tax assets. The Company does not provide taxes on undistributed earnings of foreign subsidiaries that are considered to be permanently reinvested.
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Results of Operations
The following discussion of the Company’s results of operations should be read in connection with Items 1 and 7A of this Form 10-K. These Items provide additional relevant information regarding the business of the Company, its strategy, and the various industry dynamics in the OE market and the aftermarket which have a direct and significant impact on the Company’s results of operations. Results of operations for the years ended December 31, 2003 and 2002 have been reclassified to reflect organizational changes implemented during the second quarter of 2004.
Consolidated Results
Sales by reporting segment were:
| Year Ended December 31 | |||||||||
| 2004 | 2003 | 2002 | |||||||
| (Millions of Dollars) | |||||||||
Powertrain | $ | 2,146 | $ | 1,847 | $ | 1,651 | |||
Sealing Systems and Systems Protection | 682 | 622 | 641 | ||||||
Friction | 527 | 441 | 379 | ||||||
Aftermarket | 2,819 | 2,613 | 2,486 | ||||||
| $ | 6,174 | $ | 5,523 | $ | 5,157 | ||||
Gross margin by reporting segment was:
| Year Ended December 31 | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| (Millions of Dollars) | ||||||||||||
Powertrain | $ | 316 | $ | 260 | $ | 263 | ||||||
Sealing Systems and Systems Protection | 114 | 104 | 124 | |||||||||
Friction | 112 | 119 | 99 | |||||||||
Aftermarket | 662 | 617 | 555 | |||||||||
Corporate | (27 | ) | (13 | ) | (19 | ) | ||||||
| $ | 1,177 | $ | 1,087 | $ | 1,022 | |||||||
Net sales increased by $651 million, or 12%, to $6,174 million for the year ended December 31, 2004 due to $254 million of favorable foreign currency, $254 million of new business and $239 million of increased sales volumes. These increases were partially offset by $71 million of customer price reductions and $25 million due to disruptions associated with a fire that occurred at the Company’s Smithville, Tennessee aftermarket distribution center in March 2004. The sales increase was attributable to new business experienced in both the OE and aftermarket segments. Volume increases were also experienced in both segments and were driven by increased demand for the Company’s heavy duty products and market share growth in the North American aftermarket.
Gross margin increased by $90 million, or 8%, to $1,177 million for the year ended December 31, 2004 from $1,087 million in 2003. Increased sales volumes and favorable foreign currency contributed $210 million of gross margin during 2004. These positive factors were partially offset by customer price reductions of $71 million and raw material inflation of approximately $50 million primarily in ferrous metals and hydrocarbon-based commodities. Net productivity gains of $10 million from the Company’s ongoing cost reduction activities in 2004 partially offset these increased costs. Through its centralized supply chain functions, the Company continues to work with its suppliers to reduce its global material costs. However, the Company expects raw material steel supply will continue to be constrained and the impact of increasing material costs or disruptions in supply will likely continue to pressure the Company’s operating results.
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Reporting Segment Results 2004 v. 2003
The following table provides changes in sales and gross margin for the year ended December 31, 2004 compared with the year ended December 31, 2003 for each of the Company’s reporting segments. “SSP” and “AM” represent Sealing Systems and Systems Protection and Aftermarket, respectively.
| Powertrain | SSP | Friction | AM | Corporate | Total | |||||||||||||||||||
| (Millions of Dollars) | ||||||||||||||||||||||||
2003 Sales | $ | 1,847 | $ | 622 | $ | 441 | $ | 2,613 | $ | — | $ | 5,523 | ||||||||||||
Sales volumes | 211 | 54 | 56 | 172 | — | 493 | ||||||||||||||||||
Price reductions | (37 | ) | (12 | ) | (3 | ) | (19 | ) | — | (71 | ) | |||||||||||||
Smithville business interruption | — | — | — | (25 | ) | — | (25 | ) | ||||||||||||||||
Foreign currency | 125 | 18 | 33 | 78 | — | 254 | ||||||||||||||||||
2004 Sales | $ | 2,146 | $ | 682 | $ | 527 | $ | 2,819 | $ | — | $ | 6,174 | ||||||||||||
| Powertrain | SSP | Friction | AM | Corporate | Total | |||||||||||||||||||
| (Millions of Dollars) | ||||||||||||||||||||||||
2003 Gross Margin | $ | 260 | $ | 104 | $ | 119 | $ | 617 | $ | (13 | ) | $ | 1,087 | |||||||||||
Production volumes / new business / mix | 81 | 17 | 12 | 58 | — | 168 | ||||||||||||||||||
Price reductions | (37 | ) | (12 | ) | (3 | ) | (19 | ) | — | (71 | ) | |||||||||||||
Sourcing / raw materials | (19 | ) | (17 | ) | (14 | ) | — | — | (50 | ) | ||||||||||||||
Smithville business interruption | — | — | — | (9 | ) | — | (9 | ) | ||||||||||||||||
Productivity, net of inflation | 15 | 17 | (10 | ) | 2 | (14 | ) | 10 | ||||||||||||||||
Foreign currency | 16 | 5 | 8 | 13 | — | 42 | ||||||||||||||||||
2004 Gross Margin | $ | 316 | $ | 114 | $ | 112 | $ | 662 | $ | (27 | ) | $ | 1,177 | |||||||||||
Powertrain
Despite declines in light vehicle production levels in North America and Europe, Powertrain sales volumes increased by $211 million due to higher demand for the Company’s heavy-duty products. Sales volumes were also favorably impacted by the continued growth of automotive diesel platforms in Europe. Powertrain experienced significant share gains in predominantly all markets and regions served.
Increased sales volumes contributed $81 million in gross margin during 2004. However, customer price reductions of $37 million and raw material cost inflation of $19 million more than offset the favorable impact of productivity and foreign currency. The Company’s Powertrain business continues to develop and execute restructuring programs designed to streamline its operations and reduce costs.
Sealing Systems and Systems Protection
Sales volumes increased $54 million during 2004 as compared to 2003 due to increased demand for heavy-duty products in Europe and North America, customer program launches for several domestic OEM’s and increased business in the Asian markets. During 2004, the Systems Protection business benefited from a reversal of the component rationalization program commenced by one of its large customers in 2003.
Increased sales volumes contributed $17 million in gross margin during 2004 as compared to 2003. The Sealing Systems business is a significant user of steel and hydrocarbon-based products, the cost of which increased significantly during 2004. The Company’s Sealing Systems and Systems Protection businesses continue to develop and execute restructuring programs designed to streamline their operations and reduce costs.
Friction
Sales volumes increased $56 million due to increased demand for the Company’s heavy-duty products and new business gains originating in North America and Europe. Whereas all regions benefited from higher market volumes, the net new business gains were primarily in Europe.
Increased sales volumes contributed $12 million in gross margin during 2004 as compared to 2003, which were more than offset by increased raw material costs and inefficiencies in production caused by a significant number of new product launches. Increased cost of raw materials reduced gross margin by approximately $14 million during
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2004, primarily attributable to the increased costs of steel backing plates used in disc pad production and chemicals and resins used in friction material formulations.
Aftermarket
Net sales increased during 2004 due to increased demand for the Company’s products and continued market penetration in North America. Adjusting for the effects of foreign currency and price reductions, net sales increased $172 million during 2004 as compared to 2003, comprised of $113 million in market demand and $59 million in net new business. The increased market demand and new business gains reflect continued market share performance of the Company’s products, particularly in under-car applications such as friction, drum and rotor and wheel-end product categories.
In March 2004, the Company’s chassis aftermarket distribution center located in Smithville, Tennessee was destroyed by fire. The Company estimates that the destruction of this distribution center resulted in lost sales of $25 million and lost gross margin of $9 million during 2004. The Company reestablished distribution operations in a new leased facility in Smyrna, Tennessee.
Increased sales volumes contributed $58 million in gross margin during 2004 as compared to 2003, more than offsetting customer price reductions of $19 million and the impact of the Smithville fire.
Corporate
Corporate expenses are comprised primarily of certain central headquarters functions as well as employee post-retirement benefits and other general insurance coverages. The increase of $14 million in Corporate expenses is primarily due to increased employee benefit costs associated with the Company’s U.K. pension plans.
Selling, General and Administrative Expense
Selling, general and administrative (“SG&A”) expenses were $950 million in 2004 compared to $869 million in 2003. Despite $36 million of unfavorable foreign currency and increased employee benefit costs, SG&A decreased as a percentage of sales primarily due to the Company’s cost reduction efforts.
Interest Expense
Net interest expense remained fairly consistent at $102 million in 2004 compared with $98 million in 2003. In accordance with SOP 90-7, the Company has not accrued the contractual interest of $153 million on its pre-petition debt.
Gain on Involuntary Conversion
On March 5, 2004, a fire at the Company’s Smithville, Tennessee distribution center resulted in extensive damage to the facility and the loss of substantially all of its related equipment and inventory. The Company’s insurance carrier settled the claims related to the Smithville, Tennessee fire. As a result of settling these claims, the Company received total cash proceeds of $102.2 million and recorded a gain on involuntary conversion of $46.1 million.
Other Expense, net
Other expense, net was $22 million in 2004, compared to $33 million in 2003. This change is primarily attributable to a decrease in restructuring charges of $15 million and $4 million of other insurance recoveries, partially offset by $8 million of foreign currency exchange during 2004.
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Reporting Segment Results 2003 v. 2002
The following table provides changes in sales and gross margin for the year ended December 31, 2003 compared with the year ended December 31, 2002 for each of the Company’s reporting segments. “SSP” and “AM” represent Sealing Systems and Systems Protection and Aftermarket, respectively.
| Powertrain | SSP | Friction | AM | Corporate | Total | |||||||||||||||||||
| (Millions of Dollars) | ||||||||||||||||||||||||
2002 Sales | $ | 1,651 | $ | 641 | $ | 379 | $ | 2,486 | $ | — | $ | 5,157 | ||||||||||||
Sales volumes | 49 | (34 | ) | 27 | 20 | — | 62 | |||||||||||||||||
Price reductions | (26 | ) | (11 | ) | (2 | ) | (5 | ) | — | (44 | ) | |||||||||||||
Foreign currency | 173 | 26 | 37 | 112 | — | 348 | ||||||||||||||||||
2003 Sales | $ | 1,847 | $ | 622 | $ | 441 | $ | 2,613 | $ | — | $ | 5,523 | ||||||||||||
| Powertrain | SSP | Friction | AM | Corporate | Total | |||||||||||||||||||
| (Millions of Dollars) | ||||||||||||||||||||||||
2002 Gross Margin | $ | 263 | $ | 124 | $ | 99 | $ | 555 | $ | (19 | ) | $ | 1,022 | |||||||||||
Production volumes / new business / mix | — | (19 | ) | 13 | 17 | — | 11 | |||||||||||||||||
Price reductions | (26 | ) | (11 | ) | (2 | ) | (5 | ) | — | (44 | ) | |||||||||||||
Productivity, net of inflation | (7 | ) | 5 | (3 | ) | 34 | 8 | 37 | ||||||||||||||||
Foreign currency | 30 | 5 | 12 | 16 | (2 | ) | 61 | |||||||||||||||||
2003 Gross Margin | $ | 260 | $ | 104 | $ | 119 | $ | 617 | $ | (13 | ) | $ | 1,087 | |||||||||||
Powertrain
Net sales increased during 2003 as compared to 2002, driven by favorable foreign currency of $173 million and increased sales volumes. Increased sales volumes were due to strong OE production volumes in Europe reflecting the growth of automotive diesel platforms. This favorability was partially offset by $26 million of customer price reductions, principally in Europe.
Gross margin was $260 million, or 14% of sales, for 2003 compared to $263 million, or 16% of sales in 2002. Gross margin was favorably impacted by $30 million of foreign currency, which was more than offset by customer price reductions of $26 million and other net production cost increases of $7 million.
Sealing Systems and Systems Protection
Sales volume decreased $34 million during 2003 as compared to 2002. Unfavorable OE production levels in North America adversely affected Sealing Systems sales volumes by $15 million. Systems Protection sales volumes decreased by $14 million as a result of a component rationalization program by a large customer that reduced the amount of electro-magnetic and physical shielding products in a number of its existing vehicle platforms.
Gross margin was $104 million, or 17% of sales, for 2003 compared to $124 million, or 19% of sales in 2002. The unfavorable impact of decreased production volumes and customer price reductions of $19 million and $11 million, respectively, more then offset productivity and foreign currency favorability.
Friction
Sales volume increased by $27 million during 2003 as compared to 2002. In North America, Europe and Asia, favorable automotive and heavy-duty production levels increased sales by $9 million, $11 million and $4 million, respectively. New business gains originating in both North America and Europe increased sales by $3 million.
Favorable foreign currency of $12 million and increased sales volumes of $13 million increased gross margin during 2003 as compared to 2002. These factors more than offset customer price reductions and labor inflation in excess of productivity improvements.
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Aftermarket
Adjusting for the effects of foreign currency and price reductions, net sales increased $20 million during 2003 as compared to 2002, comprised of new business in North America. New business gains were primarily attributable to continued market share performance of the Company’s products, particularly in under-car applications such as friction, drum and rotor and wheel-end product categories.
Gross margin increased by $62 million during 2003 as compared to 2002. Favorable foreign currency of $16 million and increased sales volumes of $17 million more than offset customer price reductions of $5 million.
Corporate
Corporate expenses are comprised primarily of certain central headquarters functions as well as employee post-retirement benefits and other general insurance coverages.
Selling, General and Administrative Expense
SG&A expenses were $869 million, or 16% of sales, in 2003 as compared to $809 million, or 16% of sales, in 2002. The increase in SG&A costs was due to $53 million of foreign currency and $42 million of increased pension costs, partially offset by reduced headcount and other cost reduction activities.
Interest Expense
Net interest expense decreased by $25 million in 2003 to $98 million. This decrease is due to the recognition of $17 million in interest income related to tax refunds and lower average outstanding debt. In accordance with SOP 90-7, the Company has not accrued the contractual interest of $163 million on its pre-petition debt.
Other Expense, net
Other expense, net decreased to $33 million in 2003 from $40 million in 2002. The decrease is primarily due to reduced costs of financing arrangements and the effect of foreign currency transactions.
Restructuring Activities
The Company has undertaken various restructuring activities to streamline its operations, consolidate and take advantage of available capacity and resources, and ultimately achieve net cost reductions. Restructuring activities include efforts to integrate and rationalize the Company’s businesses and to relocate manufacturing operations to lower cost markets.
The Company accounted for costs related to all restructuring activities initiated prior to January 1, 2003 under the requirements of EITF No. 94-3 “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” Accordingly, related employee termination benefits and other costs to exit an activity were recognized on the date when management committed the Company to an exit plan. Effective January 1, 2003, the Company’s restructuring accounting policy changed pursuant to the requirements of SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities.” Currently, the Company defines restructuring expense to include costs directly associated with exit or disposal activities accounted for in accordance with SFAS No. 146, employee severance costs incurred as a result of an exit or disposal activity accounted for in accordance with SFAS Nos. 88 and 112, and pension and other postemployment benefit costs incurred as a result of an exit or disposal activity accounted for in accordance with SFAS Nos. 87 and 106.
Estimates of restructuring charges are based on information available at the time such charges are recorded. In general, management anticipates that restructuring activities will be completed within a timeframe such that significant changes to the exit plan are not likely. In certain countries where the Company operates, statutory requirements include involuntary termination benefits that extend several years into the future. Accordingly, severance payments continue well past the date of termination at many international locations. Thus, these programs appear to be ongoing when, in fact, terminations and other activities under these programs have been substantially
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completed. Management expects that future savings resulting from execution of its restructuring programs will generally result in full pay back within 36 to 60 months.
Due to the inherent uncertainty involved in estimating restructuring expenses, actual amounts paid for such activities may differ from amounts initially estimated. Accordingly, the Company reversed approximately $6 million, $21 million and $21 million of previously recorded reserves in 2004, 2003 and 2002, respectively. Such reversals are recorded consistent with SEC Staff Accounting Bulletin #100 and result from actual costs at program completion being less than costs estimated at the commitment date. Subsequent to its filing for Chapter 11 bankruptcy protection, principally during 2003 and 2002 the Company was able to achieve more favorable resolution of leases and other contractual arrangements than estimated as of the commitment dates. Additionally, the Company also experienced a higher rate of voluntary employee attrition subsequent to filing Chapter 11, resulting in lower severance costs than estimated as of the commitment dates.
Management expects to finance these restructuring programs through cash generated from its ongoing operations or through cash available under its existing DIP facility, subject to the terms of applicable covenants. Management does not expect that the execution of these programs will have an adverse impact on its liquidity position.
The Company’s restructuring activities are undertaken as necessary to execute management’s strategy and generally fall into one of the following categories:
| 1. | Closure of facilities and relocation of production – In connection with the Company’s strategy, certain operations have been closed and related production relocated to low cost geographies or to other locations with available capacity. |
| 2. | Consolidation of administrative functions and standardization of manufacturing processes – As part of its productivity initiative, the Company has acted to consolidate its administrative functions and charge its manufacturing processes to reduce selling, general and administrative costs and improve operating efficiencies through standardization of processes. |
The following is a summary of the Company’s consolidated restructuring reserves and related activity for 2004, 2003 and 2002. “SSP” and “AM” represent Sealing Systems and System Protection and Aftermarket, respectively.
| Powertrain | SSP | Friction | AM | Corporate | Total | |||||||||||||||||||
| (Millions of dollars) | ||||||||||||||||||||||||
Balance of reserves at January 1, 2002 | $ | 15.2 | $ | 9.9 | $ | 15.5 | $ | 25.2 | $ | 7.7 | $ | 73.5 | ||||||||||||
Provisions | 38.8 | 3.9 | 6.3 | 3.0 | 0.5 | 52.5 | ||||||||||||||||||
Reversals | (1.2 | ) | (0.2 | ) | (0.2 | ) | (18.6 | ) | (0.3 | ) | (20.5 | ) | ||||||||||||
Payments | (24.8 | ) | (5.1 | ) | (6.9 | ) | (0.7 | ) | (1.7 | ) | (39.2 | ) | ||||||||||||
Foreign currency | 4.0 | 0.6 | 0.5 | 5.2 | 0.8 | 11.1 | ||||||||||||||||||
Balance of reserves at December 31, 2002 | 32.0 | 9.1 | 15.2 | 14.1 | 7.0 | 77.4 | ||||||||||||||||||
Provisions | 28.1 | 5.9 | 1.8 | 17.1 | 0.6 | 53.5 | ||||||||||||||||||
Reversals | (1.6 | ) | (1.5 | ) | (10.5 | ) | (4.0 | ) | (3.2 | ) | (20.8 | ) | ||||||||||||
Payments | (33.0 | ) | (11.6 | ) | (6.3 | ) | (20.9 | ) | (0.9 | ) | (72.7 | ) | ||||||||||||
Foreign currency | 5.8 | 0.3 | 0.7 | 0.6 | 0.9 | 8.3 | ||||||||||||||||||
Balance of reserves at December 31, 2003 | 31.3 | 2.2 | 0.9 | 6.9 | 4.4 | 45.7 | ||||||||||||||||||
Provisions | 13.0 | 1.7 | — | 6.6 | 1.8 | 23.1 | ||||||||||||||||||
Reversals | (1.0 | ) | — | — | (0.7 | ) | (3.9 | ) | (5.6 | ) | ||||||||||||||
Payments | (23.6 | ) | (0.2 | ) | (0.7 | ) | (10.1 | ) | (1.3 | ) | (35.9 | ) | ||||||||||||
Foreign currency | (1.0 | ) | 0.1 | 1.4 | 0.2 | (0.1 | ) | 0.6 | ||||||||||||||||
Balance of reserves at December 31, 2004 | $ | 18.7 | $ | 3.8 | $ | 1.6 | $ | 2.9 | $ | 0.9 | $ | 27.9 | ||||||||||||
The Company’s restructuring reserve balances are principally comprised of severance and employee-related costs. Significant restructuring activities for the years ended December 31, 2004, 2003 and 2002 are described below by reporting segment.
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Significant restructuring activities for the year ended December 31, 2004
Powertrain
| • | The Company recorded approximately $9 million of severance cost related to the closure of the Bradford, United Kingdom piston operations initially announced in 2003. This incremental severance charge has been recorded pursuant to an agreement reached with certain employees of the facility during 2004. While the closure of the Bradford facility was completed during 2004, payments related to this severance program will extend through 2014. As of December 31, 2004, approximately $8 million was remaining as a restructuring reserve related to this program. Expected future cost savings associated with the Bradford facility closure are estimated to be approximately $14 million per annum. |
| • | The Company’s German engine bearing operations continued their restructuring program to transfer certain low volume production with high labor content to low cost geographies, specifically Poland. Restructuring charges of approximately $3 million were recorded during 2004 related to severance costs incurred pursuant to a statutory early retirement program. These charges are in addition to the approximately $4 million, $2 million and $4 million recorded during the years ended December 31, 2003, 2002, and 2001, respectively. Payments of approximately $3 million, $2 million and $2 million were made against this reserve during 2004, 2003 and 2002, respectively. At December 31, 2004, the Company had remaining reserves of approximately $6 million related to these activities. While the transfer of production was completed during 2004, payment of employee severance costs is expected to continue through 2008. Expected savings associated with this activity are estimated to be approximately $8 million per annum. |
Aftermarket
| • | The Company initiated the relocation of its ignition operations in Naas, Ireland to existing facilities located in Burlington, Iowa and Carpi, Italy. This restructuring activity was completed during the third quarter of 2004. Related employee severance costs of approximately $6 million were charged and paid during the year ended December 31, 2004. Accordingly, the Company had no remaining reserves related to this activity as of December 31, 2004. Expected future cost savings associated with this activity are estimated to be approximately $2 million per annum. |
Significant restructuring activities for the year ended December 31, 2003
Powertrain
| • | The Company announced the closure and relocation of its Bradford, United Kingdom piston operations to other existing European manufacturing facilities with available capacity or with lower manufacturing costs. The Company recorded approximately $14 million of severance charges related to this program during the year ended December 31, 2003. Subsequently, payments of $1 million and $13 million were made against this provision during the years ended December 31, 2003 and 2004, respectively. The Company had remaining reserves of approximately $13 million as of December 31, 2003 and since closure of this facility has been completed during 2004, no reserve is remaining as of December 31, 2004 related to these costs. Expected savings associated with this activity are estimated to be approximately $14 million per annum. |
| • | The Company incurred severance charges of approximately $4 million to eliminate redundancies across its operations in France related to changes in administrative and manufacturing processes. Payments of approximately $3 million and $1 million were made during the years ended December 31, 2003 and 2004, respectively. At December 31, 2003 the Company had remaining reserves of $1 million related to these activities. Expected savings associated with these activities are estimated to be approximately $3 million per annum. |
| • | Restructuring charges of approximately $2 million were recorded to further streamline and automate administrative functions and manufacturing processes at the Company’s piston manufacturing operation in Gorzyce, Poland. These charges are in addition to similar charges of approximately $4 million recorded in 2002 and are the result of expanding the scope of the initial program. Payments of approximately $2 million were |
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made related to this program in 2003, accordingly no reserve was remaining at December 31, 2003 related to this activity. Expected savings associated with this activity are estimated to be approximately $3 million per annum. |
| • | The Company’s German engine bearing operations continued their restructuring programs to transfer certain low volume production with high labor content to low cost geographies, specifically Poland. Restructuring charges of approximately $4 million were recorded in 2003. These charges were in addition to $2 and $4 million recorded for the same program during the years ended December 31, 2002 and 2001, respectively. Payments of approximately $2 million for each of the years ended December 31, 2003 and 2002 were recorded. Approximately $6 million was recorded as a restructuring reserve related to this program as of December 31, 2003. |
| • | The Company recorded approximately $1 million during 2003 related to the previously announced closure and relocation of its piston ring operations in Sunderland, United Kingdom to other existing European facilities with available capacity. This amount was in addition to restructuring charges of $6 million recorded during the year ended December 31, 2002, related to the same program. Payments of approximately $5 million and $2 million were made during the years ended December 31, 2003 and 2002, respectively. This closure and relocation project was completed and all amounts were paid during 2003, accordingly, no reserves remain as of December 31, 2003. |
Sealing Systems & Systems Protection
| • | The Company recorded approximately $3 million related to the closure of its Sealing Systems operations in Cardiff, Wales. Production from this facility was relocated to other existing European manufacturing facilities with available capacity or with lower cost to manufacture. This amount was in addition to previously recorded restructuring charges related to the same program of $4 million and $5 million during the years ended December 31, 2002 and 2001, respectively. Payments of approximately $9 million and $3 million were made in 2003 and 2002, respectively, relating to this project. This project was completed during 2003 and all related payments were made, accordingly no reserve was remaining as of December 31, 2003. Expected savings associated with this activity are estimated to be approximately $2 million per annum. |
Friction
| • | Reserve reversals of approximately $11 million were recorded related to the planned closure of certain North American friction facilities. Such reserves were initially recorded during 2001. The reversal resulted from the Company’s decision not to complete closure of all facilities as originally intended. This decision resulted from delays in the closure due to execution difficulties and protracted negotiations with organized labor unions. During 2002 the Company began to experience a substantial increase in demand for its friction products largely due to the successful introduction of a new aftermarket friction product by the Company. Pursuant to the need for additional manufacturing capacity and successful negotiations with the UAW, a decision was made during the 4th quarter 2003 not to close all facilities as initially planned. |
Aftermarket
| • | The Company relocated its ignition production from Aubange, Belgium to Upton, England and recorded related severance and exit costs of approximately $10 million. The relocation of this production was completed during 2003. Payments of related severance and exit costs of approximately $8 million and $1 million were made during the years ended December 31, 2003 and 2004, respectively. As of December 31, 2003 and 2004 remaining reserves related to this activity approximated $2 million and $1 million, respectively. Expected savings associated with this activity are estimated to be approximately $5 million per annum. |
| • | Restructuring charges of $3 million were recorded related to the previously announced consolidation of distribution operations at the Company’s Aftermarket distribution facility located in Gif sur Yvette, France into its central European distribution facility in Belgium. This restructuring charge is in addition to a previously recorded amount of $2 million, which was recorded in 2002. Payment of related severance costs of approximately $3 million and $1 million were made during the year ended December 31, 2003 and 2002, respectively. At December 31, 2003, the Company had approximately $1 million remaining reserves related to |
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this activity. The consolidation was completed during 2003 and remaining reserve amounts were paid during 2004. Expected savings associated with this activity are estimated to be approximately $5 million per annum. Consolidation of these facilities was completed in 2003. |
Significant restructuring activities for the year ended December 31, 2002
Powertrain
| • | The Company announced the closure of its Bridgewater, United Kingdom piston operation. Related production from this operation was relocated to other existing European manufacturing facilities with available capacity or with lower cost to manufacture. In connection with this program, the Company recorded approximately $10 million for related severance and exit costs. Payments approximating $9 million were made during 2003. Remaining reserves as of December 31, 2002 and 2003 were $10 million and $1 million, respectively. This program was completed during 2003 and no reserves remained as of December 31, 2004 related to this program. Expected savings associated with this activity are estimated to be approximately $2 million per annum. |
| • | The Company recorded restructuring charges of $11 million related to the closure of its piston manufacturing operations in Flowery Branch, Georgia, Orangeburg, South Carolina and Sumter, South Carolina. Production from these facilities was relocated to other existing North American manufacturing facilities with available capacity or with lower cost to manufacture. The closure of Flowery Branch and Orangeburg was completed during 2003 and closure of Sumter was completed in 2004. Payments of approximately $2 million, $4 million and $4 million were made against this reserve during the years ended December 31, 2002, 2003 and 2004, respectively. The Company had remaining reserves related to these activities of approximately $7 million, $5 million and $1 million as of December 31, 2002, 2003 and 2004, respectively. While the closures have been completed, final payments are expected to continue through June 2005. Expected savings associated with this activity are estimated to be approximately $17 million per annum. |
| • | The Company recorded approximately $6 million during 2002 related to the closure and relocation of its piston ring operations in Sunderland, United Kingdom to other existing European facilities with available capacity. Payments of approximately $2 million were made against this reserve during the year ended December 31, 2002. The Company had remaining reserves related to these activities of approximately $4 million as of December 31, 2002. The program was completed during 2003, accordingly the Company has no reserve for this program at December 31, 2003. |
| • | The Company initiated administrative function and manufacturing process changes at the Company’s piston manufacturing operations located in Nuremburg, Germany, resulting in a reduction of the employee work force. Restructuring charges of approximately $5 million were recorded for the year ended December 31, 2002. Payments of approximately $1 million, $1 million and $1 million were made during the years ended December 31, 2002, 2003 and 2004, respectively. The Company had remaining reserves of approximately $5 million, $4 million and $3 million related to this activity as of December 31, 2002, 2003 and 2004, respectively. The administrative function and manufacturing process changes were completed during 2003. However, employee severance payments are pursuant to a local statutory program and are scheduled to continue through June 2009. Expected savings associated with this activity are estimated to be approximately $5 million per annum. |
| • | During 2002, management announced a program to streamline and automate administrative functions and manufacturing processes at Company’s piston manufacturing operation in Gorzyce, Poland. Charges of approximately $4 million were recorded during the year ended December 31, 2002 relating to this program. Approximately $4 million of payments were made related to this program in 2002. At December 31, 2002, the Company had no remaining reserves related to this activity. Expected savings associated with this activity are estimated to be approximately $5 million per annum. |
| • | The Company’s German engine bearing operations continued their restructuring programs to transfer certain low volume production with high labor content to low cost geographies, specifically Poland. Restructuring charges of approximately $2 million were recorded in 2002. These charges were in addition to $2 million recorded for the same program during the year ended December 31, 2001. Payments of approximately $2 |
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million were made during the year ended December 31, 2002. Approximately $2 million was recorded as a restructuring reserve related to this program as of December 31, 2002. |
Sealing Systems and Systems Protection
| • | The Company recorded approximately $4 million related to the closure its Sealing Systems operations in Cardiff, Wales. Production from this facility was relocated to other existing European manufacturing facilities with available capacity or with lower cost to manufacture. This amount was in addition to previously recorded restructuring charges related to the same program of $5 million during the year ended December 31, 2001. Payments of approximately $3 million were made during 2002 and a reserve of approximately $6 million was remaining as of December 31, 2002. |
Friction
| • | The Company recorded approximately $4 million related to the announced closure of its aftermarket half-block operations in Marienheide, Germany. Related severance and exit payments of approximately $3 million and $1 million were made during the years ended December 31, 2002 and 2003, respectively. At December 31, 2002, the Company had a remaining reserve of approximately $1 million related to this activity. The closure of the half-block operations in Marienheide, Germany was completed during 2003. Expected savings associated with this activity are estimated to be approximately $2 million per annum. |
Aftermarket
| • | The Company announced and began the consolidation of certain distribution operations at its Aftermarket distribution facility located in Gif sur Yvette, France into its central European distribution facility in Belgium. Restructuring charges of $2 million were recorded during the year ended December 31, 2002. Payment of related severance costs of approximately $1 million was made in during the year ended December 31, 2002. At December 31, 2002, the Company had a remaining reserve of approximately $1 million related to this activity. Expected savings associated with this activity are estimated to be approximately $5 million per annum. |
| • | Reserve reversals of approximately $19 million related to the Aftermarket distribution optimization restructuring program initially recorded in 2000 and 2001 were reversed upon completion of related restructuring activities during 2002. Approximately $7 million of this reversal was attributable to lease termination costs that were not incurred as expected under the restructuring plan. Lease contracts identified within the restructuring plan were instead separately terminated during 2002 pursuant to the Company’s Chapter 11 filing on October 1, 2001. Approximately $3 million of this reversal was attributable to planned employee severance costs that were not incurred as identified employees voluntarily terminated their employment in anticipation of the facility closure or in connection with the Company’s Chapter 11 filing. Approximately $3 million of the reversal was due to the Company’s decision not to close the Berkley, MO distribution facility as initially planned. This decision was based upon the need for additional capacity due to increasing brake hard parts and friction sales volumes not anticipated at the commitment date. The remaining amount of the reversal represents an aggregate of individually insignificant amounts resulting from differences in actual costs to exit as compared to initial estimates. |
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Adjustment of Assets to Fair Value
Definite-Lived Long-Lived Assets
The Company recorded impairment charges of $82.7 million, $23.4 million, and $62.6 million for the years ended December 31, 2004, 2003 and 2002, respectively, to adjust definitive-lived long-lived assets to their estimated fair values in accordance with SFAS No. 144. The charges by reporting segment are as follows:
| Year Ended December 31 | |||||||||
| 2004 | 2003 | 2002 | |||||||
| (Millions of Dollars) | |||||||||
Powertrain | $ | 72.7 | $ | 14.3 | $ | 52.3 | |||
Sealing Systems and System Protection | 3.1 | 0.3 | 5.5 | ||||||
Friction | 3.3 | 3.9 | — | ||||||
Aftermarket | 3.4 | 4.9 | 3.9 | ||||||
Corporate | 0.2 | — | 0.9 | ||||||
| $ | 82.7 | $ | 23.4 | $ | 62.6 | ||||
2004 Impairments
Powertrain:
| • | The total charge of $72.7 million during 2004 includes $20.0 million to write down property, plant and equipment related to the Company’s Powertrain transmission operations in France. This operation is comprised of four facilities that manufacture transmission and gear components primarily for sale to OE customers. High labor content, difficulties in commercialization of new product technology, and continued manufacturing inefficiencies resulted in a revaluation of the expected future cash flows of these facilities as compared to the carrying value of property plant and equipment. |
| • | The Company also recorded $19.0 million in impairment charges for two camshaft operations located in the United Kingdom. The impairment reflects a revaluation of future expected cash flows primarily due to anticipated lower volumes for these facilities. |
| • | The Company recorded $9.0 million, $7.8 million, $5.8 million and $4.7 million of impairment charges on property, plant and equipment located in piston manufacturing facilities in the United States, Italy, Poland and China, respectively. The United States impairment reflects the write-down of fixed assets to estimated disposition value related to the announcement of the closure and relocation of a piston manufacturing facility to other facilities primarily in the United States and Mexico. This closure is anticipated to be completed in 2005. The Italy, Poland and China impairments are due to other than temporary declines in sales and estimated future cash flows. |
Sealing Systems and Systems Protection, Friction and Aftermarket:
| • | The Company recorded impairment charges of $3.1 million, $3.3 million, and $3.4 million for impairment charges on facilities in each of the Sealing Systems and System Protection, Friction, and Aftermarket reporting segments. Each of these facilities is located in Europe. These impairments are due to other than temporary declines in sales volumes and profitability at those facilities. |
2003 Impairments
The total charge of $23.4 million during 2003 includes $14.3 million net write down of Powertrain property, plant and equipment. In addition, the Company recorded $9.1 million of impairment charges on property, plant and equipment located in various manufacturing facilities in Europe to be held and used in accordance with SFAS No. 144, due to an other than temporary decline in sales volumes and profitability at those facilities. The fair value of property, plant and equipment was based upon estimated discounted future cash flows and estimates of salvage value. The impairment charges represent the difference between the estimated fair values and the carrying value of the subject assets.
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2002 Impairments
The total charge of $62.6 million during 2002 includes $46.7 million to write-down property, plant and equipment at five facilities that the Company has closed. The estimated fair values were determined based upon discontinued future cash flows and estimates of salvage value. An additional charge of $6.6 million relates to the write down of property, plant and equipment at a European camshaft foundry related to an other than temporary decline in sales volumes at that facility. The estimated fair value of this equipment was determined based upon discounted future cash flows. The remaining charge primarily relates to the impairment of assets that the Company intends to divest. The value of these assets was estimated based upon the future discounted cash flows should the Company divest of these assets on and individual, open market basis.
Goodwill and Other Indefinite-Lived Intangible Assets
Effective January 1, 2002, the Company adopted SFAS No. 142, resulting in the discontinuance of amortization of goodwill and indefinite-lived intangible assets. The adoption of this standard also required the reclassification of various intangible asset classes according to the measurability of their useful lives. Upon the adoption of SFAS No. 142, the Company recorded a non-cash charge of $1,464.5 million to reduce the carrying value of its goodwill and indefinite-lived intangible assets to their estimated fair value as required by SFAS No. 142. The tax impact related to the charge was $46.6 million and was limited to the benefit derived from the impairment of certain intangible assets other than goodwill. The charge is presented as a cumulative effect of change in accounting principle in the consolidated statement of operations for the year ended December 31, 2002.
As of October 1, 2003, the Company completed its annual impairment analysis as required by SFAS No. 142 and recorded an impairment charge in a Powertrain operating unit of $70.5 million to adjust the carrying value of indefinite-lived intangible assets to estimated fair value. The estimated fair value of the reporting unit was determined based upon consideration of various valuation methodologies, including guideline transaction multiples, multiples of current earnings, and projected future cash flows discounted at rates commensurate with the risk involved. The 2003 impairment charge is primarily attributable to a decrease in the operating unit’s estimated fair value based upon management’s expectation of future financial performance.
As of October 1, 2004, the Company performed its annual impairment analysis as required by SFAS No. 142 and recorded an impairment charge in the Sealing Systems operating unit of $193.7 million to adjust the carrying value of goodwill to estimated fair value. The estimated fair value of the reporting unit was determined based upon consideration of various valuation methodologies, including guideline transaction multiples, multiples of current earnings, and projected future cash flows discounted at rates commensurate with the risk involved. The 2004 impairment charge is primarily attributable to a decrease in the operating unit’s estimated fair value based upon the effect of market conditions on current operating results and on management’s projections of future financial performance.
The 2004 goodwill impairment charge is based upon the Company’s best estimate under SFAS No. 5. The ultimate amount of impairment will be determined based upon finalization of the implied fair value of goodwill pursuant to asset valuation and allocation procedures. Any difference between the Company’s best estimate and the final implied fair value of goodwill will be recorded during the first quarter of 2005.
A summary of the impairment charges for goodwill and other intangible assets by reporting segment pursuant to the provisions of SFAS No. 142 is as follows:
| Year Ended December 31 | |||||||||
| 2004 | 2003 | 2002 | |||||||
| (Millions of Dollars) | |||||||||
Powertrain | $ | — | $ | 70.5 | $ | 453.8 | |||
Sealing Systems and Systems Protection | 193.7 | — | — | ||||||
Friction | — | — | 381.9 | ||||||
Aftermarket | — | — | 155.3 | ||||||
Corporate | — | — | 473.5 | ||||||
| $ | 193.7 | $ | 70.5 | $ | 1,464.5 | ||||
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Chapter 11 and Administration Related Reorganization Expenses
Chapter 11 and Administration related reorganization expenses in the consolidated statements of operations consist of legal, financial and advisory fees, including fees of the U.K. Administrators, critical employee retention costs, and other directly related internal costs as summarized below. These expenses fluctuate largely based upon the necessity for professional services by third-party advisors in connection with the Restructuring Proceedings.
| Year Ended December 31 | ||||||||||
| 2004 | 2003 | 2002 | ||||||||
| (Millions of Dollars) | ||||||||||
Professional fees directly related to the filing | $ | 92.5 | $ | 70.4 | $ | 73.7 | ||||
Critical employee retention costs | 10.3 | 8.2 | 19.2 | |||||||
Other direct costs | 15.4 | 18.5 | 14.5 | |||||||
Gain on settlement of outstanding claim | (18.5 | ) | — | — | ||||||
| $ | 99.7 | $ | 97.1 | $ | 107.4 | |||||
In July 2004, the Company reached an agreement with a creditor of one of the Company’s U.S. subsidiaries whereby the Company and the creditor settled an outstanding liability of $20.0 million in exchange for a general unsecured claim of $1.5 million. The settlement agreement was approved by the Bankruptcy Court on July 30, 2004. As a result of this agreement, the Company reduced its recorded liability for this claim and recorded $18.5 million as a reduction to Chapter 11 and Administration related reorganization expense.
Income Taxes
For 2004, the Company recorded income tax expense of $136.1 million on a loss from continuing operations before income taxes of $189.4 million, compared to income tax expense of $52.5 million on a loss from continuing operations before income taxes of $116.1 million in 2003. Income taxes for 2004 varied from the U.S. statutory rate primarily due to non-recognition of income tax benefits on U.K. operating losses and non-deductible items in certain foreign jurisdictions and the U.S., including goodwill impairment. Income taxes for 2003 varied from the U.S. statutory rate primarily due to an increase in deferred tax asset valuation allowances in the U.K. and France partially offset by a U.S. federal income tax benefit. The 2003 U.S. income tax benefit is primarily related to the favorable outcome of refund claims filed in prior years.
At December 31, 2004, the Company had deferred tax assets of $797.2 million, net of a valuation allowance of $1,122.9 million, and deferred tax liabilities of $891.2 million. At December 31, 2003, the Company had deferred tax assets of $769.4 million, net of a valuation allowance of $892.3 million, and deferred tax liabilities of $842.5 million. The deferred tax asset valuation allowance increased by $230.6 million in 2004 due primarily to an increase in the valuation allowance related to the additional minimum pension liability in the U.K., the impact of foreign currency and losses in certain foreign jurisdictions.
The Company evaluates its deferred taxes and related valuation allowances quarterly. If the Company believes that changes in current or future taxable income (loss) will impact the basis for recognizing the benefit of deferred tax assets and related valuation allowances, then adjustments will be provided accordingly.
Liquidity and Capital Resources
Cash Flow Provided by Operating Activities
Net cash provided by operating activities totaled $466 million for the year ended December 31, 2004 compared to $313 million and $257 million for the same periods ended December 31, 2003 and 2002, respectively. Net cash provided by operating activities during 2004 was favorably impacted by the receipt of $102 million of insurance proceeds related to a fire that occurred in March 2004 at the Company’s Smithville, Tennessee aftermarket
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distribution center. Certain significant restructuring activities were completed during 2003 resulting in a $40 million improvement in net cash provided by operating activities during 2004.
Net cash provided by operating activities during 2002 included $16 million of higher Chapter 11 and Administration related reorganization expenses resulting from costs associated with the initial filing process. Restructuring payments were $6 million higher as compared to 2003 due to large programs that were completed during 2002 and such payments did not recur in 2003. Net cash provided by operating activities during 2002 was unfavorably impacted by changes in working capital as compared to 2003.
Cash in the United Kingdom is available only for use by the debtor entities within the United Kingdom and is not available for use outside of such entities subject to final settlement of the U.K. Restructuring proceedings. At December 31, 2004 and 2003, such cash balances were $425 million and $261 million, respectively.
Cash Flow Used by Investing Activities
Cash flow used by investing activities was $227 million in 2004. Capital expenditures amounted to $268 million, partially offset by proceeds from the divestiture of assets and various businesses.
Cash flow used by investing activities was $271 million in 2003. Capital expenditures amounted to $301 million, partially offset by proceeds from the divestiture of assets and various businesses.
The Company maintains investments in 21 non-consolidated affiliates, which are located in Turkey, China, Korea, India, Japan, the United States and Mexico. The Company’s direct ownership in such affiliates ranges from approximately 5% to 50%. The aggregate investment in these affiliates approximates $160 million and $131 million as of December 31, 2004 and 2003, respectively.
The Company’s joint ventures are businesses established and maintained in connection with its operating strategy and are not special purpose entities. In general, the Company does not extend guarantees, loans or other instruments of a variable nature that may result in incremental risk to the Company’s liquidity position. Furthermore, the Company does not rely on dividend payments or other cash flows from its non-consolidated affiliates to fund its operations and, accordingly, does not believe that they have a material effect on the Company’s liquidity.
The Company holds a 50% non-controlling interest in a joint venture located in Turkey. This joint venture was established for the purpose of manufacturing and marketing automotive parts including pistons, pins, piston rings, and cylinder liners to original equipment (“OE”) and Aftermarket customers. Pursuant to the joint venture agreement, the Company’s partner holds an option to put its shares to a subsidiary of the Company at the higher of the current fair value or at a guaranteed minimum amount. The guaranteed minimum amount represents a contingent guarantee of the initial investment of the investment partner. The contingent guarantee can be exercised at the discretion of the joint venture partner. The term of the contingent guarantee is indefinite, consistent with the terms of the joint venture agreement. However, the contingent guarantee would not survive termination of the joint venture agreement. As of December 31, 2004, the total amount of the contingent guarantee, were all triggering events to occur, approximated $55 million. Management believes that this contingent guarantee is substantially less than the estimated current fair value of the guarantees’ interest in the affiliate. Management also believes that exercise of the put option is not reasonably likely within the foreseeable future. However, if this put option is exercised at its estimated current fair value, such exercise would have a material effect on the Company’s liquidity.
In accordance with Statement of Financial Accounting Standards No. 150, the Company has determined that its investments in Chinese joint venture arrangements are considered to be “limited-lived” as such entities have specified durations ranging from 30 to 50 years pursuant to regional statutory regulations. In general, these arrangements call for extension, renewal or liquidation at the discretion of the parties to the arrangement at the end of the contractual agreement. Accordingly, a reasonable assessment cannot be made as to the impact of such contingencies on the future liquidity position of the Company.
Cash Flow Provided from Financing Activities
Cash flow used by financing activities of $37 million and $14 million in 2004 and 2003, respectively, primarily resulted from net payments on the Company’s available credit facilities.
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In December 2004, the Company renegotiated its DIP credit facility. This DIP credit facility expires in December 2005, and the interest rate is either the alternate base rate (“ABR”) plus 1¼ percentage points or a formula based on the London Inter-Bank Offered Rate (“LIBOR”) plus 2¼ percentage points. The ABR is the greater of either the bank’s base rate or the federal funds rate plus ½ percentage point. In addition, the commitment available under the DIP credit facility is mandatorily reduced by a portion of proceeds received from future asset or business divestitures.
The Company’s available borrowings under the DIP credit facility are determined by the underlying collateral at any point in time, consisting of its domestic inventories and domestic accounts receivable. The DIP lenders received permission from the lenders of the Senior Credit Agreements to have priority over their collateral interest. Based upon the collateral securing the DIP credit facility and the overall contractual commitment, the Company had $500 million available for borrowings at December 31, 2004, of which the Company had $278 million of outstanding borrowings and has issued $45 million in letters of credit.
The Company has the following contractual debt obligations and commercial commitments outstanding at December 31, 2004:
Maturities of Contractual Obligations | Debt | Operating Leases | ||||
| (Millions of Dollars) | ||||||
Less than 1 year | $ | 309.6 | $ | 27.2 | ||
1-3 years | 10.1 | 34.6 | ||||
4-5 years | — | 23.0 | ||||
Thereafter | — | 24.3 | ||||
Liabilities subject to compromise | 4,141.5 | — | ||||
Total(1) | $ | 4,461.2 | $ | 109.1 | ||
Expiration of Other Commercial Commitments | Letters of Credit | ||
| (Millions of Dollars) | |||
Less than 1 year | $ | 45.3 | |
Liabilities subject to compromise | 55.4 | ||
Total | $ | 100.7 | |
| (1) | The amounts above exclude the Company’s minimum statutory or negotiated pension plan funding requirements, which are $266 million over the next two years, including $76 million in 2005. The minimum funding requirements after 2005 are dependent upon several factors. The Company also has payments due under other postemployment benefit plans. These other plans are funded as benefits are paid, and are not required to be funded in advance. |
The Company’s ability to obtain cash adequate to fund its needs depends generally on the results of its operations, restructuring initiatives, the Bankruptcy Court’s approval of management’s plans and the availability of financing. Management believes that cash on hand, cash flow from operations, and available borrowings under its DIP credit facility, will be sufficient to fund capital expenditures and meet its post-petition operating obligations for the next fiscal year. In the longer term, the Company believes that the benefits from its announced restructuring programs and favorable resolution of its asbestos liability through Chapter 11 and Administration will provide adequate long-term cash flows. However, there can be no assurance that such initiatives are achievable in this regard or that the terms available for any future financing, if required, would be available or favorable to the Company. Also, resolutions of certain obligations, particularly asbestos obligations, are impacted by factors outside the Company’s control. Given these uncertainties, the Company’s auditors have raised substantial doubt regarding the Company’s ability to continue as a going concern.
At December 31, 2004 the Company was in compliance with all debt covenants under its existing DIP credit facility. Based on current forecasts, the Company expects to be in compliance through the December 2005 expiration of the facility. Changes in the business environment, market factors, macroeconomic factors, or the Company’s ability to achieve its forecasts and other factors outside of the Company’s control, could adversely impact its ability to remain
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in compliance with debt covenants. If the Company were to not be in compliance at a measurement date, the Company would be required to renegotiate its facility. No assurance can be provided as to the impact of such actions.
Asbestos Liability and Legal Proceedings
Note 20 to the consolidated financial statements, entitled “Litigation and Environmental Matters”, on pages 93 through 100 hereof, is incorporated herein by reference.
| ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
In the normal course of business, the Company is subject to market exposure from changes in foreign currency exchange rates, interest rates and raw material prices. To manage a portion of these inherent risks, the Company purchases various derivative financial instruments and commodity futures contracts to hedge against unfavorable market changes. The Company does not hold or issue derivative financial instruments for trading purposes.
Foreign Currency Risk
The Company is subject to the risk of changes in foreign currency exchange rates due to its global operations. The Company manufactures and sells its products in North America, South America, Asia, Europe and Africa. As a result, the Company’s financial results could be significantly affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets in which the Company manufactures and distributes its products. The Company’s operating results are primarily exposed to changes in exchange rates between the U.S. dollar and European currencies.
As currency exchange rates change, translation of the statements of operations of the Company’s international businesses into United States dollars affects year-over-year comparability of operating results. The Company does not generally hedge operating translation risks because cash flows from international operations are generally reinvested locally. Changes in foreign currency exchange rates are generally reported as a component of stockholders’ equity for the Company’s foreign subsidiaries reporting in local currencies and as a component of income for its foreign subsidiaries using the U.S. dollar as the functional currency. The Company’s other comprehensive loss was decreased by $291 million and $355 million in 2004 and 2003, respectively, due to cumulative translation adjustments resulting primarily from changes in the U.S. Dollar to the Euro and British Pound.
As of December 31, 2004 and 2003, the Company’s net current assets (defined as current assets less current liabilities) subject to foreign currency translation risk were $1,096 million and $933 million, respectively. The potential decrease in net current assets from a hypothetical 10% adverse change in quoted foreign currency exchange rates would be $109.6 million and $93.3 million, respectively. The sensitivity analysis presented assumes a parallel shift in foreign currency exchange rates. Exchange rates rarely move in the same direction. This assumption may overstate the impact of changing exchange rates on individual assets and liabilities denominated in a foreign currency.
The Company manages certain aspects of its foreign currency activities and larger transactions through the use of foreign currency options or forward contracts. The Company generally tries to utilize natural hedges within its foreign currency activities, including the matching of revenues and costs. The Company did not have any contracts outstanding at December 31, 2004, and had two contracts outstanding with a combined notional value of $10.4 million at December 31, 2003.
Interest Rate Risk
In connection with the Restructuring Proceedings and in accordance with SOP 90-7, the Company ceased recording interest expense on its outstanding pre-petition Notes, Medium-term notes, and Senior notes effective October 1, 2001. The Company’s contractual interest not accrued or paid in 2004, 2003 and 2002 was $152.5 million, $162.8 million and $164.4 million, respectively. The Company continues to accrue and pay contractual interest on the Senior Credit Agreement in the month incurred, totaling $75.8 million, $71.4 million and $81.8 million in 2004, 2003 and 2002, respectively.
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In connection with the Restructuring Proceedings, the Company entered into a debtor-in-possession (“DIP”) credit facility to supplement liquidity and fund operations during the restructuring proceedings. In December 2004, the Company renegotiated its DIP credit facility. Prior to December 2004, the Company’s DIP credit facility had an interest rate of either the alternate base rate (“ABR”) plus 2 percentage points or a formula based on the London Inter-Bank Offered Rate (“LIBOR”) plus 3 percentage points. The ABR is the greater of either the bank’s prime rate or the base CD rate plus 1 percentage point or the federal funds rate plus ½ percentage point.
The December 2004 DIP credit facility expires in December 2005, and the interest rate is either the alternate base rate (“ABR”) plus 1¼ percentage points or a formula based on the London Inter-Bank Offered Rate (“LIBOR”) plus 2¼ percentage points. The ABR is the greater of either the bank’s base rate or the federal funds rate plus ½ percentage point. In addition, the commitment available under the DIP credit facility is mandatorily reduced by a portion of proceeds received from future asset or business divestitures. The amount outstanding from the DIP facility as of December 31, 2004 was approximately $323 million.
Accordingly, management believes that interest rate risk to the Company is immaterial while the Restructuring Proceedings continue due to the relatively low level of outstanding borrowings on the Company’s DIP credit facility. However, management cannot predict with any certainty the level of interest rate risk that may exist following the completion of the Restructuring Proceedings.
Commodity Price Risk
The Company is dependent upon the supply of certain raw materials used in its production processes; these raw materials are exposed to price fluctuations on the open market. The primary purpose of the Company’s commodity price hedging activities is to manage the volatility associated with these forecasted purchases. The Company monitors its commodity price risk exposures periodically to maximize the overall effectiveness of its commodity forward contracts. Principal raw materials hedged include natural gas, copper, nickel, lead, high-grade aluminum and aluminum alloy. Forward contracts used to mitigate commodity price risk associated with raw materials, for up to eighteen months in the future, are designated as cash flow hedging instruments. These instruments are intended to offset the effect of changes in raw materials prices on forecasted purchases. The Company had three contracts outstanding with a combined notional value of $6.5 million at December 31, 2004, and two contracts outstanding with a combined notional value of $9.2 million at December 31, 2003.
Management believes that commodity price risk associated with its outstanding commodity contracts is immaterial due to the low volume of commodity hedging activity.
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| ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
MANAGEMENT’S REPORT ON
INTERNAL CONTROL OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the U.S. Securities Exchange Act of 1934. Under the supervision and with the participation of the principal executive and financial officers of the Company, an evaluation of the effectiveness of internal controls over financial reporting was conducted based upon the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Based on the evaluation performed under the COSO Framework as of December 31, 2004, management has concluded that the Company’s internal control over financial reporting is effective.
Ernst & Young LLP, an independent registered public accounting firm, has audited management’s assessment of the effectiveness of the Company’s internal control over financial reporting as at December 31, 2004, as stated in their report which is included herein.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Federal-Mogul Corporation
We have audited management’s assessment, included within the accompanying Management Report on Internal Control over Financial Reporting included as Item 8, that Federal-Mogul Corporation (the Company) maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established inInternal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of December 31, 2004 and 2003, the related consolidated statements of operations, shareholders’ deficit, and cash flows for each of the three years in the period ended December 31, 2004, and the financial statement schedule for the three years in the period ended December 31, 2004, and our report dated February 25, 2005 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP |
Detroit, Michigan |
February 25, 2005 |
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Federal-Mogul Corporation
We have audited the accompanying consolidated balance sheets of Federal-Mogul Corporation and subsidiaries (the Company) as of December 31, 2004 and 2003, and the related consolidated statements of operations, shareholders’ deficit, and cash flows for each of the three years in the period ended December 31, 2004. Our audits also included the financial statement schedule for the three years in the period ended December 31, 2004, listed in the index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at December 31, 2004 and 2003, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with U. S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule for the three years in the period ended December 31, 2004, when considered in relation to the basic financial statements, taken as a whole, represents fairly in all material respects the information set forth therein.
The accompanying consolidated financial statements have been prepared assuming that Federal-Mogul Corporation and subsidiaries will continue as a going concern. As more fully described in the notes to the consolidated financial statements, on October 1, 2001, Federal-Mogul Corporation and its wholly-owned United States subsidiaries filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy Code. In addition, certain Federal-Mogul subsidiaries in the United Kingdom have filed jointly for Chapter 11 and Administration under the United Kingdom Insolvency Act of 1986. Uncertainties inherent in the bankruptcy process raise substantial doubt about Federal-Mogul Corporation’s ability to continue as a going concern. Management’s intentions with respect to these matters are also described in the notes. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
As discussed in Note 3 to the consolidated financial statements, the Company changed its method of accounting for goodwill and indefinite-lived intangible assets in 2002.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, based on the criteria established inInternal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 25, 2005 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP |
Detroit, Michigan |
February 25, 2005 |
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CONSOLIDATED STATEMENTS OF OPERATIONS
| Year Ended December 31 | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
(Millions of Dollars, Except Per Share Amounts) | ||||||||||||
Net sales | $ | 6,174.1 | $ | 5,522.9 | $ | 5,157.3 | ||||||
Cost of products sold | 4,996.8 | 4,435.8 | 4,135.0 | |||||||||
Gross margin | 1,177.3 | 1,087.1 | 1,022.3 | |||||||||
Selling, general and administrative expenses | 949.7 | 869.3 | 808.8 | |||||||||
Adjustment of assets to fair value | 276.4 | 93.9 | 62.6 | |||||||||
Asbestos charge | — | 38.9 | — | |||||||||
Interest expense, net | 101.5 | 98.2 | 128.8 | |||||||||
Chapter 11 and Administration related reorganization expenses | 99.7 | 97.1 | 107.4 | |||||||||
Equity earnings of unconsolidated affiliates | (36.0 | ) | (27.3 | ) | (19.8 | ) | ||||||
Gain on involuntary conversion | (46.1 | ) | — | — | ||||||||
Other expense, net | 21.5 | 33.1 | 40.3 | |||||||||
Loss from continuing operations before income taxes and cumulative effect of change in accounting principle | (189.4 | ) | (116.1 | ) | (105.8 | ) | ||||||
Income tax expense | 136.1 | 52.5 | 77.9 | |||||||||
Loss from continuing operations before cumulative effect of change in accounting principle | (325.5 | ) | (168.6 | ) | (183.7 | ) | ||||||
Loss from discontinued operations, net of income taxes | (8.5 | ) | (20.9 | ) | (33.0 | ) | ||||||
Cumulative effect of change in accounting principle, continuing operations, net of income tax benefit | — | — | (1,412.2 | ) | ||||||||
Net loss | $ | (334.0 | ) | $ | (189.5 | ) | $ | (1,628.9 | ) | |||
Basic and Diluted Loss Per Common Share: | ||||||||||||
Loss from continuing operations before cumulative effect of change in accounting principle | $ | (3.73 | ) | $ | (1.93 | ) | $ | (2.21 | ) | |||
Loss from discontinued operations, net of income taxes | (0.10 | ) | (0.24 | ) | (0.40 | ) | ||||||
Cumulative effect of change in accounting principle, net of applicable income tax benefit | — | — | (17.01 | ) | ||||||||
Net loss | $ | (3.83 | ) | $ | (2.17 | ) | $ | (19.62 | ) | |||
See accompanying notes to consolidated financial statements.
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CONSOLIDATED BALANCE SHEETS
| December 31 | ||||||||
| 2004 | 2003 | |||||||
| (Millions of Dollars) | ||||||||
| ASSETS | ||||||||
Current Assets: | ||||||||
Cash and equivalents | $ | 700.6 | $ | 472.4 | ||||
Accounts receivable, net | 1,049.5 | 976.5 | ||||||
Inventories, net | 952.9 | 834.4 | ||||||
Prepaid expenses | 230.9 | 257.5 | ||||||
Total Current Assets | 2,933.9 | 2,540.8 | ||||||
Property, plant and equipment, net | 2,363.9 | 2,404.8 | ||||||
Goodwill and indefinite-lived intangible assets | 1,283.7 | 1,517.1 | ||||||
Definite-lived intangible assets, net | 335.3 | 348.0 | ||||||
Asbestos-related insurance recoverable | 853.8 | 806.1 | ||||||
Prepaid pension costs | 257.4 | 309.2 | ||||||
Other noncurrent assets | 237.2 | 190.7 | ||||||
| $ | 8,265.2 | $ | 8,116.7 | |||||
| LIABILITIES AND SHAREHOLDERS’ DEFICIT | ||||||||
Current Liabilities: | ||||||||
Short-term debt, including current portion of long-term debt | $ | 309.6 | $ | 14.8 | ||||
Accounts payable | 435.9 | 332.3 | ||||||
Accrued liabilities | 559.7 | 474.6 | ||||||
Other current liabilities | 145.6 | 185.1 | ||||||
Total Current Liabilities | 1,450.8 | 1,006.8 | ||||||
Liabilities subject to compromise | 6,018.5 | 6,087.8 | ||||||
Long-term debt | 10.1 | 331.2 | ||||||
Postemployment benefits | 2,355.9 | 1,728.6 | ||||||
Long-term portion of deferred income taxes | 102.0 | 70.4 | ||||||
Other accrued liabilities | 221.2 | 214.4 | ||||||
Minority interest in consolidated subsidiaries | 32.4 | 54.4 | ||||||
Shareholders’ Deficit: | ||||||||
Series C ESOP preferred stock | 28.0 | 28.0 | ||||||
Common stock | 445.3 | 435.6 | ||||||
Additional paid-in capital | 2,148.0 | 2,060.5 | ||||||
Accumulated deficit | (3,267.9 | ) | (2,933.9 | ) | ||||
Accumulated other comprehensive loss | (1,279.1 | ) | (967.1 | ) | ||||
Total Shareholders’ Deficit | (1,925.7 | ) | (1,376.9 | ) | ||||
| $ | 8,265.2 | $ | 8,116.7 | |||||
See accompanying notes to consolidated financial statements.
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CONSOLIDATED STATEMENTS OF CASH FLOWS
| Year Ended December 31 | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| (Millions of Dollars) | ||||||||||||
Cash Provided From (Used By) Operating Activities | ||||||||||||
Net loss | $ | (334.0 | ) | $ | (189.5 | ) | $ | (1,628.9 | ) | |||
Adjustments to reconcile net loss to net cash provided from operating activities | ||||||||||||
Cumulative effect of change in accounting principle | — | — | 1,464.5 | |||||||||
Depreciation and amortization | 335.7 | 307.1 | 277.1 | |||||||||
Chapter 11 and Administration related reorganization expenses | 99.7 | 97.1 | 107.4 | |||||||||
Payments for Chapter 11 and Administration related reorganization expenses | (88.8 | ) | (88.1 | ) | (104.0 | ) | ||||||
Adjustment of assets to fair value | 276.4 | 106.0 | 70.2 | |||||||||
Restructuring charges, net | 17.7 | 36.0 | 43.3 | |||||||||
Payments against restructuring reserves | (36.1 | ) | (76.7 | ) | (53.1 | ) | ||||||
Asbestos charge | — | 38.9 | — | |||||||||
Loss (gain) on sale of businesses | 2.4 | 7.9 | (1.1 | ) | ||||||||
Gain on involuntary conversion | (46.1 | ) | — | — | ||||||||
Insurance proceeds | 102.2 | — | — | |||||||||
Change in postemployment benefits, including pensions | 83.4 | 84.6 | 19.7 | |||||||||
Change in deferred taxes | 15.8 | 15.5 | (31.5 | ) | ||||||||
(Increase) decrease in accounts receivable | (29.1 | ) | 50.1 | 44.1 | ||||||||
(Increase) decrease in inventories | (122.7 | ) | 18.5 | (46.8 | ) | |||||||
Increase (decrease) in accounts payable | 82.3 | (27.6 | ) | 6.4 | ||||||||
Changes in other assets and liabilities | 106.7 | (67.3 | ) | 89.2 | ||||||||
Net Cash Provided From Operating Activities | 465.5 | 312.5 | 256.5 | |||||||||
Cash Provided From (Used By) Investing Activities | ||||||||||||
Expenditures for property, plant and equipment | (267.5 | ) | (300.9 | ) | (339.1 | ) | ||||||
Net proceeds from sale of property, plant and equipment | 29.9 | 6.5 | — | |||||||||
Net proceeds from sales of businesses | 10.7 | 23.6 | 34.6 | |||||||||
Net Cash Used By Investing Activities | (226.9 | ) | (270.8 | ) | (304.5 | ) | ||||||
Cash Provided From (Used By) Financing Activities | ||||||||||||
Increase (decrease) in short-term debt | 13.4 | (16.6 | ) | 6.5 | ||||||||
Proceeds from borrowings on DIP credit facility | 357.7 | 125.5 | 75.0 | |||||||||
Principal payments on DIP credit facility | (400.0 | ) | (120.2 | ) | (10.3 | ) | ||||||
Proceeds from borrowings of long-term debt | — | 1.2 | 6.6 | |||||||||
Principal payments on long-term debt | (2.0 | ) | (4.3 | ) | (2.4 | ) | ||||||
Debt issuance fees | (6.5 | ) | — | — | ||||||||
Net Cash (Used By) Provided From Financing Activities | (37.4 | ) | (14.4 | ) | 75.4 | |||||||
Effect of foreign currency exchange rate fluctuations on cash | 27.0 | 50.0 | 20.8 | |||||||||
Increase in cash and equivalents | 228.2 | 77.3 | 48.2 | |||||||||
Cash and equivalents at beginning of year | 472.4 | 395.1 | 346.9 | |||||||||
Cash and equivalents at end of year | $ | 700.6 | $ | 472.4 | $ | 395.1 | ||||||
See accompanying notes to consolidated financial statements.
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CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIT)
Series C ESOP Preferred Stock | Common Stock | Additional Paid-In Capital | Accumulated Deficit | Accumulated Other Comprehensive Loss | Total | ||||||||||||||||
| (Millions of Dollars) | |||||||||||||||||||||
Balance at January 1, 2002 | $ | 28.0 | $ | 411.9 | $ | 1,844.6 | $ | (1,115.5 | ) | $ | (750.0 | ) | $ | 419.0 | |||||||
Net loss | (1,628.9 | ) | (1,628.9 | ) | |||||||||||||||||
Currency translation | 259.2 | 259.2 | |||||||||||||||||||
Minimum pension liability | (692.8 | ) | (692.8 | ) | |||||||||||||||||
Other | 0.3 | 0.3 | |||||||||||||||||||
Total Comprehensive Loss | (2,062.2 | ) | |||||||||||||||||||
Issuance of stock, net | 23.7 | 215.9 | 239.6 | ||||||||||||||||||
Balance at December 31, 2002 | 28.0 | 435.6 | 2,060.5 | (2,744.4 | ) | (1,183.3 | ) | (1,403.6 | ) | ||||||||||||
Net loss | (189.5 | ) | (189.5 | ) | |||||||||||||||||
Currency translation | 355.0 | 355.0 | |||||||||||||||||||
Minimum pension liability | (138.0 | ) | (138.0 | ) | |||||||||||||||||
Other | (0.8 | ) | (0.8 | ) | |||||||||||||||||
Total Comprehensive Income | 26.7 | ||||||||||||||||||||
Balance at December 31, 2003 | $ | 28.0 | $ | 435.6 | $ | 2,060.5 | $ | (2,933.9 | ) | $ | (967.1 | ) | $ | (1,376.9 | ) | ||||||
Net loss | (334.0 | ) | (334.0 | ) | |||||||||||||||||
Currency translation | 290.7 | 290.7 | |||||||||||||||||||
Minimum pension liability | (602.7 | ) | (602.7 | ) | |||||||||||||||||
Total Comprehensive Loss | (646.0 | ) | |||||||||||||||||||
Issuance of stock, net | 9.7 | 87.5 | 97.2 | ||||||||||||||||||
Balance at December 31, 2004 | $ | 28.0 | $ | 445.3 | $ | 2,148.0 | $ | (3,267.9 | ) | $ | (1,279.1 | ) | $ | (1,925.7 | ) | ||||||
See accompanying notes to consolidated financial statements.
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1. Basis of Presentation and Summary of Significant Accounting Policies
Financial Statement Presentation:As further discussed in Note 2 to the consolidated financial statements, “Voluntary Reorganization Under Chapter 11 and Administration”, on October 1, 2001 (the “Petition Date”), the Company and all of its wholly-owned United States subsidiaries filed voluntary petitions for reorganization (the “U.S. Restructuring”) under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”). Also on October 1, 2001, certain of the Company’s United Kingdom subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the Bankruptcy Code with the Bankruptcy Court, and filed petitions for Administration (the “U.K. Restructuring”) under the United Kingdom Insolvency Act of 1986 (the “Act”) in the High Court of Justice, Chancery division in London, England (the “High Court”). The Company and its U.S. and U.K. subsidiaries included in the U.S. Restructuring or the U.K. Restructuring are herein referred to as the “Debtors.” The U.S. Restructuring and U.K. Restructuring are herein referred to as the “Restructuring Proceedings.” The Chapter 11 cases of the Debtors (collectively, the “Chapter 11 Cases”) have been consolidated for purposes of joint administration asIn re: Federal-Mogul Global Inc., T&N Limited, et al(Case No. 01-10578(RTL)). Subsidiaries outside of the aforementioned U.S. and U.K. subsidiaries are not party to the Chapter 11 Cases and, therefore, are not currently provided protection from creditors by any bankruptcy court and are operating in the normal course.
The accompanying consolidated financial statements have been prepared in accordance with AICPA Statement of Position 90-7 (“SOP 90-7”), “Financial Reporting by Entities in Reorganization under the Bankruptcy Code” and on a going concern basis, which contemplates continuity of operations and realization of assets and liquidation of liabilities in the ordinary course of business. However, as a result of the Restructuring Proceedings, such realization of assets and liquidation of liabilities, without substantial adjustments and/or changes of ownership, is highly uncertain. While operating as debtors-in-possession (“DIP”) under the protection of Chapter 11 of the Bankruptcy Code and Administration under the Act, and subject to approval of the Bankruptcy Court, Administrators or the High Court or otherwise as permitted in the ordinary course of business, the Debtors, or some of them, may sell or otherwise dispose of assets and liquidate or settle liabilities for some amounts other than those reflected in the consolidated financial statements. Further, a plan of reorganization, scheme of arrangement, or company voluntary arrangement could materially change the amounts and classifications in the historical consolidated financial statements.
The appropriateness of using the going concern basis for the Company’s financial statements is dependent upon, among other things: (i) the Company’s ability to comply with the terms of the DIP credit facility and any cash management order entered by the Bankruptcy Court in connection with the Chapter 11 Cases; (ii) the ability of the Company to maintain adequate cash on hand; (iii) the ability of the Company to generate cash from operations; (iv) confirmation of a plan(s) of reorganization under the Bankruptcy Code; (v) confirmation of a scheme(s) of arrangement or company voluntary arrangement(s) in the U.K. under Administration; and (vi) the Company’s ability to achieve profitability following such confirmations.
Principles of Consolidation:The consolidated financial statements include the accounts of the Company and all subsidiaries that are more than 50% owned. Investments in affiliates of 50% or less but greater than 20% are accounted for using the equity method, while investments in affiliates of 20% or less are accounted for under the cost method. The Company does not hold a controlling interest in an entity based on exposure to economic risks and potential rewards (variable interests) for which it is the primary beneficiary. Further, the Company’s joint ventures are businesses established and maintained in connection with its operating strategy and are not special purpose entities.
Use of Estimates:The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported therein. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may be based upon amounts that differ from these estimates.
Cash and Equivalents:The Company considers all highly liquid investments with maturities of 90 days or less from the date of purchase to be cash equivalents.
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Trade Accounts Receivable and Allowance for Doubtful Accounts:Trade accounts receivable are stated at historical value, which approximates fair value. The Company does not generally require collateral for its trade accounts receivable.
Accounts receivable have been reduced by an allowance for amounts that may become uncollectible in the future. This estimated allowance is based primarily on management’s evaluation of specific balances as the balances become past due, the financial condition of its customers and the Company’s historical experience of write-offs. If not reserved through specific examination procedures, the Company’s general policy for uncollectible accounts is to reserve based upon the aging categories of accounts receivable and whether amounts are due from an OE or aftermarket customer. Past due status is based upon the invoice date of the original amounts outstanding. Included in selling, general and administration (“SG&A”) expenses is net bad debt recoveries of $1.4 million for the year-end December 31, 2004 and bad debt expense of $13.1 million for each of the years ended December 31, 2003 and 2002. The allowance for doubtful accounts was $57.9 million and $67.4 million at December 31, 2004 and 2003, respectively.
Federal-Mogul subsidiaries in Germany, France and Italy have entered into factoring facilities. Accounts receivable factored or discounted under these facilities was $186 million as of December 31, 2004, of which $172 million was factored without recourse. Expenses associated with receivables factored or discounted are recorded in the statement of operations as “other expense, net.”
Inventories:Inventories are stated at the lower of cost or market. Cost determined by the last-in, first-out (LIFO) method was used for 45% and 46% of the inventory at December 31, 2004 and 2003, respectively. The remaining inventories are recorded using the first-in, first-out (FIFO) method. Inventories are reduced by an allowance for excess and obsolete inventories based on management’s review of on-hand inventories compared to historical and estimated future sales and usage.
Long-Lived Assets:Long-lived assets, such as property, plant and equipment and definite-lived intangible assets, are stated at cost. Depreciation and amortization is computed principally by the straight-line method for financial reporting purposes and by accelerated methods for income tax purposes. Definite-lived assets are periodically reviewed for impairment indicators. If impairment indicators exist, the Company performs the required analysis and records an impairment charge, as required, in accordance with Statement of Financial Accounting Standard (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS No. 144). If the carrying value of a long-lived asset is considered impaired, an impairment charge is recorded for the amount by which the carrying value of the long-lived asset exceeds its fair value.
Indefinite-lived Intangible Assets: Indefinite-lived intangible assets, such as goodwill and trademarks, are carried at historical value and not amortized. Indefinite-lived intangible assets are reviewed for impairment annually as of October 1, or more frequently if impairment indicators exist. In accordance with SFAS No. 142 “Accounting for Goodwill and Other Intangible Assets”, the impairment analysis compares the estimated fair value of these assets to the related carrying value, and an impairment charge is recorded for any excess of carrying value over estimated fair value. The estimated fair value is based upon consideration of various valuation methodologies, including guideline transaction multiples, multiples of current earnings, and projected future cash flows discounted at rates commensurate with the risk involved.
Pensions and Other Postemployment Obligations:Pension and other postemployment benefit costs are dependent upon assumptions used in calculating such costs. These assumptions include discount rates, health care cost trends, expected returns on plan assets, and other factors. In accordance with United States generally accepted accounting principles, actual results that differ from the assumptions used are accumulated and amortized over future periods and, accordingly, generally affect recognized expense and the recorded obligation in future periods.
Revenue Recognition:The Company records sales when products are shipped and title has transferred to the customer, the sales price is fixed and determinable, and the collectibility of revenue is reasonably assured. Accruals for sales returns and other allowances are provided at the time of shipment based upon past experience. Adjustments to such returns and allowances are made as new information becomes available.
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Shipping and Handling Costs:The Company recognizes shipping and handling costs as a component of cost of products sold in the statement of operations.
Recoverable Customer Engineering and Tooling:Pre-production tooling and engineering costs that the Company will not own and that will be used in producing products under long-term supply arrangements are expensed as incurred unless the supply arrangement provides the Company the noncancelable right to use the tools or the reimbursement of such costs is agreed to by the customer. Pre-production tooling and engineering costs that are owned by the Company are capitalized as part of machinery and equipment, and are depreciated over the shorter of the toolings’ expected life or the duration of the related program.
Research and Development and Advertising Costs:The Company expenses research and development costs and costs associated with advertising and promotion as incurred. Research and development expense for continuing operations was $137.1 million, $122.7 million and $106.7 million for 2004, 2003 and 2002, respectively. Advertising and promotion expense for continuing operations was $44.5 million, $46.7 million and $45.7 million for 2004, 2003 and 2002, respectively.
Restructuring:The Company defines restructuring expense to include costs directly related to exit or disposal activities accounted for in accordance with SFAS No. 146, employee severance costs incurred as a result of an exit or disposal activity accounted for in accordance with SFAS Nos. 88 and 112, and pension and other postemployment benefit costs incurred as a result of an exit or disposal activity accounted for in accordance with SFAS Nos. 87 and 106.
Rebates/Sales Incentives:The Company accrues for rebates pursuant to specific arrangements with certain of its customers, primarily in the aftermarket. Rebates generally provide for price reductions based upon the achievement of specified purchase volumes and are recorded as a reduction of sales as earned by such customers.
Foreign Currency Translation:Exchange adjustments related to international currency transactions and translation adjustments for subsidiaries whose functional currency is the United States dollar (principally those located in highly inflationary economies) are reflected in the consolidated statements of operations. Translation adjustments of international subsidiaries for which the local currency is the functional currency are reflected in the consolidated balance sheets as a component of accumulated other comprehensive loss. Deferred taxes are not provided on translation adjustments as the earnings of the subsidiaries are considered to be permanently reinvested.
Environmental Liabilities:The Company recognizes environmental liabilities when a loss is probable and reasonably estimable. Such liabilities are generally not subject to insurance coverage. Engineering and legal specialists within the Company, based on current law and existing technologies, estimate each environmental obligation. Such estimates are based primarily upon the estimated cost of investigation and remediation required and the likelihood that other potentially responsible parties will be able to fulfill their commitments at the sites where the Company may be jointly and severally liable with such parties (refer to Note 20, “Litigation and Environmental Matters”). The Company regularly evaluates and revises its estimates for environmental obligations based on expenditures against established reserves and the availability of additional information.
Derivative Financial Instruments:The Company is exposed to market risks, such as fluctuations in foreign currency risk and commodity price risk. To manage the volatility relating to these exposures, the Company evaluates its aggregate exposures to identify natural offsets. For exposures that are not offset within its operations, the Company may enter into derivative transactions pursuant to its risk management policies. Designation is performed on a transaction basis to support hedge accounting in accordance with SFAS No. 133 “. The Company assesses the initial and ongoing effectiveness of its hedging relationships in accordance with its documented policy. The Company does not hold or issue derivative financial instruments for trading purposes. The Company’s objectives for holding derivatives are to minimize risks using the most effective and cost-efficient methods available.
Reclassifications:Certain items in the prior years’ financial statements have been reclassified to conform with the presentation used in 2004.
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2. Voluntary Reorganization Under Chapter 11 and Administration
On October 1, 2001, Federal-Mogul and all of its wholly-owned United States subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code in the Bankruptcy Court. Also on October 1, 2001, certain of the Company’s United Kingdom subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the Bankruptcy Code with the Bankruptcy Court, and filed petitions for Administration under the United Kingdom Insolvency Act of 1986 in the High Court. Subsidiaries outside of the aforementioned U.S. and U.K. subsidiaries are not party to the Chapter 11 Cases and, therefore, are not currently provided protection from creditors by any bankruptcy court and are operating in the normal course.
The Restructuring Proceedings were initiated in response to a sharply increasing number of asbestos-related claims and their demand on the Company’s cash flows and liquidity. Under the Restructuring Proceedings, the Debtors expect to develop and implement a plan for addressing the asbestos-related claims against them.
Consequences of the Restructuring Proceedings
The U.S. Debtors are operating their businesses as debtors-in-possession subject to the provisions of the Bankruptcy Code. The U.K. Debtors are continuing to manage their operations under the supervision of Administrators approved by the High Court. All vendors are being paid for all goods furnished and services provided after the Petition Date. However, as a consequence of the Restructuring Proceedings, pending litigation against the Debtors as of the Petition Date is stayed (subject to certain exceptions in the case of governmental authorities), and no party may take any action to pursue or collect pre-petition claims except pursuant to an order of the Bankruptcy Court or the High Court, as applicable. It is the Debtors’ intention to address pending and future asbestos-related claims and other pre-petition claims through a unified plan of reorganization under the Bankruptcy Code or schemes of arrangement or company voluntary arrangements under the Act.
In the U.S., four committees, representing asbestos claimants, asbestos property damage claimants, unsecured creditors and equity security holders (collectively, the “Committees”) have been appointed as official committees in the Chapter 11 Cases and, in accordance with the provisions of the Bankruptcy Code, have the right to be heard on all matters that come before the Bankruptcy Court. The Committees, together with the legal representative for the future asbestos claimants, play important roles in the Restructuring Proceedings. In the U.K., the Administrators have appointed creditors committees, representing both asbestos claimants and general unsecured creditors.
On June 4, 2004, the Third Amended Joint Plan of Reorganization (the “Plan”) for the Company and the other U.S. and U.K. Debtors was filed with the Bankruptcy Court. The Plan was jointly proposed by the Company, the Unsecured Creditors Committee, the Asbestos Claimants Committee, the Future Asbestos Claimants Representative, the Agent for the Prepetition Bank Lenders and the Equity Security Holders Committee (collectively referred to as the “Plan Proponents”). Also on June 4, 2004, a Disclosure Statement to be used in soliciting votes to accept or reject the Plan (the “Disclosure Statement”) was approved by the Bankruptcy Court and a December 2004 hearing was scheduled to determine whether the Bankruptcy Court should approve the Plan. On December 7, 2004, the Bankruptcy Court delayed this confirmation hearing pending a hearing to estimate asbestos personal injury claims against the U.K. Debtors. Such estimation hearing has not yet been scheduled.
On July 12, 2004, solicitation packages containing the Plan and Disclosure Statement, various supporting documents and a ballot, if appropriate, were mailed to known creditors of the Company and holders of common and preferred stock interests in the Company. All votes were due by the close of business on November 3, 2004. Although the Plan Proponents have granted extensions of the November 3, 2004 voting deadline to a few significant claimants, the voting agent has confirmed that the overwhelming majority of the classes of claims and interests have voted to accept the Plan. For the few classes of claims that voted to reject the Plan, the Plan proponents intend to either amend the Plan so as to obtain such classes’ accepting votes or seek to confirm the Plan over the objection of such classes.
The Plan provides that asbestos personal injury claimants, both present and future, will be permanently channeled to a trust or series of trusts established pursuant to Section 524(g) of the Bankruptcy Code, thereby protecting Federal-Mogul and its affiliates in the Chapter 11 Cases from existing and future asbestos liability. Although certain issues remain to be resolved, the Plan provides that all currently outstanding stock of Federal-Mogul will be cancelled, and 50.1% of newly authorized and issued common stock of reorganized Federal-Mogul will be distributed to the asbestos trusts, and 49.9% of the newly authorized and issued common stock will be distributed pro rata to the noteholders. If the classes of holders of common and preferred stock of Federal-Mogul vote in favor of the Plan, the holders of currently outstanding common and preferred stock of Federal-Mogul will receive warrants that may be used to purchase shares of reorganized Federal-Mogul at a predetermined exercise price.
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Unsecured creditors, including trade creditors, of the U.S. Debtors are projected to receive cash distributions under the Plan equal to 35% of their allowed claims, payable in three annual installments, provided that the aggregate of all allowed unsecured claims against the U.S. Debtors does not exceed $258 million. Any excess above this amount could result in a reduction in the percentage distribution that the unsecured creditors of the U.S. Debtors ultimately receive. Unsecured creditors, including trade creditors, of the U.K. Debtors will receive distributions that vary according to terms specified within the Plan and Disclosure Statement.
There are two possible types of U.K. schemes of arrangements. The first is under Section 425 of the Companies Act of 1985, which may involve a scheme for the reconstruction of the Company. If a majority in number representing three-fourths in value of the creditors or members or any class of them agree to the compromise or arrangement, it is binding if sanctioned by the High Court. Section 425 may be invoked where there is an Administration order in force in relation to the Company. The other possible type of scheme arises under Section 1 of the Insolvency Act of 1986 in relation to Company Voluntary Arrangements (“CVAs”). If a majority in value representing more than three-fourths of the creditors agrees to the compromise or arrangement set out in the CVA proposal, it will be approved.
The Plan Proponents have prepared forms of Schemes of Arrangement and CVAs to be submitted for the U.K. Debtors in the U.K. Restructuring proceedings. These forms of Schemes of Arrangement and CVAs parallel the provisions of the Plan to the fullest extent possible under English and Scottish insolvency law. Under English and Scottish law, the Administrators are the only persons with authority to recommend and submit Schemes of Arrangement and/or CVAs. The Administrators have not yet agreed to recommend the Schemes of Arrangement and CVAs that parallel the Plan. The Plan Proponents are working toward an agreement with the Administrators to recommend parallel Schemes of Arrangement and CVAs. Alternatively, if such an agreement cannot be achieved, the Plan Proponents will work toward an agreement with the Administrators to retain the businesses of those U.K. Debtors that are valuable to Federal-Mogul and its customers and to jointly market those U.K. Debtors that are not valuable to Federal-Mogul and its customers. This process is consistent with the Company’s strategy to focus on core business segments, and to consider for divestiture or other exit activities those non-core operations determined by management not to have a sustainable competitive advantage.
In October 2004, the Administrators applied to the High Court for directions related to: 1) questions of fairness of the Plan; 2) the approach of the High Court to CVAs and schemes of arrangement designed to implement the Plan within the U.K.; 3) the compatibility with English pension laws of the proposals for the trustees of pension schemes of the U.K. debtors; and 4) the impact under English insolvency law should the Administrators not propose CVAs and schemes of arrangement. In response to the application for directions, the High Court directed the Administrators to not propose schemes of arrangement and CVAs consistent with the draft schemes and draft CVAs included within the currently filed Plan without further order of the High Court. In addition, the High Court directed the Administrators to not convene meetings of creditors of the U.K. Companies pursuant to any demands or requisitions made pursuant to the Plan. Additionally, the High Court granted the Administrators leave to modify their consent, if necessary, with the directors of the U.K. Debtors exercising their powers either to a) promote and/or confirm the Plan; or b) file or continue any motion in the Bankruptcy Court which seeks relief in relation to the Administrators or the U.K. Debtors.
If the Plan Proponents and the Administrators cannot reach an agreement regarding either Schemes of Arrangement and CVAs that parallel the Plan or the means by which the Federal-Mogul will retain the businesses of those U.K. Debtors that are valuable to Federal-Mogul and its customers, then one or more of the following may occur with respect to each U.K. Debtor: (a) the U.K. Debtors and the Plan Proponents may ask the High Court to approve the Plan with respect to the U.K. Debtors as a matter of comity; or (b) Federal-Mogul may bid for those businesses of the U.K. Debtors that are valuable to Federal-Mogul and its customers and any actual or deemed transfer of assets to Federal-Mogul in connection therewith shall be entitled to the benefits of the injunction pursuant to Section 524(g) of the Bankruptcy Code. If Federal-Mogul is not the successful bidder, the injunction pursuant to Section 524(g) of the Bankruptcy Code shall not apply to the transfer of any assets to any entity other than Federal-Mogul or its designee. The Company believes that, in the event the assets of the U.K. debtors are marketed for public sale, Federal-Mogul ultimately will be the successful bidder for those assets that are valuable to Federal-Mogul and its customers. Any remaining assets would be liquidated. The Company believes that such a non-consensual process with the Administrators is not in the best interest of the creditors of the U.K. Debtors, including pension creditors,
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and employees of the U.K. Debtors, and that the failure to arrive at a consensual plan could be damaging to the interests of such parties.
The Company is unable to predict with a high degree of certainty at this time what treatment will be accorded under any such plan of reorganization to claims against the U.K. Debtors arising from intercompany indebtedness, licenses, executory contracts, transfers of goods and services, and other intercompany arrangements, transactions and relationships that were entered into prior to the Petition Date. Various parties in the Chapter 11 Cases may challenge these arrangements, transactions, and relationships, and the outcome of those challenges, if any, may have an impact on the treatment of various claims under such plan of reorganization.
The Bankruptcy Court may confirm a plan of reorganization only upon making certain findings required by the Bankruptcy Code, and a plan may be confirmed over the dissent of non-accepting creditors and equity security holders if certain requirements of the Bankruptcy Code are met. The payment rights and other entitlements of pre-petition creditors and equity security holders may be substantially altered by any plan of reorganization confirmed in the Chapter 11 Cases. There is no assurance that there will be sufficient assets to satisfy the Debtors’ pre-petition liabilities in whole or in part, and the pre-petition creditors of some Debtors may be treated differently than those of other Debtors.
Chapter 11 Financing
In connection with the Restructuring Proceedings, the Company entered into a DIP credit facility to supplement liquidity and fund operations during the restructuring proceedings. In December 2004, the Company renegotiated its DIP credit facility. Prior to December 2004, the Company’s DIP credit facility had an interest rate of either the alternate base rate (“ABR”) plus 2 percentage points or a formula based on the London Inter-Bank Offered Rate (“LIBOR”) plus 3 percentage points. The ABR is the greater of either the bank’s prime rate or the base CD rate plus 1 percentage point or the federal funds rate plus ½ percentage point.
The December 2004 DIP credit facility expires in December 2005, and the interest rate is either the ABR plus 1¼ percentage points or a formula based on LIBOR plus 2¼ percentage points. The ABR is the greater of either the bank’s base rate or the federal funds rate plus ½ percentage point. In addition, the commitment available under the DIP credit facility is mandatorily reduced by a portion of proceeds received from future asset or business divestitures.
The Company’s available borrowings under the existing DIP credit facility are determined by the underlying collateral at any point in time, consisting of its domestic inventories, domestic accounts receivable, and domestic property, plant, and equipment. The DIP lenders received permission from the lenders of the Senior Credit Agreements to have priority over their collateral interest. Amounts available and outstanding on the DIP credit facility are further discussed in Note 13 to the consolidated financial statements.
As a condition of the existing DIP credit facility, the Bankruptcy Court ordered that the noteholders receive, in cash, adequate protection payments equal to one-half of one percent (0.5%) per year of the outstanding notes per year. These cash payments, which approximate $2.6 million per quarter, are recorded as interest expense in the statement of operations. All cash adequate protection payments made to the noteholders are provisional in nature and are subject to recharacterization, credit against allowed claims, or other relief if the Bankruptcy Court were to ultimately conclude that the noteholders were not entitled to such payments.
The Bankruptcy Court further ordered additional adequate protection to the noteholders in the form of either cash payment of one-half of one percent (0.5%) per year of the outstanding notes or the granting of an administrative expense claim pursuant to Section 507(b) of the Bankruptcy Code in the amount of one percent (1.0%) per year of the outstanding notes. The Company has elected to grant an administrative expense claim in favor of the noteholders for this additional adequate protection. All adequate protection administrative expense claims inured in favor of the noteholders are provisional in nature and subject to challenge by all parties-in-interest to the Restructuring Proceedings. Accordingly, the ultimate amount and related payment terms, if any, for these administrative expense claims will be established in connection with the Restructuring Proceedings. Accordingly, such administrative expense claims, approximating $68 million as of December 31, 2004, have not been recorded in the accompanying financial statements.
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Financial Statement Presentation
The accompanying consolidated financial statements have been prepared in accordance with AICPA Statement of Position 90-7 (“SOP 90-7”), “Financial Reporting by Entities in Reorganization under the Bankruptcy Code” and on a going concern basis, which contemplates continuity of operations and realization of assets and liquidation of liabilities in the ordinary course of business. However, as a result of the Restructuring Proceedings, such realization of assets and liquidation of liabilities, without substantial adjustments and/or changes of ownership, is highly uncertain. Given this uncertainty, there is substantial doubt about the ability of the Company to continue as a going concern. While operating as debtors-in-possession under the protection of Chapter 11 of the Bankruptcy Code and Administration under the Act, and subject to approval of the Bankruptcy Court, Administrators or the High Court or otherwise as permitted in the ordinary course of business, the Debtors, or some of them, may sell or otherwise dispose of assets and liquidate or settle liabilities for some amounts other than those reflected in the consolidated financial statements. Further, a plan of reorganization or scheme of arrangement could materially change the amounts and classifications in the historical consolidated financial statements.
Virtually all of the Company’s pre-petition debt is in default. At December 31, 2004, the Debtors’ pre-petition debt is classified under the caption “Liabilities subject to compromise”. This includes debt outstanding of $1,937.8 million under the pre-petition Senior Credit Agreements and $2,118.2 million of other outstanding debt, primarily notes payable at various unsecured rates, less capitalized debt issuance fees of $29.1 million. The carrying value of the pre-petition debt will be adjusted once it has become an allowed claim by the Bankruptcy Court to the extent the related carrying value differs from the amount of the allowed claim. Such adjustment may be material to the consolidated financial statements.
As a result of the Restructuring Proceedings, the Company is in default to its affiliate holder of its convertible junior subordinated debentures and is no longer accruing interest expense or making interest payments on the debentures. As a result, the affiliate will no longer have the funds available to pay distributions on the Company-Obligated Mandatorily Redeemable Preferred Securities and stopped accruing and paying such distributions on October 1, 2001. The affiliate is in default on the Company-Obligated Mandatorily Redeemable Preferred Securities. The Company is a guarantor on the outstanding debentures and, as a result of the default, the Company has become a debtor to the holders of the debentures directly. This liability is a pre-petition liability. As a result, the Company has classified these securities as “Liabilities subject to compromise” in the consolidated balance sheets.
As reflected in the consolidated financial statements, “Liabilities subject to compromise” refers to Debtors’ liabilities incurred prior to the commencement of the Restructuring Proceedings. The amounts of the various liabilities that are subject to compromise are set forth below. These amounts represent the Company’s estimate of known or potential pre-petition claims to be resolved in connection with the Restructuring Proceedings. Such claims remain subject to future adjustments. Future adjustments may result from (i) negotiations; (ii) actions of the Bankruptcy Court, High Court or Administrators; (iii) further developments with respect to disputed claims; (iv) rejection of executory contracts and unexpired leases; (v) the determination as to the value of any collateral securing claims; (vi) proofs of claim; or (vii) other events. Payment terms for these claims will be established in connection with the Restructuring Proceedings.
Liabilities subject to compromise include the following:
| December 31 | ||||||
| 2004 | 2003 | |||||
| (Millions of Dollars) | ||||||
Debt | $ | 4,026.9 | $ | 4,020.7 | ||
Asbestos liabilities | 1,584.0 | 1,568.4 | ||||
Accounts payable | 204.5 | 201.8 | ||||
Company-obligated mandatorily redeemable securities | 114.6 | 211.0 | ||||
Interest payable | 43.9 | 43.9 | ||||
Environmental liabilities | 23.6 | 23.8 | ||||
Other accrued liabilities | 21.0 | 18.2 | ||||
Subtotal | 6,018.5 | 6,087.8 | ||||
Intercompany payables to affiliates | 3,301.3 | 3,204.9 | ||||
| $ | 9,319.8 | $ | 9,292.7 | |||
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The Debtors have received approval from the Bankruptcy Court to pay or otherwise honor certain of their pre-petition obligations, including employee wages, salaries, benefits and other employee obligations and from limited available funds, pre-petition claims of certain critical vendors, certain customer programs and warranty claims, adequate protection payments on the Company’s notes, and certain other pre-petition claims.
Cash in the United Kingdom is available only for use by the debtor entities within the United Kingdom and is not available for use outside of such entities subject to final settlement of the U.K. Restructuring proceedings. At December 31, 2004 and 2003, such cash balances were $425 million and $261 million, respectively.
Chapter 11 and Administration related reorganization expenses in the consolidated statements of operations consist of legal, financial and advisory fees, including fees of the U.K. Administrators, critical employee retention costs, and other directly related internal costs as follows:
| Year Ended December 31 | ||||||||||
| 2004 | 2003 | 2002 | ||||||||
| (Millions of Dollars) | ||||||||||
Professional fees directly related to the filing | $ | 92.5 | $ | 70.4 | $ | 73.7 | ||||
Critical employee retention costs | 10.3 | 8.2 | 19.2 | |||||||
Other direct costs | 15.4 | 18.5 | 14.5 | |||||||
Gain on settlement of outstanding claim | (18.5 | ) | — | — | ||||||
| $ | 99.7 | $ | 97.1 | $ | 107.4 | |||||
In July 2004, the Company reached an agreement with a creditor of one of the Company’s U.S. subsidiaries whereby the Company and the creditor settled an outstanding liability of $20.0 million in exchange for a general unsecured claim of $1.5 million. The settlement agreement was approved by the Bankruptcy Court on July 30, 2004. As a result of this agreement, the Company reduced its recorded liability for this claim and recorded $18.5 million as a reduction to Chapter 11 and Administration related reorganization expense.
Pursuant to the Bankruptcy Code, the Debtors have filed schedules with the Bankruptcy Court setting forth the assets and liabilities of the Debtors as of the Petition Date. On October 4, 2002, the Debtors issued approximately 100,000 proof of claim forms to its current and prior employees, known creditors, vendors and other parties with whom the Debtors have previously conducted business. To the extent that recipients disagree with the claims as quantified on these forms, the recipient may file discrepancies with the Bankruptcy Court. Differences between amounts recorded by the Debtors and claims filed by creditors will be investigated and resolved as part of the Restructuring Proceedings. The Bankruptcy Court ultimately will determine liability amounts that will be allowed for these claims in the Chapter 11 Cases. A March 3, 2003 bar date was set for the filing of proofs of claim against the Debtors. Because the Debtors have not completed evaluation of the claims received in connection with this process, the ultimate number and allowed amount of such claims are not presently known. The resolution of such claims could result in a material adjustment to the Company’s financial statements.
Approximately 10,600 proofs of claim totaling approximately $158.5 billion alleging a right to payment from a Debtor were filed in connection with the March 3, 2003 bar date as follows:
| • | Approximately 2,200 claims, totaling approximately $142.1 billion, which the Company believes should be disallowed by the Bankruptcy Court primarily because these claims appear to be duplicative or unsubstantiated claims. |
| • | Approximately 400 claims, totaling approximately $8.1 billion, are associated with asbestos-related contribution, indemnity, or reimbursement claims. Based upon its preliminary review, the Company believes that a large number of these claims should be disallowed as contingent contribution or reimbursement claims. |
| • | Approximately 100 claims, totaling approximately $7.1 billion, represent bank and note-holder debt claims. The Company has previously recorded approximately $4.3 billion for these claims, which is included in the financial statement caption “Liabilities subject to compromise”. The Company believes amounts in excess of its books and records are duplicative and will ultimately be resolved in the consensual plan of reorganization. |
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| • | Approximately 3,800 claims, totaling approximately $200 million, are alleging asbestos-related property damage. Based on its review, the Company believes most of these claims are duplicative or unsubstantiated. The Company has entered into a stipulation with certain claimants that will result in the withdrawal of approximately 1,200 of these claims with prejudice. This stipulation is subject to and pending the approval of the Bankruptcy Court. |
| • | Approximately 2,000 claims, totaling approximately $40 million, have been reviewed and are deemed allowed by the Company. The liability for such claims is included within the financial statement caption “Liabilities subject to compromise.” |
The Company has not completed its evaluation of the approximate remaining 2,100 claims, totaling approximately $1.0 billion, alleging rights to payment for financing, environmental, trade accounts payable and other matters. The Company continues to investigate these unresolved proofs of claim, and intends to file objections to the claims that are inconsistent with its books and records. As of December 31, 2004, the Debtors have filed objections to more than 5,600 proofs of claim, and have obtained stipulations or orders involving approximately 2,300 claims, which (i) reduce the filed claims to an amount that is consistent with the Debtors books or records, (ii) completely disallow the claims, or (iii) withdraw the claims.
The Debtors continue to review and analyze the proofs of claim filed to date. In addition, the Debtors continue to file objections and seek stipulations to certain claims. Additional claims may be filed after the general bar date, which could be allowed by the Bankruptcy Court. Accordingly, the ultimate number and allowed amount of such claims are not presently known and cannot be reasonably estimated at this time. The resolution of such claims could result in a material adjustment to the Company’s financial statements.
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Debtors’ Financial Statements
The condensed consolidated financial statements of the Debtors are presented below. These statements reflect the financial position, results of operations and cash flows of the combined Debtor subsidiaries, including certain amounts and activities between Debtor and non-Debtor subsidiaries of the Company, which are eliminated in the consolidated financial statements.
Debtors’ Condensed Consolidated Statements of Operations
| Year Ended December 31 | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| (Millions of Dollars) | ||||||||||||
Net sales | $ | 3,621.5 | $ | 3,372.3 | $ | 3,431.5 | ||||||
Cost of products sold | 3,033.3 | 2,771.3 | 2,827.1 | |||||||||
Gross margin | 588.2 | 601.0 | 604.4 | |||||||||
Selling, general and administrative expenses | 599.0 | 565.0 | 517.9 | |||||||||
Adjustment of assets to fair value | 224.2 | 62.3 | 66.8 | |||||||||
Asbestos charge | — | 38.9 | — | |||||||||
Interest expense, net | 95.4 | 94.8 | 124.9 | |||||||||
Chapter 11 and Administration related reorganization expenses | 99.7 | 97.1 | 107.4 | |||||||||
Gain on involuntary conversion | (46.1 | ) | — | — | ||||||||
Intercompany interest income from non-filers | (358.1 | ) | (332.2 | ) | (310.0 | ) | ||||||
Other income, net | (22.5 | ) | (25.0 | ) | (10.8 | ) | ||||||
Earnings (loss) from continuing operations before income taxes, equity loss of non-Debtor subsidiaries, and cumulative effect of change in accounting principle | (3.4 | ) | 100.1 | 108.2 | ||||||||
Income tax expense | 44.5 | 22.8 | 51.1 | |||||||||
Earnings (loss) from continuing operations before equity loss of non-Debtor subsidiaries and cumulative effect of change in accounting principle | (47.9 | ) | 77.3 | 57.1 | ||||||||
Equity loss from continuing operations of non-Debtor subsidiaries before cumulative effect of change in accounting principle | (277.6 | ) | (245.9 | ) | (240.8 | ) | ||||||
Loss from continuing operations before cumulative effect of change in accounting principle | (325.5 | ) | (168.6 | ) | (183.7 | ) | ||||||
(Loss) income from discontinued operations, net of income taxes, Debtors | 0.8 | (18.3 | ) | (4.4 | ) | |||||||
Loss from discontinued operations, net of income taxes, non-Debtors | (9.3 | ) | (2.6 | ) | (28.6 | ) | ||||||
Cumulative effect of change in accounting principle, Debtors, net of applicable income tax benefit | — | — | 1,095.0 | |||||||||
Cumulative effect of change in accounting principle, non-Debtors, net of applicable income tax benefit | — | — | 317.2 | |||||||||
Net loss | $ | (334.0 | ) | $ | (189.5 | ) | $ | (1,628.9 | ) | |||
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Debtors’ Condensed Consolidated Balance Sheets
| December 31 | ||||||||
| 2004 | 2003 | |||||||
| (Millions of Dollars) | ||||||||
| ASSETS | ||||||||
Current Assets: | ||||||||
Cash and equivalents | $ | 433.5 | $ | 281.5 | ||||
Accounts receivable, net | 582.8 | 558.4 | ||||||
Accounts receivable, non-Debtors | 461.9 | 457.7 | ||||||
Inventories, net | 483.6 | 443.9 | ||||||
Prepaid expenses | 101.9 | 116.2 | ||||||
Total Current Assets | 2,063.7 | 1,857.7 | ||||||
Property, plant and equipment, net | 1,016.4 | 1,127.7 | ||||||
Goodwill and indefinite-lived intangible assets | 1,097.6 | 1,341.1 | ||||||
Definite-lived intangible assets, net | 280.3 | 293.5 | ||||||
Asbestos-related insurance recoverable | 853.8 | 806.1 | ||||||
Loans receivable from and investments in non-Debtors | 4,828.1 | 4,619.1 | ||||||
Other noncurrent assets | 402.1 | 439.5 | ||||||
| $ | 10,542.0 | $ | 10,484.7 | |||||
| LIABILITIES AND SHAREHOLDERS’ DEFICIT | ||||||||
Current Liabilities: | ||||||||
Short-term debt, including current portion of long-term debt | $ | 277.8 | $ | 0.2 | ||||
Accounts payable and accrued compensation | 269.1 | 237.0 | ||||||
Accounts payable, non-Debtors | 191.5 | 174.9 | ||||||
Other accrued liabilities | 256.4 | 254.1 | ||||||
Total Current Liabilities | 994.8 | 666.2 | ||||||
Long-term debt | — | 320.0 | ||||||
Postemployment benefits | 2,033.5 | 1,458.8 | ||||||
Other accrued liabilities | 119.6 | 123.9 | ||||||
Liabilities subject to compromise | 9,319.8 | 9,292.7 | ||||||
Shareholders’ deficit | (1,925.7 | ) | (1,376.9 | ) | ||||
| $ | 10,542.0 | $ | 10,484.7 | |||||
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Debtors’ Condensed Consolidated Statements of Cash Flows
| Year Ended December 31 | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| (Millions of Dollars) | ||||||||||||
Net Cash Provided From Operating Activities | $ | 281.4 | $ | 154.0 | $ | 76.4 | ||||||
Cash Provided From (Used By) Investing Activities | ||||||||||||
Expenditures for property, plant and equipment | (118.9 | ) | (109.8 | ) | (153.4 | ) | ||||||
Net proceeds from sales of businesses | 8.2 | 20.7 | 34.6 | |||||||||
Net Cash Used By Investing Activities | (110.7 | ) | (89.1 | ) | (118.8 | ) | ||||||
Cash Provided From (Used By) Financing Activities | ||||||||||||
Proceeds from borrowings on DIP credit facility | 357.7 | 125.5 | 75.0 | |||||||||
Principal payments on DIP credit facility | (400.0 | ) | (120.2 | ) | (10.3 | ) | ||||||
Net Cash (Used by) Provided From Financing Activities | (42.3 | ) | 5.3 | 64.7 | ||||||||
Effect of foreign currency exchange rate fluctuations on cash and equivalents | 23.6 | 21.7 | 20.8 | |||||||||
Increase in cash and equivalents | 152.0 | 91.9 | 43.1 | |||||||||
Cash and equivalents at beginning of year | 281.5 | 189.6 | 146.5 | |||||||||
Cash and equivalents at end of year | $ | 433.5 | $ | 281.5 | $ | 189.6 | ||||||
3. Adjustment of Assets to Fair Value
Definite-Lived Long-Lived Assets
The Company recorded impairment charges of $82.7 million, $23.4 million, and $62.6 million for the years ended December 31, 2004, 2003 and 2002, respectively, to adjust definitive-lived long-lived assets to their estimated fair values in accordance with SFAS No. 144. The charges by reporting segment are as follows:
| Year Ended December 31 | |||||||||
| 2004 | 2003 | 2002 | |||||||
| (Millions of Dollars) | |||||||||
Powertrain | $ | 72.7 | $ | 14.3 | $ | 52.3 | |||
Sealing Systems and System Protection | 3.1 | 0.3 | 5.5 | ||||||
Friction | 3.3 | 3.9 | — | ||||||
Aftermarket | 3.4 | 4.9 | 3.9 | ||||||
Corporate | 0.2 | — | 0.9 | ||||||
| $ | 82.7 | $ | 23.4 | $ | 62.6 | ||||
2004 Impairments
Powertrain:
| • | The total charge of $72.7 million during 2004 includes $20.0 million to write down property, plant and equipment related to the Company’s Powertrain transmission operations in France. This operation is comprised of four facilities that manufacture transmission and gear components primarily for sale to OE customers. High labor content, difficulties in commercialization of new product technology, and continued manufacturing inefficiencies resulted in a revaluation of the expected future cash flows of these facilities as compared to the carrying value of property plant and equipment. |
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| • | The Company also recorded $19.0 million in impairment charges for two camshaft operations located in the United Kingdom. The impairment reflects a revaluation of future expected cash flows primarily due to anticipated lower volumes for these facilities. |
| • | The Company recorded $9.0 million, $7.8 million, $5.8 million and $4.7 million of impairment charges on property, plant and equipment located in piston manufacturing facilities in the United States, Italy, Poland and China, respectively. The United States impairment reflects the write-down of fixed assets to estimated disposition value related to the announcement of the closure and relocation of a piston manufacturing facility to other facilities primarily in the United States and Mexico. This closure is anticipated to be completed in 2005. The Italy, Poland and China impairments are due to other than temporary declines in sales and estimated future cash flows. |
Sealing Systems and Systems Protection, Friction and Aftermarket:
| • | The Company recorded impairment charges of $3.1 million, $3.3 million, and $3.4 million for impairment charges on facilities in each of the Sealing Systems and System Protection, Friction, and Aftermarket reporting segments. Each of these facilities is located in Europe. These impairments are due to other than temporary declines in sales volumes and profitability at those facilities. |
2003 Impairments
The total charge of $23.4 million during 2003 includes $14.3 million net write down of Powertrain property, plant and equipment. In addition, the Company recorded $9.1 million of impairment charges on property, plant and equipment located in various manufacturing facilities in Europe to be held and used in accordance with SFAS No. 144, due to an other than temporary decline in sales volumes and profitability at those facilities. The fair value of property, plant and equipment was based upon estimated discounted future cash flows and estimates of salvage value. The impairment charges represent the difference between the estimated fair values and the carrying value of the subject assets.
2002 Impairments
The total charge of $62.6 million during 2002 includes $46.7 million to write-down property, plant and equipment at five facilities that the Company has closed. The estimated fair values were determined based upon discontinued future cash flows and estimates of salvage value. An additional charge of $6.6 million relates to the write down of property, plant and equipment at a European camshaft foundry related to an other than temporary decline in sales volumes at that facility. The estimated fair value of this equipment was determined based upon discounted future cash flows. The remaining charge primarily relates to the impairment of assets that the Company intends to divest. The value of these assets was estimated based upon the future discounted cash flows should the Company divest of these assets on and individual, open market basis.
Goodwill and Other Indefinite-Lived Intangible Assets
At December 31, 2004 and 2003, goodwill and other intangible assets consist of the following:
| December 31, 2004 | December 31, 2003 | |||||||||||||||||||
Gross Amount | Accumulated Amortization | Net Carrying Amount | Gross Amount | Accumulated Amortization | Net Carrying Amount | |||||||||||||||
| (Millions of Dollars) | ||||||||||||||||||||
Intangible Assets | ||||||||||||||||||||
Developed technology | $ | 368.9 | $ | (107.6 | ) | $ | 261.3 | $ | 346.2 | $ | (82.7 | ) | $ | 263.5 | ||||||
Other | 58.8 | (37.1 | ) | 21.7 | 60.1 | (39.5 | ) | 20.6 | ||||||||||||
| $ | 427.7 | $ | (144.7 | ) | $ | 283.0 | $ | 406.3 | $ | (122.2 | ) | $ | 284.1 | |||||||
Unamortized Intangible Assets | ||||||||||||||||||||
Goodwill | $ | 1,114.9 | $ | 1,350.3 | ||||||||||||||||
Trademarks | 168.8 | 166.8 | ||||||||||||||||||
Intangible Pension Asset | 52.3 | 63.9 | ||||||||||||||||||
| $ | 1,336.0 | $ | 1,581.0 | |||||||||||||||||
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The Company expects that amortization expense for its definite-lived intangible assets for each of the years between 2005 and 2009 will be approximately $21 million.
Effective January 1, 2002, the Company adopted SFAS No. 142, resulting in the discontinuance of amortization of goodwill and indefinite-lived intangible assets. The adoption of this standard also required the reclassification of various intangible asset classes according to the measurability of their useful lives. Upon the adoption of SFAS No. 142, the Company recorded a non-cash charge of $1,464.5 million to reduce the carrying value of its goodwill and indefinite-lived intangible assets to their estimated fair value as required by SFAS No. 142. The tax impact related to the charge was $46.6 million and was limited to the benefit derived from the impairment of certain intangible assets other than goodwill. The charge is presented as a cumulative effect of change in accounting principle in the consolidated statement of operations for the year ended December 31, 2002.
As of October 1, 2003, the Company completed its annual impairment analysis as required by SFAS No. 142 and recorded an impairment charge in a Powertrain operating unit of $70.5 million to adjust the carrying value of indefinite-lived intangible assets to estimated fair value. The estimated fair value of the reporting unit was determined based upon consideration of various valuation methodologies, including guideline transaction multiples, multiples of current earnings, and projected future cash flows discounted at rates commensurate with the risk involved. The 2003 impairment charge is primarily attributable to a decrease in the operating unit’s estimated fair value based upon management’s expectation of future financial performance.
As of October 1, 2004, the Company performed its annual impairment analysis as required by SFAS No. 142 and recorded an impairment charge in the Sealing Systems operating unit of $193.7 million to adjust the carrying value of goodwill to estimated fair value. The estimated fair value of the reporting unit was determined based upon consideration of various valuation methodologies, including guideline transaction multiples, multiples of current earnings, and projected future cash flows discounted at rates commensurate with the risk involved. The 2004 impairment charge is primarily attributable to a decrease in the operating unit’s estimated fair value based upon the effect of market conditions on current operating results and on management’s projections of future financial performance.
The 2004 goodwill impairment charge is based upon the Company’s best estimate under SFAS No. 5. The ultimate amount of impairment will be determined based upon finalization of the implied fair value of goodwill pursuant to asset valuation and allocation procedures. Any difference between the Company’s best estimate and the final implied fair value of goodwill will be recorded during the first quarter of 2005.
A summary of the impairment charges for goodwill and other intangible assets by reporting segment pursuant to the provisions of SFAS No. 142 is as follows:
| Year Ended December 31 | |||||||||
| 2004 | 2003 | 2002 | |||||||
| (Millions of Dollars) | |||||||||
Powertrain | $ | — | $ | 70.5 | $ | 453.8 | |||
Sealing Systems and Systems Protection | 193.7 | — | — | ||||||
Friction | — | — | 381.9 | ||||||
Aftermarket | — | — | 155.3 | ||||||
Corporate | — | — | 473.5 | ||||||
| $ | 193.7 | $ | 70.5 | $ | 1,464.5 | ||||
4. Restructuring
The Company has undertaken various restructuring activities to streamline its operations, consolidate and take advantage of available capacity and resources, and ultimately achieve net cost reductions. Restructuring activities include efforts to integrate and rationalize the Company’s businesses and to relocate manufacturing operations to lower cost markets.
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The Company accounted for costs related to all restructuring activities initiated prior to January 1, 2003 under the requirements of EITF No. 94-3 “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” Accordingly, related employee termination benefits and other costs to exit an activity were recognized on the date when management committed the Company to an exit plan. Effective January 1, 2003, the Company’s restructuring accounting policy changed pursuant to the requirements of SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities.” Currently, the Company defines restructuring expense to include costs directly associated with exit or disposal activities accounted for in accordance with SFAS No. 146, employee severance costs incurred as a result of an exit or disposal activity accounted for in accordance with SFAS Nos. 88 and 112, and pension and other postemployment benefit costs incurred as a result of an exit or disposal activity accounted for in accordance with SFAS Nos. 87 and 106.
Estimates of restructuring charges are based on information available at the time such charges are recorded. In general, management anticipates that restructuring activities will be completed within a timeframe such that significant changes to the exit plan are not likely. In certain countries where the Company operates, statutory requirements include involuntary termination benefits that extend several years into the future. Accordingly, severance payments continue well past the date of termination at many international locations. Thus, these programs appear to be ongoing when, in fact, terminations and other activities under these programs have been substantially completed. Management expects that future savings resulting from execution of its restructuring programs will generally result in full pay back within 36 to 60 months.
Due to the inherent uncertainty involved in estimating restructuring expenses, actual amounts paid for such activities may differ from amounts initially estimated. Accordingly, the Company reversed approximately $6 million, $21 million and $21 million of previously recorded reserves in 2004, 2003 and 2002, respectively. Such reversals are recorded consistent with SEC Staff Accounting Bulletin #100 and result from actual costs at program completion being less than costs estimated at the commitment date. Subsequent to its filing for Chapter 11 bankruptcy protection, principally during 2003 and 2002 the Company was able to achieve more favorable resolution of leases and other contractual arrangements than estimated as of the commitment dates. Additionally, the Company also experienced a higher rate of voluntary employee attrition subsequent to filing Chapter 11, resulting in lower severance costs than estimated as of the commitment dates.
Management expects to finance these restructuring programs through cash generated from its ongoing operations or through cash available under its existing DIP facility, subject to the terms of applicable covenants. Management does not expect that the execution of these programs will have an adverse impact on its liquidity position.
The Company’s restructuring activities are undertaken as necessary to execute management’s strategy and generally fall into one of the following categories:
| 1. | Closure of facilities and relocation of production – In connection with the Company’s strategy, certain operations have been closed and related production relocated to low cost geographies or to other locations with available capacity. |
| 2. | Consolidation of administrative functions and standardization of manufacturing processes – As part of its productivity initiative, the Company has acted to consolidate its administrative functions and charge its manufacturing processes to reduce selling, general and administrative costs and improve operating efficiencies through standardization of processes. |
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The following is a summary of the Company’s consolidated restructuring reserves and related activity for 2004, 2003 and 2002. “SSP” and “AM” represent Sealing Systems and System Protection and Aftermarket, respectively.
| Powertrain | SSP | Friction | AM | Corporate | Total | |||||||||||||||||||
| (Millions of dollars) | ||||||||||||||||||||||||
Balance of reserves at January 1, 2002 | $ | 15.2 | $ | 9.9 | $ | 15.5 | $ | 25.2 | $ | 7.7 | $ | 73.5 | ||||||||||||
Provisions | 38.8 | 3.9 | 6.3 | 3.0 | 0.5 | 52.5 | ||||||||||||||||||
Reversals | (1.2 | ) | (0.2 | ) | (0.2 | ) | (18.6 | ) | (0.3 | ) | (20.5 | ) | ||||||||||||
Payments | (24.8 | ) | (5.1 | ) | (6.9 | ) | (0.7 | ) | (1.7 | ) | (39.2 | ) | ||||||||||||
Foreign currency | 4.0 | 0.6 | 0.5 | 5.2 | 0.8 | 11.1 | ||||||||||||||||||
Balance of reserves at December 31, 2002 | 32.0 | 9.1 | 15.2 | 14.1 | 7.0 | 77.4 | ||||||||||||||||||
Provisions | 28.1 | 5.9 | 1.8 | 17.1 | 0.6 | 53.5 | ||||||||||||||||||
Reversals | (1.6 | ) | (1.5 | ) | (10.5 | ) | (4.0 | ) | (3.2 | ) | (20.8 | ) | ||||||||||||
Payments | (33.0 | ) | (11.6 | ) | (6.3 | ) | (20.9 | ) | (0.9 | ) | (72.7 | ) | ||||||||||||
Foreign currency | 5.8 | 0.3 | 0.7 | 0.6 | 0.9 | 8.3 | ||||||||||||||||||
Balance of reserves at December 31, 2003 | 31.3 | 2.2 | 0.9 | 6.9 | 4.4 | 45.7 | ||||||||||||||||||
Provisions | 13.0 | 1.7 | — | 6.6 | 1.8 | 23.1 | ||||||||||||||||||
Reversals | (1.0 | ) | — | — | (0.7 | ) | (3.9 | ) | (5.6 | ) | ||||||||||||||
Payments | (23.6 | ) | (0.2 | ) | (0.7 | ) | (10.1 | ) | (1.3 | ) | (35.9 | ) | ||||||||||||
Foreign currency | (1.0 | ) | 0.1 | 1.4 | 0.2 | (0.1 | ) | 0.6 | ||||||||||||||||
Balance of reserves at December 31, 2004 | $ | 18.7 | $ | 3.8 | $ | 1.6 | $ | 2.9 | $ | 0.9 | $ | 27.9 | ||||||||||||
The Company’s restructuring reserve balances are principally comprised of severance and employee-related costs. Significant restructuring activities for the years ended December 31, 2004, 2003 and 2002 are described below by reporting segment.
Significant restructuring activities for the year ended December 31, 2004
Powertrain
| • | The Company recorded approximately $9 million of severance cost related to the closure of the Bradford, United Kingdom piston operations initially announced in 2003. This incremental severance charge has been recorded pursuant to an agreement reached with certain employees of the facility during 2004. While the closure of the Bradford facility was completed during 2004, payments related to this severance program will extend through 2014. As of December 31, 2004, approximately $8 million was remaining as a restructuring reserve related to this program. Expected future cost savings associated with the Bradford facility closure are estimated to be approximately $14 million per annum. |
| • | The Company’s German engine bearing operations continued their restructuring program to transfer certain low volume production with high labor content to low cost geographies, specifically Poland. Restructuring charges of approximately $3 million were recorded during 2004 related to severance costs incurred pursuant to a statutory early retirement program. These charges are in addition to the approximately $4 million, $2 million and $4 million recorded during the years ended December 31, 2003, 2002, and 2001, respectively. Payments of approximately $3 million, $2 million and $2 million were made against this reserve during 2004, 2003 and 2002, respectively. At December 31, 2004, the Company had remaining reserves of approximately $6 million related to these activities. While the transfer of production was completed during 2004, payment of employee severance costs is expected to continue through 2008. Expected savings associated with this activity are estimated to be approximately $8 million per annum. |
Aftermarket
| • | The Company initiated the relocation of its ignition operations in Naas, Ireland to existing facilities located in Burlington, Iowa and Carpi, Italy. This restructuring activity was completed during the third quarter of 2004. Related employee severance costs of approximately $6 million were charged and paid during the year ended December 31, 2004. Accordingly, the Company had no remaining reserves related to this activity as of December 31, 2004. Expected future cost savings associated with this activity are estimated to be approximately $2 million per annum. |
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Significant restructuring activities for the year ended December 31, 2003
Powertrain
| • | The Company announced the closure and relocation of its Bradford, United Kingdom piston operations to other existing European manufacturing facilities with available capacity or with lower manufacturing costs. The Company recorded approximately $14 million of severance charges related to this program during the year ended December 31, 2003. Subsequently, payments of $1 million and $13 million were made against this provision during the years ended December 31, 2003 and 2004, respectively. The Company had remaining reserves of approximately $13 million as of December 31, 2003 and since closure of this facility has been completed during 2004, no reserve is remaining as of December 31, 2004 related to these costs. Expected savings associated with this activity are estimated to be approximately $14 million per annum. |
| • | The Company incurred severance charges of approximately $4 million to eliminate redundancies across its operations in France related to changes in administrative and manufacturing processes. Payments of approximately $3 million and $1 million were made during the years ended December 31, 2003 and 2004, respectively. At December 31, 2003 the Company had remaining reserves of $1 million related to these activities. Expected savings associated with these activities are estimated to be approximately $3 million per annum. |
| • | Restructuring charges of approximately $2 million were recorded to further streamline and automate administrative functions and manufacturing processes at the Company’s piston manufacturing operation in Gorzyce, Poland. These charges are in addition to similar charges of approximately $4 million recorded in 2002 and are the result of expanding the scope of the initial program. Payments of approximately $2 million were made related to this program in 2003, accordingly no reserve was remaining at December 31, 2003 related to this activity. Expected savings associated with this activity are estimated to be approximately $3 million per annum. |
| • | The Company’s German engine bearing operations continued their restructuring programs to transfer certain low volume production with high labor content to low cost geographies, specifically Poland. Restructuring charges of approximately $4 million were recorded in 2003. These charges were in addition to $2 and $4 million recorded for the same program during the years ended December 31, 2002 and 2001, respectively. Payments of approximately $2 million for each of the years ended December 31, 2003 and 2002 were recorded. Approximately $6 million was recorded as a restructuring reserve related to this program as of December 31, 2003. |
| • | The Company recorded approximately $1 million during 2003 related to the previously announced closure and relocation of its piston ring operations in Sunderland, United Kingdom to other existing European facilities with available capacity. This amount was in addition to restructuring charges of $6 million recorded during the year ended December 31, 2002, related to the same program. Payments of approximately $5 million and $2 million were made during the years ended December 31, 2003 and 2002, respectively. This closure and relocation project was completed and all amounts were paid during 2003, accordingly, no reserves remain as of December 31, 2003. |
Sealing Systems & Systems Protection
| • | The Company recorded approximately $3 million related to the closure of its Sealing Systems operations in Cardiff, Wales. Production from this facility was relocated to other existing European manufacturing facilities with available capacity or with lower cost to manufacture. This amount was in addition to previously recorded restructuring charges related to the same program of $4 million and $5 million during the years ended December 31, 2002 and 2001, respectively. Payments of approximately $9 million and $3 million were made in 2003 and 2002, respectively, relating to this project. This project was completed during 2003 and all related payments were made, accordingly no reserve was remaining as of December 31, 2003. Expected savings associated with this activity are estimated to be approximately $2 million per annum. |
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Friction
| • | Reserve reversals of approximately $11 million were recorded related to the planned closure of certain North American friction facilities. Such reserves were initially recorded during 2001. The reversal resulted from the Company’s decision not to complete closure of all facilities as originally intended. This decision resulted from delays in the closure due to execution difficulties and protracted negotiations with organized labor unions. During 2002 the Company began to experience a substantial increase in demand for its friction products largely due to the successful introduction of a new aftermarket friction product by the Company. Pursuant to the need for additional manufacturing capacity and successful negotiations with the UAW, a decision was made during the 4th quarter 2003 not to close all facilities as initially planned. |
Aftermarket
| • | The Company relocated its ignition production from Aubange, Belgium to Upton, England and recorded related severance and exit costs of approximately $10 million. The relocation of this production was completed during 2003. Payments of related severance and exit costs of approximately $8 million and $1 million were made during the years ended December 31, 2003 and 2004, respectively. As of December 31, 2003 and 2004 remaining reserves related to this activity approximated $2 million and $1 million, respectively. Expected savings associated with this activity are estimated to be approximately $5 million per annum. |
| • | Restructuring charges of $3 million were recorded related to the previously announced consolidation of distribution operations at the Company’s Aftermarket distribution facility located in Gif sur Yvette, France into its central European distribution facility in Belgium. This restructuring charge is in addition to a previously recorded amount of $2 million, which was recorded in 2002. Payment of related severance costs of approximately $3 million and $1 million were made during the year ended December 31, 2003 and 2002, respectively. At December 31, 2003, the Company had approximately $1 million remaining reserves related to this activity. The consolidation was completed during 2003 and remaining reserve amounts were paid during 2004. Expected savings associated with this activity are estimated to be approximately $5 million per annum. Consolidation of these facilities was completed in 2003. |
Significant restructuring activities for the year ended December 31, 2002
Powertrain
| • | The Company announced the closure of its Bridgewater, United Kingdom piston operation. Related production from this operation was relocated to other existing European manufacturing facilities with available capacity or with lower cost to manufacture. In connection with this program, the Company recorded approximately $10 million for related severance and exit costs. Payments approximating $9 million were made during 2003. Remaining reserves as of December 31, 2002 and 2003 were $10 million and $1 million, respectively. This program was completed during 2003 and no reserves remained as of December 31, 2004 related to this program. Expected savings associated with this activity are estimated to be approximately $2 million per annum. |
| • | The Company recorded restructuring charges of $11 million related to the closure of its piston manufacturing operations in Flowery Branch, Georgia, Orangeburg, South Carolina and Sumter, South Carolina. Production from these facilities was relocated to other existing North American manufacturing facilities with available capacity or with lower cost to manufacture. The closure of Flowery Branch and Orangeburg was completed during 2003 and closure of Sumter was completed in 2004. Payments of approximately $2 million, $4 million and $4 million were made against this reserve during the years ended December 31, 2002, 2003 and 2004, respectively. The Company had remaining reserves related to these activities of approximately $7 million, $5 million and $1 million as of December 31, 2002, 2003 and 2004, respectively. While the closures have been completed, final payments are expected to continue through June 2005. Expected savings associated with this activity are estimated to be approximately $17 million per annum. |
| • | The Company recorded approximately $6 million during 2002 related to the closure and relocation of its piston ring operations in Sunderland, United Kingdom to other existing European facilities with available capacity. |
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Payments of approximately $2 million were made against this reserve during the year ended December 31, 2002. The Company had remaining reserves related to these activities of approximately $4 million as of December 31, 2002. The program was completed during 2003, accordingly the Company has no reserve for this program at December 31, 2003. |
| • | The Company initiated administrative function and manufacturing process changes at the Company’s piston manufacturing operations located in Nuremburg, Germany, resulting in a reduction of the employee work force. Restructuring charges of approximately $5 million were recorded for the year ended December 31, 2002. Payments of approximately $1 million, $1 million and $1 million were made during the years ended December 31, 2002, 2003 and 2004, respectively. The Company had remaining reserves of approximately $5 million, $4 million and $3 million related to this activity as of December 31, 2002, 2003 and 2004, respectively. The administrative function and manufacturing process changes were completed during 2003. However, employee severance payments are pursuant to a local statutory program and are scheduled to continue through June 2009. Expected savings associated with this activity are estimated to be approximately $5 million per annum. |
| • | During 2002, management announced a program to streamline and automate administrative functions and manufacturing processes at Company’s piston manufacturing operation in Gorzyce, Poland. Charges of approximately $4 million were recorded during the year ended December 31, 2002 relating to this program. Approximately $4 million of payments were made related to this program in 2002. At December 31, 2002, the Company had no remaining reserves related to this activity. Expected savings associated with this activity are estimated to be approximately $5 million per annum. |
| • | The Company’s German engine bearing operations continued their restructuring programs to transfer certain low volume production with high labor content to low cost geographies, specifically Poland. Restructuring charges of approximately $2 million were recorded in 2002. These charges were in addition to $2 million recorded for the same program during the year ended December 31, 2001. Payments of approximately $2 million were made during the year ended December 31, 2002. Approximately $2 million was recorded as a restructuring reserve related to this program as of December 31, 2002. |
Sealing Systems and Systems Protection
| • | The Company recorded approximately $4 million related to the closure its Sealing Systems operations in Cardiff, Wales. Production from this facility was relocated to other existing European manufacturing facilities with available capacity or with lower cost to manufacture. This amount was in addition to previously recorded restructuring charges related to the same program of $5 million during the year ended December 31, 2001. Payments of approximately $3 million were made during 2002 and a reserve of approximately $6 million was remaining as of December 31, 2002. |
Friction
| • | The Company recorded approximately $4 million related to the announced closure of its aftermarket half-block operations in Marienheide, Germany. Related severance and exit payments of approximately $3 million and $1 million were made during the years ended December 31, 2002 and 2003, respectively. At December 31, 2002, the Company had a remaining reserve of approximately $1 million related to this activity. The closure of the half-block operations in Marienheide, Germany was completed during 2003. Expected savings associated with this activity are estimated to be approximately $2 million per annum. |
Aftermarket
| • | The Company announced and began the consolidation of certain distribution operations at its Aftermarket distribution facility located in Gif sur Yvette, France into its central European distribution facility in Belgium. Restructuring charges of $2 million were recorded during the year ended December 31, 2002. Payment of related severance costs of approximately $1 million was made in during the year ended December 31, 2002. At December 31, 2002, the Company had a remaining reserve of approximately $1 million related to this activity. Expected savings associated with this activity are estimated to be approximately $5 million per annum. |
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| • | Reserve reversals of approximately $19 million related to the Aftermarket distribution optimization restructuring program initially recorded in 2000 and 2001 were reversed upon completion of related restructuring activities during 2002. Approximately $7 million of this reversal was attributable to lease termination costs that were not incurred as expected under the restructuring plan. Lease contracts identified within the restructuring plan were instead separately terminated during 2002 pursuant to the Company’s Chapter 11 filing on October 1, 2001. Approximately $3 million of this reversal was attributable to planned employee severance costs that were not incurred as identified employees voluntarily terminated their employment in anticipation of the facility closure or in connection with the Company’s Chapter 11 filing. Approximately $3 million of the reversal was due to the Company’s decision not to close the Berkley, MO distribution facility as initially planned. This decision was based upon the need for additional capacity due to increasing brake hard parts and friction sales volumes not anticipated at the commitment date. The remaining amount of the reversal represents an aggregate of individually insignificant amounts resulting from differences in actual costs to exit as compared to initial estimates. |
5. Smithville, Tennessee Distribution Center Fire
On March 5, 2004, a fire at the Company’s Smithville, Tennessee distribution center resulted in extensive damage to the facility and the loss of substantially all of its related equipment and inventory. The 244,000 square foot facility was the principal distribution center for Moog and TRW chassis aftermarket products in the United States. The Company resumed distribution operations at a new leased facility in Smyrna, Tennessee on March 12, 2004.
The Company has settled this claim with its insurance carrier, resulting in cash proceeds of $102.2 million and the recognition of a gain on involuntary conversion of $46.1 million.
6. Other Expense, Net
The specific components of “other expense, net” are provided in the following table:
| Year Ended December 31 | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| (Millions of Dollars) | ||||||||||||
Restructuring expense | $ | (17.5 | ) | $ | (32.7 | ) | $ | (32.0 | ) | |||
Amortization of intangible assets | (17.2 | ) | (16.9 | ) | (14.0 | ) | ||||||
Foreign currency exchange | (5.6 | ) | 2.6 | 8.4 | ||||||||
Royalty income | 3.9 | 4.9 | 3.4 | |||||||||
Accounts receivable discount expense | (3.6 | ) | (2.7 | ) | (8.9 | ) | ||||||
Other insurance recoveries | 4.0 | — | — | |||||||||
Other | 14.5 | 11.7 | 2.8 | |||||||||
| $ | (21.5 | ) | $ | (33.1 | ) | $ | (40.3 | ) | ||||
7. Discontinued Operations
In connection with its strategic planning process, the Company assesses its operations for market position, product technology and capability, and profitability. Those businesses determined by management not to have a sustainable competitive advantage are considered non-core and may be considered for divestiture or other exit activities. The elimination of these non-core businesses has freed up both human and capital resources which have been devoted to the Company’s core businesses.
During 2004, the Company completed the following divestitures of non-core businesses:
| • | During July 2004, the Company completed the divestitures of its large bearing operations in Pinetown, South Africa and Uslar, Germany. |
| • | During December 2004, the Company divested its transmission operations located in Dayton, Ohio. |
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During 2003, the Company completed the following divestitures of non-core businesses:
| • | During April 2003, the Company completed the divestitures of its U.S. camshaft operations and the majority of its original equipment lighting operations. The divested U.S. camshaft operations include manufacturing operations in Grand Haven, Michigan and Orland, Indiana, as well as the Company’s share of an assembled camshaft joint venture operation in Grand Haven. The original equipment lighting divestitures include operations in Matamoros, Mexico; Brownsville, Texas; and Toledo, Ohio. |
| • | During September 2003, the Company divested operations located in Hampton, Virginia and Solon, Ohio. |
During 2002, the Company completed the following divestitures of non-core businesses:
| • | In March 2002, the Company completed the divestiture of its Signal-Stat Lighting Products business (“Signal-Stat”). Signal-Stat produces exterior lighting and power distribution products primarily for the heavy-duty and commercial vehicle markets. |
| • | In July 2002, the Company completed the divestiture of its automotive camshaft manufacturing plant in Jackson, Michigan, under the terms of a management buyout. The Company also entered into a three-year supply agreement to market and sell aftermarket camshafts produced at the Jackson facility through its aftermarket business. |
| • | In November 2002, the Company completed the divestiture of Federal-Mogul Camshafts de Mexico S. de R.L. de C.V. (“Camshafts de Mexico”). Camshafts de Mexico manufactures camshafts for the North American original equipment market. |
Further information related to the Company’s discontinued operations is as follows:
| Year Ended December 31 | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| (Millions of Dollars) | ||||||||||||
Net sales | $ | 17.0 | $ | 90.9 | $ | 265.1 | ||||||
Cost of products sold | 22.5 | 82.5 | 245.3 | |||||||||
Gross margin | (5.5 | ) | 8.4 | 19.8 | ||||||||
Selling, general and administrative expenses | 2.3 | 5.6 | 17.5 | |||||||||
Restructuring charges | 0.2 | 3.3 | 6.4 | |||||||||
Adjustment of assets to fair value | — | 12.1 | 7.6 | |||||||||
Net loss (gain) on divestitures | 1.7 | 6.8 | (0.5 | ) | ||||||||
Other expense, net | 0.7 | 1.1 | 3.2 | |||||||||
Loss before income taxes and cumulative effect of change in accounting principle | (10.4 | ) | (20.5 | ) | (14.4 | ) | ||||||
Income tax expense (benefit) | (1.9 | ) | 0.4 | 12.9 | ||||||||
Loss from discontinued operations before cumulative effect of change in accounting principle | (8.5 | ) | (20.9 | ) | (27.3 | ) | ||||||
Cumulative effect of change in accounting principle | — | — | (5.7 | ) | ||||||||
Loss from discontinued operations, net of income taxes | $ | (8.5 | ) | $ | (20.9 | ) | $ | (33.0 | ) | |||
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In accordance with SFAS No. 144, the Company’s 2004 divestitures are considered as “held for sale” as of December 31, 2003. As such, the Company had assets held for sale included in its consolidated balance sheet as follows:
December 31 2003 | ||||
| (Millions of Dollars) | ||||
Accounts receivable, net | $ | 4.5 | ||
Inventories, net | 3.9 | |||
Other current assets | 0.2 | |||
Total Current Assets | 8.6 | |||
Property, plant and equipment, net | 3.8 | |||
Total Assets | $ | 12.4 | ||
Accounts payable | $ | (1.6 | ) | |
Other accrued liabilities | (5.1 | ) | ||
Total Liabilities | $ | (6.7 | ) | |
8. Financial Instruments
Foreign Currency Risk
Certain forecasted and recorded transactions and assets and liabilities are exposed to foreign currency risk. The Company monitors its foreign currency exposures to maximize the overall effectiveness of its foreign currency hedge positions. Principal currencies hedged include the Euro, British pound, Japanese yen and Canadian dollar. Options used to mitigate foreign currency risk associated with a portion of forecasted transactions, for up to twelve months in the future, are designated as cash flow hedging instruments. Options and forwards used to hedge certain booked transactions and assets and liabilities are not designated as hedging instruments under SFAS 133 as they are natural hedges. The effect of changes in the fair value of these hedges and the underlying exposures are recognized in earnings each period. These hedges were highly effective and their impact on earnings was not significant during 2004 and 2003. The Company did not have any contracts outstanding at December 31, 2004, and two contracts outstanding with a combined notional value of $10.4 million at December 31, 2003. Unrealized amounts related to outstanding contracts were not material at December 31, 2003.
Commodity Price Risk
The Company is dependent upon the supply of certain raw materials in its production processes; these raw materials are exposed to price fluctuations on the open market. The primary purpose of the Company’s commodity price hedging activities is to manage the volatility associated with these forecasted purchases. The Company monitors its commodity price risk exposures periodically to maximize the overall effectiveness of its commodity forward contracts. Principal raw materials hedged include natural gas, copper, nickel, lead, high-grade aluminum and aluminum alloy. Forward contracts used to mitigate commodity price risk associated with raw materials, for up to eighteen months in the future, are designated as cash flow hedging instruments. These instruments are intended to offset the effect of changes in raw materials prices on forecasted purchases. The Company had three contracts outstanding with a combined notional value of $6.5 million at December 31, 2004, and two contracts outstanding with a combined notional value of $9.2 million at December 31, 2003. Unrealized amounts related to outstanding contracts were not material at December 31, 2004 or 2003.
Other
For derivatives designated either as fair value or cash flow hedges, changes in the time value are excluded from the assessment of hedge effectiveness. Hedge ineffectiveness, determined in accordance with SFAS No. 133, did not
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have a material effect on operations for 2004 or 2003. No fair value hedges or cash flow hedges were re-designated or discontinued during 2004 or 2003.
Derivative gains and losses included in Other Comprehensive Income are reclassified into operations at the time forecasted transactions are recognized. Such amounts were not material in 2004, 2003 or 2002.
Concentrations of Credit Risk
Financial instruments, which potentially subject the Company to concentrations of credit risk, consist primarily of accounts receivable and cash investments. The Company’s customer base includes virtually every significant global automotive manufacturer and a large number of distributors and installers of automotive aftermarket parts. The Company’s credit evaluation process, reasonably short collection terms and the geographical dispersion of sales transactions help to mitigate credit risk concentration. The Company requires placement of cash in financial institutions evaluated as highly creditworthy.
Fair Value of Financial Instruments
At December 31, 2004 and 2003, the carrying amounts of certain financial instruments such as cash and equivalents, accounts receivable, accounts payable, and borrowings under the DIP credit facility approximate their fair values. The fair value of financial instruments included in liabilities subject to compromise are highly uncertain as a result of the Restructuring Proceedings.
9. Inventory
Cost determined by the last-in, first-out (LIFO) method was used for 45% and 46% of the inventory at December 31, 2004 and 2003, respectively. If inventories had been valued at current cost, amounts reported would have been increased by $69.4 million and $58.1 million as of December 31, 2004 and 2003, respectively. The carrying value of inventories has also been reduced for excess and obsolete inventories based on management’s review of on-hand inventories compared to historical and estimated future sales and usage.
Inventory quantity reductions resulting in liquidations of certain LIFO inventory layers decreased net loss by $0.2 million ($0.00 per diluted share) in 2004, decreased net loss by $2.1 million ($0.02 per diluted share) in 2003, and increased net loss by $3.5 million ($0.04 per diluted share) in 2002.
Inventories consisted of the following:
| December 31 | ||||||||
| 2004 | 2003 | |||||||
| (Millions of Dollars) | ||||||||
Raw materials | $ | 185.8 | $ | 167.7 | ||||
Work-in-process | 157.7 | 136.6 | ||||||
Finished products | 680.1 | 597.9 | ||||||
| 1,023.6 | 902.2 | |||||||
Valuation reserves | (70.7 | ) | (67.8 | ) | ||||
| $ | 952.9 | $ | 834.4 | |||||
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10. Property, Plant and Equipment
Depreciation expense for continuing operations for the years ended December 31, 2004, 2003 and 2002, was $306.6 million, $276.0 million and $246.5 million, respectively.
Property, plant and equipment consisted of the following:
Estimated Useful Life | December 31 | |||||||||
| 2004 | 2003 | |||||||||
| (Millions of Dollars) | ||||||||||
Land | — | $ | 119.2 | $ | 118.7 | |||||
Buildings and building improvements | 24 - 40 years | 582.2 | 558.0 | |||||||
Machinery and equipment | 3 - 12 years | 3,198.2 | 2,977.2 | |||||||
| 3,899.6 | 3,653.9 | |||||||||
Accumulated depreciation | (1,535.7 | ) | (1,249.1 | ) | ||||||
| $ | 2,363.9 | $ | 2,404.8 | |||||||
Future minimum payments under noncancelable operating leases with initial or remaining terms of more than one year are as follows (in millions of dollars):
2005 | $ | 27.2 | |
2006 | 20.0 | ||
2007 | 14.6 | ||
2008 | 12.3 | ||
2009 | 10.7 | ||
Thereafter | 24.3 | ||
| $ | 109.1 | ||
Total rental expense for continuing operations under operating leases for the years ended December 31, 2004, 2003 and 2002 was $48.3 million, $40.2 million and $45.1 million, respectively, exclusive of property taxes, insurance and other occupancy costs generally payable by the Company.
11. Investments in Non-Consolidated Affiliates
The Company maintains investments in 21 non-consolidated affiliates, which are located in Turkey, China, Korea, India, Japan, the United States and Mexico. The Company’s direct ownership in such affiliates ranges from approximately 5% to 50%. The aggregate investment in these affiliates approximates $160 million and $131 million at December 31, 2004 and 2003, respectively, and are included in the consolidated balance sheets as “other noncurrent assets.” The Company’s equity in the earnings of such affiliates amounted to approximately $36 million, $27 million and $20 million for the years ended December 31, 2004, 2003 and 2002, respectively. During 2004 these entities generated sales of approximately $579 million, net income of approximately $67 million and at December 31, 2004 had total net assets of approximately $302 million. The Company does not hold a controlling interest in an entity based on exposure to economic risks and potential rewards (variable interests) for which it is the primary beneficiary. Further, the Company’s joint ventures are businesses established and maintained in connection with its operating strategy and are not special purpose entities.
The Company holds a 50% non-controlling interest in a joint venture located in Turkey. This joint venture was established for the purpose of manufacturing and marketing automotive parts including pistons, pins, piston rings, and cylinder liners to original equipment (“OE”) and Aftermarket customers. Pursuant to the joint venture agreement, the Company’s partner holds an option to put its shares to a subsidiary of the Company at the higher of the current fair value or at a guaranteed minimum amount. The guaranteed minimum amount represents a contingent guarantee of the initial investment of the investment partner. The contingent guarantee can be exercised at the discretion of the joint venture partner. The term of the contingent guarantee is indefinite, consistent with the terms of the joint venture agreement. However, the contingent guarantee would not survive termination of the joint venture agreement. As of December 31, 2004, the total amount of the contingent guarantee, were all triggering events to
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occur, approximated $55 million. Management believes that this contingent guarantee is substantially less than the estimated current fair value of the guarantees’ interest in the affiliate. Management also believes that exercise of the put option is not reasonably likely within the foreseeable future. However, if this put option is exercised at its estimated current fair value, such exercise would have a material effect on the Company’s liquidity.
12. Accrued Liabilities
Accrued liabilities consisted of the following:
| December 31 | ||||||
| 2004 | 2003 | |||||
| (Millions of Dollars) | ||||||
Accrued compensation | $ | 255.5 | $ | 220.3 | ||
Accrued income taxes | 75.9 | 31.4 | ||||
Accrued rebates | 73.2 | 59.7 | ||||
Accrued Chapter 11 and Administration expenses | 44.8 | 34.0 | ||||
Non-income taxes payable | 34.5 | 40.0 | ||||
Restructuring reserves | 27.9 | 45.7 | ||||
Accrued product returns | 20.4 | 21.0 | ||||
Accrued warranty | 14.8 | 11.4 | ||||
Accrued professional services | 12.7 | 11.1 | ||||
Total current accrued liabilities | $ | 559.7 | $ | 474.6 | ||
13. Debt
Long-term debt consisted of the following:
| December 31 | ||||||||
| 2004 | 2003 | |||||||
| (Millions of Dollars) | ||||||||
DIP Credit Facility | $ | 277.7 | $ | 320.0 | ||||
Other | 42.0 | 26.0 | ||||||
| 319.7 | 346.0 | |||||||
Less: current maturities included in short-term debt | (309.6 | ) | (14.8 | ) | ||||
Total long-term debt | $ | 10.1 | $ | 331.2 | ||||
Due to the Restructuring Proceedings (see Note 2), pre-petition long-term debt of the Debtors has been reclassified to the caption “Liabilities subject to compromise” in the consolidated balance sheets. The following is the long-term debt included in liabilities subject to compromise:
| December 31 | ||||||||
| 2004 | 2003 | |||||||
| (Millions of Dollars) | ||||||||
Senior Credit Agreements: | ||||||||
Term loans | $ | 788.5 | $ | 788.5 | ||||
Multi-currency revolving credit facility | 1,149.3 | 1,144.8 | ||||||
Notes due 2004 — 7.5%, issued in 1998 | 239.8 | 239.8 | ||||||
Notes due 2006 — 7.75%, issued in 1998 | 391.9 | 391.9 | ||||||
Notes due 2006 — 7.375%, issued in 1999 | 394.0 | 394.0 | ||||||
Notes due 2009 — 7.5%, issued in 1999 | 562.2 | 562.2 | ||||||
Notes due 2010 — 7.875%, issued in 1998 | 340.4 | 340.4 | ||||||
Medium-term notes — due between 2002 and 2005, average rate of 8.8%, issued in 1994 and 1995. | 84.0 | 84.0 | ||||||
Senior notes — due in 2007, rate of 8.8%, issued in 1997 | 103.3 | 103.3 | ||||||
Other | 2.6 | 2.5 | ||||||
| 4,056.0 | 4,051.4 | |||||||
Less: debt issuance fees | (29.1 | ) | (30.7 | ) | ||||
Total debt included in liabilities subject to compromise | $ | 4,026.9 | $ | 4,020.7 | ||||
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In accordance with SOP 90-7, the Company ceased recording interest expense on its outstanding Notes, Medium-term notes, and Senior notes effective October 1, 2001. The Company’s contractual interest not accrued or paid in 2004, 2003 and 2002 was $152.5 million, $162.8 million and $164.4 million, respectively. The Company continues to accrue and pay the contractual interest on the Senior Credit Agreement in the month incurred, totaling $75.8 million, $71.4 million and $81.8 million in 2004, 2003 and 2002, respectively.
Additionally, the Company has agreed to pay, with the approval of the Bankruptcy Court, adequate protection payments approximating $2.6 million per quarter to the holders of the Company’s Notes. The amount is paid quarterly in equal installments during the time in which the plan of reorganization is being developed. The Company has additionally elected to grant each quarter since the commencement of the Restructuring Proceedings an administrative claim in the amount of one percent per annum on the outstanding notes. The amount of such administrative expense claim each quarter is approximately $5.3 million. Amounts paid and administrative claims granted under this arrangement are provisional in nature and remain subject to re-characterization, credit against distributions in respect of allowed claims on a plan of reorganization, and other appropriate relief if and to the extent the Bankruptcy Court ultimately concludes that the holders were not entitled to adequate protection for any reason. Additionally, these amounts remain subject to challenge by all parties in interest to the Restructuring Proceedings.
In connection with the Restructuring Proceedings, the Company entered into a DIP credit facility to supplement liquidity and fund operations during the restructuring proceedings. In December 2004, the Company renegotiated its DIP credit facility. Prior to December 2004, the Company’s DIP credit facility had an interest rate of either the alternate base rate (“ABR”) plus 2 percentage points or a formula based on the London Inter-Bank Offered Rate (“LIBOR”) plus 3 percentage points. The ABR is the greater of either the bank’s prime rate or the base CD rate plus 1 percentage point or the federal funds rate plus ½ percentage point.
The December 2004 DIP credit facility expires in December 2005, and the interest rate is either the ABR plus 1¼ percentage points or a formula based on LIBOR plus 2¼ percentage points. The ABR is the greater of either the bank’s base rate or the federal funds rate plus ½ percentage point. In addition, the commitment available under the DIP credit facility is mandatorily reduced by a portion of proceeds received from future asset or business divestitures.
The Company’s available borrowings under its DIP credit facilities are determined by the underlying collateral at any point in time, consisting of its domestic inventories, domestic accounts receivable, and domestic property, plant, and equipment. The DIP lenders received permission from the lenders of the Senior Credit Agreements to have priority over their collateral interest. The borrowing base available to the Company is calculated weekly based upon the value of this underlying collateral. The total commitment and amounts outstanding on the DIP credit facilities are as follows:
| December 31 | ||||||
| 2004 | 2003 | |||||
| (Millions of Dollars) | ||||||
Contractual commitment | $ | 500.0 | $ | 600.0 | ||
Mandatory commitment reductions - divestitures | — | — | ||||
Current commitment | $ | 500.0 | $ | 600.0 | ||
Outstanding: | ||||||
Current borrowings | $ | 277.7 | $ | 320.0 | ||
Letters of credit | 45.3 | 17.9 | ||||
Total outstanding | 323.0 | 337.9 | ||||
Available to borrow | 177.0 | 236.6 | ||||
Total borrowing base | $ | 500.0 | $ | 574.5 | ||
The DIP credit facility contains restrictive covenants. The more significant of these covenants include the maintenance of certain levels of earnings before interest, taxes, depreciation and amortization and limitations on quarterly capital expenditures. Additional covenants include, but are not limited to, restrictions on the early retirement of debt, additional borrowings, payment of dividends and the sale of assets or businesses.
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At December 31, 2004 and 2003, the Company had $100.7 million and $76.1 million, respectively, of letters of credit outstanding under its DIP and pre-petition credit facilities. To the extent letters of credit associated with the DIP credit facility are issued, there is a corresponding decrease in borrowings available under the facility.
The Company has pledged 100% of the capital stock of certain U.S. subsidiaries, 65% of capital stock of certain foreign subsidiaries and certain intercompany loans to secure the Senior Credit Agreements of the Company. Certain of such pledges also extend to the Notes, Medium-Term Notes and Senior Notes. In addition, certain subsidiaries of the Company have guaranteed the senior debt (refer to Note 23, “Consolidating Condensed Financial Information of Guarantor Subsidiaries”).
The weighted average interest rate for the Company’s short-term debt was approximately 4.7% and 3.9% as of December 31, 2004 and 2003, respectively. Interest paid in 2004, 2003 and 2002 was $119.0 million, $119.5 million and $127.9 million, respectively.
14. Company-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Holding Solely Convertible Subordinated Debentures of the Company
In December 1997, the Company’s wholly-owned financing trust (“Affiliate”) completed a $575 million private issue of 11.5 million shares of 7.0% Trust Convertible Preferred Securities (“TCP Securities”) with a liquidation value of $50 per convertible security. The net proceeds from the TCP Securities were used to purchase an equal amount of 7.0% Convertible Junior Subordinate Debentures (“Debentures”) of the Company. The TCP Securities represent an undivided interest in the Affiliate’s assets, with a liquidation preference of $50 per security.
The shares of the TCP Securities are convertible, at the option of the holder, into the Company’s common stock at an equivalent conversion price of $51.50 per share, subject to adjustment in certain events. The TCP Securities and the Debentures became redeemable, at the option of the Company, on or after December 6, 2000 at a redemption price, expressed as a percentage of principal, which is added to accrued and unpaid interest. The redemption price range is from 104.2% on December 6, 2000 to 100.0% after December 1, 2007. All outstanding TCP Securities and Debentures are required to be redeemed by December 1, 2027. In 2004, the holders of the TCP Securities redeemed 1,984,136 shares into 1,926,398 shares of common stock. The effect was an increase to common stock of $9.7 million and an increase to paid in capital of $87.5 million.
Distributions on the TCP Securities are cumulative and are due quarterly in arrears at an annual rate of 7.0%. As a result of the Restructuring Proceedings, the Company is in default to its affiliate holder of its convertible junior subordinated debentures and is no longer accruing expense or making interest payments on the debentures. As a result, the affiliate no longer has the funds available to pay distributions on the Company Mandatorily Redeemable Preferred Securities and ceased paying such distributions in October 2001. The affiliate is in default on the Company Mandatorily Redeemable Preferred Securities. The Company is a guarantor of its subsidiary’s debentures, and has classified these debentures as liabilities subject to compromise in the December 31, 2004 and 2003 consolidated balance sheets.
15. Accumulated Other Comprehensive Loss
Accumulated Other Comprehensive Loss consists of the following:
| December 31 | |||||||
| 2004 | 2003 | ||||||
| (Millions of Dollars) | |||||||
Foreign currency translation | $ | (278.4 | ) | $ | 12.3 | ||
Additional minimum liability for pension plans | 1,557.5 | 954.8 | |||||
| $ | 1,279.1 | $ | 967.1 | ||||
16. Capital Stock and Preferred Share Purchase Rights
The Company’s articles of incorporation authorize the issuance of 260,000,000 shares of common stock, of which 89,057,696 and 87,131,298 shares were outstanding at December 31, 2004 and 2003, respectively. The Company’s
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common stock is subject to a Rights Agreement under which each share has attached to it a Right to purchase one one-thousandth of a share of a new series of preferred stock, at a price of $250 per Right. In the event an entity acquires or attempts to acquire 10% (20% in the case of an institutional investor) or more of the then outstanding shares, each Right would entitle the holder to purchase a number of shares of common stock pursuant to a formula contained in the Agreement. These Rights will expire on April 30, 2009, but may be redeemed by the Company at a price of $.01 per Right at any time prior to a public announcement that the above event has occurred. The Board may amend the Rights at any time without shareholder approval.
The Series C ESOP Convertible Preferred Stock Shares (the “Preferred Shares”) were used to fund a portion of the Company’s matching contributions within the Salaried Employees’ Investment Program. The Preferred Shares are convertible into shares of the Company’s common stock at a rate of two shares of common stock for each share of preferred stock. The Preferred Shares have a guaranteed price of $63.75/share. There were 439,937 Preferred Shares outstanding at December 31, 2004, 2003 and 2002. The Preferred Shares were paid dividends at a rate of 7.5% until 2001. As a result of the Restructuring Proceedings, the payment of dividends was discontinued, and no Preferred Shares were retired in 2004 or 2003. Additionally, no charge was recorded for the cost of the ESOP nor were any cash contributions made to the plan for the years ended December 31, 2004, 2003 or 2002. ESOP shares are released as principal and interest on the debt is paid. Compensation expense is measured based on the fair value of shares committed to be released to employees. Dividends on ESOP shares are treated as a reduction of shareholders’ equity in the period declared. The number of allocated shares held by the ESOP was 439,937 at December 31, 2004, 2003 and 2002. There were no committed-to-be-released or suspense shares at December 31, 2004 or 2003. Any repurchase of the ESOP shares is strictly at the option of the Company.
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17. Income Taxes
Under the liability method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The components of income (loss) from continuing operations before income taxes and cumulative effect of change in accounting principle due to the adoption of SFAS No. 142 consisted of the following:
| Year Ended December 31 | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| (Millions of Dollars) | ||||||||||||
Domestic | $ | (136.1 | ) | $ | 12.2 | $ | (22.1 | ) | ||||
International | (53.3 | ) | (128.3 | ) | (83.7 | ) | ||||||
Total | $ | (189.4 | ) | $ | (116.1 | ) | $ | (105.8 | ) | |||
Significant components of the provision for income taxes are as follows:
| Year Ended December 31 | |||||||||||
| 2004 | 2003 | 2002 | |||||||||
| (Millions of Dollars) | |||||||||||
Current: | |||||||||||
Federal | $ | 7.9 | $ | (5.0 | ) | $ | — | ||||
State and local | 1.1 | (1.0 | ) | 1.0 | |||||||
International | 99.5 | 21.3 | 70.3 | ||||||||
Total current | 108.5 | 15.3 | 71.3 | ||||||||
Deferred: | |||||||||||
Federal | — | (16.0 | ) | 27.4 | |||||||
State and local | — | — | — | ||||||||
International | 27.6 | 53.2 | (20.8 | ) | |||||||
Total deferred | 27.6 | 37.2 | 6.6 | ||||||||
| $ | 136.1 | $ | 52.5 | $ | 77.9 | ||||||
The reconciliation of income taxes computed at the United States federal statutory tax rate to income tax expense is:
| Year Ended December 31 | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| (Millions of Dollars) | ||||||||||||
Income taxes at United States statutory rate | $ | (66.3 | ) | $ | (40.6 | ) | $ | (37.0 | ) | |||
Tax effect from: | ||||||||||||
State income taxes | 1.1 | 1.0 | 1.0 | |||||||||
Foreign operations | 22.5 | 21.3 | 20.9 | |||||||||
Goodwill impairment | 67.8 | 24.7 | — | |||||||||
Favorable audit settlements and tax refunds | (8.2 | ) | (22.9 | ) | — | |||||||
Valuation allowances | 44.6 | 67.8 | 89.2 | |||||||||
Non-deductible interest, fees and other | 74.6 | 1.2 | 3.8 | |||||||||
| $ | 136.1 | $ | 52.5 | $ | 77.9 | |||||||
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The following table summarizes the Company’s total provision for income taxes/(tax benefit) by component:
| Year Ended December 31 | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| (Millions of Dollars) | ||||||||||||
Income tax expense | $ | 136.1 | $ | 52.5 | $ | 77.9 | ||||||
Cumulative effect of change in accounting principle | — | — | (46.6 | ) | ||||||||
Discontinued operations | (1.9 | ) | 0.4 | 12.9 | ||||||||
Adjustments to goodwill | (66.2 | ) | (36.2 | ) | (23.9 | ) | ||||||
Allocated to equity: | ||||||||||||
Foreign currency translation | 8.4 | 21.3 | 11.6 | |||||||||
Pension | (166.3 | ) | (27.8 | ) | (216.3 | ) | ||||||
Valuation allowances | 154.2 | 27.1 | 216.3 | |||||||||
Significant components of the Company’s deferred tax assets and liabilities are as follows:
| December 31 | ||||||||
| 2004 | 2003 | |||||||
| (Millions of Dollars) | ||||||||
Deferred tax assets | ||||||||
Asbestos liability | $ | 565.5 | $ | 541.6 | ||||
Tax credits | 97.4 | 98.9 | ||||||
Postemployment benefits, including pensions | 553.2 | 385.0 | ||||||
Net operating loss carryforwards | 612.2 | 500.5 | ||||||
Other temporary differences | 91.8 | 135.7 | ||||||
Total deferred tax assets | 1,920.1 | 1,661.7 | ||||||
Valuation allowances for deferred tax assets | (1,122.9 | ) | (892.3 | ) | ||||
Net deferred tax assets | 797.2 | 769.4 | ||||||
Deferred tax liabilities | ||||||||
Fixed assets | (260.3 | ) | (265.8 | ) | ||||
Intangible assets | (176.2 | ) | (153.4 | ) | ||||
Asbestos insurance | (270.5 | ) | (254.2 | ) | ||||
Deferred gains | (184.2 | ) | (169.1 | ) | ||||
Total deferred tax liabilities | (891.2 | ) | (842.5 | ) | ||||
| $ | (94.0 | ) | $ | (73.1 | ) | |||
Deferred tax assets and liabilities are recorded in the consolidated balance sheets as follows:
| December 31 | ||||||||
| 2004 | 2003 | |||||||
| (Millions of Dollars) | ||||||||
Assets: | ||||||||
Prepaid expenses | $ | 17.7 | $ | 9.3 | ||||
Other noncurrent assets | 1.2 | 5.7 | ||||||
Liabilities: | ||||||||
Other current liabilities | (10.9 | ) | (17.7 | ) | ||||
Long-term portion of deferred income taxes | (102.0 | ) | (70.4 | ) | ||||
| $ | (94.0 | ) | $ | (73.1 | ) | |||
Income taxes paid, net of refunds, in 2004, 2003, and 2002 were $35.9 million, $18.1 million and $19.8 million, respectively.
The Company did not provide taxes with respect to $693.4 million of undistributed earnings at December 31, 2004, since these earnings are considered by the Company to be permanently reinvested. Upon distribution of these earnings, the Company may be subject to United States income taxes and foreign withholding taxes. Determining the unrecognized deferred tax liability on the distribution of these earnings is not practicable as such liability, if any, is dependent on circumstances existing when remittance occurs.
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At December 31, 2004, the Company had a deferred tax asset of $709.6 million for tax loss carryforwards and tax credits, including $304.1 million in the United States, that expire in various amounts from 2007-2024; $252.5 million in the United Kingdom with no expiration date; and $153.0 million in other jurisdictions with various expiration dates. Included in the above amounts are deferred tax assets for tax loss carryforwards and tax credits acquired with the purchases of T&N, Cooper Automotive and Fel-Pro. A valuation allowance was recorded on $116.0 million of these purchased deferred tax assets and, to the extent such benefits are ever realized, such benefits will be recorded as a reduction of goodwill.
On October 22, 2004, the American Jobs Creation Act of 2004 (“the Act”) was signed into law. The Act creates a temporary incentive for U.S. corporations to repatriate earnings from foreign subsidiaries by providing an 85% dividends received deductions for certain dividends from controlled foreign corporations to the extent the dividends exceed a base amount and are invested in the U.S. pursuant to a domestic reinvestment plan. The temporary incentive is available to the Company in 2005. The amount of the Company’s dividends potentially eligible for the deduction is limited to $500 million.
The deduction is subject to a number of limitations and uncertainty remains as to the interpretation of numerous provisions in the Act. The U.S. Treasury Department is in the process of providing clarifying guidance on key elements of the repatriation provision and Congress may reintroduce legislation that provides for certain technical corrections to the Act. The Company has not completed its evaluation of the repatriation provision due to the uncertainty associated with the interpretation of the provision as well as numerous tax, legal, treasury, bankruptcy and other business considerations. The Company expects to complete its evaluation of the potential dividends the Company may pursue, if any, and the related tax ramifications within a reasonable period of time after additional guidance is issued.
18. Earnings Per Share
Basic and diluted loss from continuing operations before cumulative effect of change in accounting principle per share are calculated as follows:
| Year Ended December 31 | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| (In Millions of Dollars, Except Per Share Amounts) | ||||||||||||
Loss from continuing operations before cumulative effect of change in accounting principle | $ | (325.5 | ) | $ | (168.6 | ) | $ | (183.7 | ) | |||
Weighted average shares outstanding, basic and diluted (in millions) | 87.3 | 87.1 | 83.0 | |||||||||
Basic and diluted loss from continuing operations per share before cumulative effect of change in accounting principle | $ | (3.73 | ) | $ | (1.93 | ) | $ | (2.21 | ) | |||
The effect of the assumed conversion of the Preferred Stock was not considered in 2004, 2003, or 2002 as its effect was anti-dilutive to the loss per share.
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19. Pensions and Other Postemployment Benefits
The Company sponsors several defined benefit pension plans (“Pension Benefits”) and health care and life insurance benefits (“Other Benefits”) for certain employees and retirees around the world. The Company funds the Pension Benefits based on the funding requirements of federal and international laws and regulations in advance of benefit payments and the Other Benefits as benefits are provided to participating employees.
| United States Plans | International Plans | |||||||||||||||||||||||
| Pension Benefits | Other Benefits | Pension Benefits | ||||||||||||||||||||||
| 2004 | 2003 | 2004 | 2003 | 2004 | 2003 | |||||||||||||||||||
| (Millions of Dollars) | ||||||||||||||||||||||||
Change in benefit obligation: | ||||||||||||||||||||||||
Benefit obligation at beginning of year | $ | 961.1 | $ | 891.2 | $ | 545.1 | $ | 549.3 | $ | 2,540.4 | $ | 2,051.6 | ||||||||||||
Service cost | 26.0 | 25.2 | 11.3 | 2.5 | 13.4 | 16.7 | ||||||||||||||||||
Interest cost | 57.9 | 58.8 | 35.0 | 33.8 | 138.5 | 125.1 | ||||||||||||||||||
Employee contributions | — | — | 2.2 | 1.6 | 4.7 | 6.5 | ||||||||||||||||||
Benefits paid | (62.3 | ) | (60.8 | ) | (48.9 | ) | (48.5 | ) | (153.7 | ) | (157.9 | ) | ||||||||||||
Curtailment | (2.8 | ) | — | (0.9 | ) | — | (25.5 | ) | — | |||||||||||||||
Plan amendments | — | — | (43.0 | ) | — | 0.6 | (0.6 | ) | ||||||||||||||||
Actuarial losses and changes in actuarial assumptions | 45.0 | 46.7 | 70.7 | 6.4 | 637.3 | 256.6 | ||||||||||||||||||
Currency translation adjustment | — | — | — | — | 245.5 | 242.4 | ||||||||||||||||||
Benefit obligation at end of year | $ | 1,024.9 | $ | 961.1 | $ | 571.5 | $ | 545.1 | $ | 3,401.2 | $ | 2,540.4 | ||||||||||||
Change in plan assets: | ||||||||||||||||||||||||
Fair value of plan assets at beginning of year | $ | 651.0 | $ | 569.6 | $ | — | $ | — | $ | 1,862.9 | $ | 1,593.3 | ||||||||||||
Actual return on plan assets | 65.9 | 119.0 | — | — | 158.8 | 216.9 | ||||||||||||||||||
Company contributions | 41.2 | 23.2 | — | — | 11.5 | 18.4 | ||||||||||||||||||
Benefits paid | (62.3 | ) | (60.8 | ) | — | — | (138.7 | ) | (144.5 | ) | ||||||||||||||
Employee contributions | — | — | — | — | 4.7 | 6.5 | ||||||||||||||||||
Currency translation adjustment | — | — | — | — | 155.6 | 172.3 | ||||||||||||||||||
Fair value of plan assets at end of year | $ | 695.8 | $ | 651.0 | $ | — | $ | — | $ | 2,054.8 | $ | 1,862.9 | ||||||||||||
Funded status of the plan | $ | (329.1 | ) | $ | (310.1 | ) | $ | (571.5 | ) | $ | (545.1 | ) | $ | (1,346.4 | ) | $ | (677.5 | ) | ||||||
Unrecognized net actuarial loss | 256.5 | 249.7 | 177.2 | 118.8 | 1,360.0 | 737.8 | ||||||||||||||||||
Unrecognized prior service cost | 51.7 | 64.4 | (43.2 | ) | (4.2 | ) | 0.7 | — | ||||||||||||||||
Net amount recognized | $ | (20.9 | ) | $ | 4.0 | $ | (437.5 | ) | $ | (430.5 | ) | $ | 14.3 | $ | 60.3 | |||||||||
Amounts recognized in the consolidated balance sheets: | ||||||||||||||||||||||||
Prepaid pension cost | 5.1 | 23.0 | — | — | 261.2 | 292.4 | ||||||||||||||||||
Accrued pension liability | (26.0 | ) | (19.0 | ) | (437.5 | ) | (430.5 | ) | (246.9 | ) | (232.1 | ) | ||||||||||||
Additional minimum liability | (288.2 | ) | (298.4 | ) | — | — | (1,339.3 | ) | (733.0 | ) | ||||||||||||||
Intangible assets | 52.3 | 63.9 | — | — | — | — | ||||||||||||||||||
Deferred tax asset | — | — | — | — | 17.7 | 12.7 | ||||||||||||||||||
Accumulated other comprehensive loss | 235.9 | 234.5 | — | — | 1,321.6 | 720.3 | ||||||||||||||||||
Net amount recognized | $ | (20.9 | ) | $ | 4.0 | $ | (437.5 | ) | $ | (430.5 | ) | $ | 14.3 | $ | 60.3 | |||||||||
Net prepaid (accrued) benefit cost for pension benefits is comprised of plans with $266.3 million and $315.4 million of prepaid pension costs and $272.9 million and $251.1 million of accrued pension costs as of December 31, 2004 and 2003, respectively. The accumulated benefit obligation for all defined benefit pension plans was approximately $4,382 million and $3,463 million at December 31, 2004 and 2003, respectively. In addition, increases in the minimum pension liability related to pension benefits of $602.7 million and $138.0 million are included in other comprehensive loss for the years ended December 31, 2004 and 2003, respectively.
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Components of net periodic benefit cost for the years ended December 31:
| United States Plans | International Plans | |||||||||||||||||||||||||||||||||||
| Pension Benefits | Other Benefits | Pension Benefits | ||||||||||||||||||||||||||||||||||
| 2004 | 2003 | 2002 | 2004 | 2003 | 2002 | 2004 | 2003 | 2002 | ||||||||||||||||||||||||||||
| (Millions of Dollars) | ||||||||||||||||||||||||||||||||||||
Service cost | $ | 26.0 | $ | 25.2 | $ | 22.8 | $ | 11.3 | $ | 2.5 | $ | 2.9 | $ | 13.4 | $ | 16.7 | $ | 23.8 | ||||||||||||||||||
Interest cost | 57.9 | 58.8 | 58.6 | 35.0 | 33.8 | 35.0 | 138.5 | 125.1 | 119.2 | |||||||||||||||||||||||||||
Expected return on plan assets | (54.4 | ) | (48.4 | ) | (65.5 | ) | — | — | — | (130.5 | ) | (119.8 | ) | (131.9 | ) | |||||||||||||||||||||
Unrecognized loss | 25.3 | 32.1 | 10.9 | 11.0 | 3.2 | 0.5 | 57.9 | 48.2 | 28.0 | |||||||||||||||||||||||||||
Unrecognized prior service cost | 8.0 | 8.3 | 8.4 | (4.1 | ) | (0.8 | ) | (0.8 | ) | — | — | — | ||||||||||||||||||||||||
Settlement and curtailment (gain)/loss | 3.3 | — | — | (0.9 | ) | — | — | (0.6 | ) | — | — | |||||||||||||||||||||||||
Net periodic cost | $ | 66.1 | $ | 76.0 | $ | 35.2 | $ | 52.3 | $ | 38.7 | $ | 37.6 | $ | 78.7 | $ | 70.2 | $ | 39.1 | ||||||||||||||||||
Weighted-average assumptions used to determine the benefit obligation as of December 31:
| United States Plans | International Plans | |||||||||||||||||
| Pension Benefits | Other Benefits | Pension Benefits | ||||||||||||||||
| 2004 | 2003 | 2004 | 2003 | 2004 | 2003 | |||||||||||||
Discount rate | 5.75 | % | 6.25 | % | 5.75 | % | 6.25 | % | 4.5-5.25 | % | 5.25-5.5 | % | ||||||
Expected return on plan assets | 8.50 | % | 8.50 | % | — | — | 5.25-6.5 | % | 7.0-7.5 | % | ||||||||
Rate of compensation increase | 4.60 | % | 4.60 | % | — | — | 2.0-5.0 | % | 2.5-3.3 | % | ||||||||
Weighted-average assumptions used to net periodic benefit cost for the years ended December 31:
| United States Plans | International Plans | |||||||||||||||||
| Pension Benefits | Other Benefits | Pension Benefits | ||||||||||||||||
| 2004 | 2003 | 2004 | 2003 | 2004 | 2003 | |||||||||||||
Discount rate | 6.25 | % | 6.75 | % | 6.25 | % | 6.75 | % | 5.25-5.5 | % | 5.5-5.75 | % | ||||||
Expected return on plan assets | 8.50 | % | 9.00 | % | — | — | 7.0-7.5 | % | 7.0-7.5 | % | ||||||||
Rate of compensation increase | 4.60 | % | 4.60 | % | — | — | 2.5-3.3 | % | 2.5-3.4 | % | ||||||||
The Company evaluates its discount rate assumption annually as of December 31 for each of its retirement-related benefit plans based upon the yield of high quality, fixed-income debt instruments.
The Company’s expected return on plan assets is evaluated annually based upon a detailed study which includes a review of anticipated future long-term performance of individual asset classes, and consideration of the appropriate asset allocation strategy to provide for the timing and amount of benefits included in the projected benefit obligation. While the study gives appropriate consideration to recent fund performance and historical returns, the assumption is primarily a long-term prospective rate.
For measurement purposes, the Company has made the following assumptions for its Other Benefits:
| Other Benefits | ||||||
| 2004 | 2003 | |||||
Health care cost trend rate | 8.0 | % | 8.5 | % | ||
Ultimate health care trend rate | 5.0 | % | 5.5 | % | ||
Year ultimate health care trend rate reached | 2010 | 2009 | ||||
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The assumed health care trend rate has a significant impact on the amounts reported for Other Benefits plans. The following table illustrates the sensitivity to a change in the assumed health care trend rate:
Total Service and Interest Cost | APBO | |||||
| (Millions of Dollars) | ||||||
100 basis point (bp) increase in health care trend rate | $ | + 5.1 | $ | + 68.2 | ||
100 bp decrease in health care trend rate | - 4.3 | - 58.1 | ||||
On December 8, 2003, the Medicare Prescription Drug Improvement and Modernization Act (the “Medicare Act”) was signed into law. The Medicare Act provides for a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to the benefit established by the law.
Effective July 1, 2004, the Company adopted accounting guidance in accordance with Financial Accounting Standards Board Staff Position No. 106-2. The total impact of the Medicare Act on the Company’s accumulated benefit obligation is $60 million and is being accounted for as an actuarial gain. As a result, the gain will be amortized as a reduction of the Company’s net periodic benefit cost over approximately thirteen years. The reduction in the accumulated benefit obligation was attributable to the federal subsidy. The Medicare Act reduced the Company’s net periodic other benefit cost by $4 million in 2004, comprised of $1.9 million of interest cost and $2.1 million of amortization of unrecognized net actuarial loss. A prescription drug benefit plan must be “actuarially equivalent” in order to qualify for the subsidy. While the United States Department of Health and Human services has not yet defined the tests for “actuarially equivalent” prescription plans, the Company has certain plans that it believes will satisfy the “actuarially equivalent” test and will receive the subsidy. The reduction in the accumulated postretirement benefit obligation and ongoing net periodic other benefit cost did not require a modification or amendment of the Company’s benefit plans. However, if certain plans were amended, the Medicare Act could further reduce the accumulated other benefit obligation and ongoing net periodic other benefit cost.
In July 2004, the Administrators of the U.K. Debtors took the unilateral action of withdrawing certain of the U.K. Debtors from participating in the T&N Retirement Benefits Scheme (1989) (the “T&N pension Scheme”). The Administrators indicated that this action was taken to preserve the contributions made by current employees of these debtors into the T&N Pension Scheme and to protect the other creditors of these debtors in the event the independent pension plan trustee rejects the treatment afforded the T&N Pension Scheme in the Plan.
The following table illustrates the sensitivity to a change in certain assumptions for Pension Benefits and Other Benefits. The changes in these assumptions have no impact on the Company’s 2004 funding requirements.
| United States Plans | International Plans | |||||||||||||||||||||||
| Pension Benefits | Other Plans | Pension Benefits | ||||||||||||||||||||||
Impact on expense | Impact PBO | Impact on equity | Impact on expense | Impact APBO | Impact on Expense | Impact PBO | Impact on equity | |||||||||||||||||
| (Millions of dollars) | ||||||||||||||||||||||||
25 bp decrease in discount rate | $ | + 2.4 | $ | + 24.1 | $ | - 23.2 | $ | + 1.9 | $ | + 14.1 | $ | + 4.5 | $ | + 62.2 | $ | - 62.0 | ||||||||
25 bp increase in discount rate | - 2.4 | - 23.6 | + 22.7 | - 1.9 | - 13.8 | - 4.4 | - 58.8 | + 58.4 | ||||||||||||||||
25 bp decrease in rate of return on assets | + 1.9 | — | — | — | — | + 2.5 | — | — | ||||||||||||||||
25 bp increase in rate of return on assets | -1.9 | — | — | — | — | -2.5 | — | — | ||||||||||||||||
The Company’s pension plan weighted-average asset allocations at the measurement dates of December 31, 2004, and 2003, by asset category are as follows:
| United States Plan Assets December 31 | International Plan Assets December 31 | |||||||||||||||||
| Actual | Target | Actual | Target | |||||||||||||||
| 2004 | 2003 | 2005 | 2004 | 2003 | 2005 | |||||||||||||
Asset Category | ||||||||||||||||||
Equity securities | 76 | % | 71 | % | 75 | % | 19 | % | 44 | % | 20 | % | ||||||
Debt securities | 24 | % | 29 | % | 25 | % | 80 | % | 56 | % | 80 | % | ||||||
Real estate | — | — | — | 1 | % | — | — | |||||||||||
| 100 | % | 100 | % | 100 | % | 100 | % | 100 | % | 100 | % | |||||||
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The Company invests in a diversified portfolio consisting of an array of asset classes that attempts to maximize returns while minimizing volatility. These asset classes include, U.S. domestic equities, emerging market equities, global high quality and high yield fixed income and real estate. The Company expects to contribute approximately $76.2 million to its pension plans in 2005.
The following table summarizes benefit payments, which reflect expected future service, as appropriate, expected to be paid:
| United States Plans | International Plans | ||||||||
| Pension Benefits | Other Benefits | Pension Benefits | |||||||
| (Millions of Dollars) | |||||||||
2005 | $ | 67.6 | $ | 45.4 | $ | 152.0 | |||
2006 | 70.3 | 46.5 | 154.7 | ||||||
2007 | 71.5 | 47.2 | 159.1 | ||||||
2008 | 73.1 | 47.5 | 166.0 | ||||||
2009 | 73.2 | 48.2 | 168.6 | ||||||
Years 2010 - 2014 | 379.6 | 234.2 | 915.3 | ||||||
The Company also maintains a defined-contribution pension plan that is qualified under Section 401(k) of the Internal Revenue Code. Effective January 1, 2004, the Company generally matched 25% of an employee’s first 8% of contributions. During 2002 and 2003, the Company generally provided no contributions to the plan; unless required by a collective bargaining agreement. The total expense attributable to the Company’s defined-contribution savings plan was $12.7 million, $2.3 million, and $4.9 million for the years ended December 31, 2004, 2003 and 2002, respectively.
20. Litigation and Environmental Matters
T&N Companies Asbestos Litigation
Background
The Company’s U.K. subsidiary, T&N Ltd., and two U.S. subsidiaries (the “T&N Companies”) are among many defendants named in numerous court actions in the U.S. alleging personal injury resulting from exposure to asbestos or asbestos-containing products. T&N Ltd. is also subject to asbestos-disease litigation, to a lesser extent, in the United Kingdom and France. As of the Petition Date, T&N Ltd. was a defendant in approximately 115,000 pending personal injury claims. The two United States subsidiaries were defendants in approximately 199,000 pending personal injury claims. As a result of the Restructuring Proceedings, the Company includes as a pending claim open served claims, settled but not documented claims and settled but not paid claims. Notice of complaints continue to be received post-petition and are in violation of the automatic stay.
Recorded Liability
In 2000, the Company increased its estimate of asbestos-related liability for the T&N Companies by $751 million and recorded a related insurance recoverable asset of $577 million. The revision in the estimate of probable asbestos-related liability principally resulted from a study performed by an econometric firm that specializes in these types of matters. The liability (approximately $1.4 billion as of December 31, 2004) represented the Company’s estimate prior to the Restructuring Proceedings for claims currently pending and those which were reasonably estimated to be asserted and paid through 2012. The Company did not provide a liability for claims that may be paid subsequent to this period as it could not reasonably estimate such claims. In estimating the liability prior to the Restructuring Proceedings, the Company made assumptions regarding the total number of claims anticipated to be received in a future period, the typical cost of settlement (which is sensitive to the industry in which the plaintiff claims exposure, the alleged disease type and the jurisdiction in which the action is being brought), the rate of receipt of claims, the settlement strategy in dealing with outstanding claims and the timing of settlements. As a result of the Restructuring Proceedings, pending asbestos-related litigation against the Company in the United States and the U.K. is stayed (subject to certain exceptions in the case of governmental authorities), and no party may take
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action to pursue or collect on such asbestos claims absent specific authorization of the Bankruptcy Court or the High Court. Since the Restructuring Proceedings, the Company has ceased making payments with respect to asbestos-related lawsuits. An asbestos creditors’ committee has been appointed in the U.S. representing asbestos claimants with pending claims against the Company, and the Bankruptcy Court has appointed a legal representative for the interests of potential future asbestos claimants. In the U.K. a creditors committee consisting in large part of representatives of asbestos claimants has been appointed. The Company’s obligations with respect to present and future claims could be determined through litigation in Bankruptcy Court, the High Court, and/or through negotiations with each of the official committees appointed.
In December of 2000, the Company entered into $250 million of surety bonds on behalf of the T&N Companies to meet certain collateral requirements for asbestos indemnity obligations associated with their prior membership in the Center for Claims Resolution (“CCR”). This amount was stepped down by contract to $225 million effective June, 2001. As a result of the filing, the Company has sought declaratory and injunctive relief in an adversary proceeding filed in the Bankruptcy Court, in order to enjoin any post-petition payments to asbestos claimants by the CCR and any post-petition draw by the CCR on $225 million in face amount of the surety bonds. The CCR now seeks to draw on the surety bonds to fund past and future payments although the basis of such draw, the validity of such claims under the pre-petition bond terms, and whether such draw may be utilized to pay obligations of other CCR members are all disputed. On March 28, 2003, the Federal District Court Judge held that, with respect to phase one, the CCR has the right to draw upon the bonds to the extent that a settlement between an individual and the CCR member was consummated as of the Petition Date, i.e., a release has been obtained from such individual. The CCR moved for reconsideration and the ruling was modified to require a state-by-state analysis of what steps were required for the settlement to be binding. This is in process, as is a yet to be heard second phase of litigation, which will ultimately determine the amount of any such draw. As a result of information obtained during the initial discovery phase of this litigation, the Company along with other defendants, sought and obtained leave to file amended complaints against the CCR.
On February 24, 2005, the Plan Proponents reached final agreement with Travelers Casualty and Surety Company of America, SAFECO Insurance Company of America and National Fire Insurance Company of Hartford and Continental Casualty Company (the Sureties) whereby the Sureties will allow the CCR to draw up to $29 million against the bonds on the earlier of emergence or May 2, 2005. The Sureties will receive a secured claim to be treated under the Plan in the same fashion as the secured bank claims. The Plan Proponents have also reached an agreement-in-principle with the CCR. Neither settlement agreement has been approved by the Bankruptcy Court and the settlement with the Sureties is contingent upon obtaining court approval of the agreement with the CCR.
The Company also issued various letters of credit in connection with asbestos lawsuits that had resulted in verdicts against the Company or its subsidiaries prior to its filing for bankruptcy protection. The letters of credit were issued as security for the judgments entered against the Company or its subsidiaries to permit the Company to pursue appeals to those judgments. The Bankruptcy Court lifted the automatic stay with respect to certain cases where letters of credit were in place to allow the appeals of those cases to proceed. During 2003, the final appeal in three of these cases were denied, and draws were made upon the letters of credit of approximately $16.0 million.
Except for the effect of foreign currency, the Company has not adjusted its estimate of the asbestos liability since September 30, 2001. This liability is included in the consolidated balance sheet under the caption “Liabilities subject to compromise” as of December 31, 2004 for the Company’s U.S. and U.K. subsidiaries.
While the Company believes that the liability recorded was appropriate as of October 1, 2001 for anticipated losses arising from asbestos-related claims against the T&N Companies through 2012, it is the Company’s view that, as a result of the Restructuring Proceedings, there is even greater uncertainty in estimating the timing and amount of future asbestos liability and related insurance recovery for pending and future claims. There are significant differences in the treatment of asbestos claims in a bankruptcy proceeding as compared to the tort litigation system. Among other things, it is uncertain at this time as to the number of asbestos-related claims that will be filed in the Restructuring Proceedings, the number of future claims that will be included in a plan of reorganization, how claims for punitive damages and claims by persons with no asbestos-related physical impairment will be treated and whether such claims will be allowed, and the impact that historical settlement values for asbestos claims may have on the estimation of asbestos liability in the Restructuring Proceedings.
No assurance can be given that the T&N Companies will not be subject to material additional liabilities and significant additional litigation relating to asbestos matters through 2012 or thereafter. In the event that such liabilities exceed the amounts recorded by the Company or the remaining insurance coverage, the Company’s results of operations and financial condition could be materially affected.
Insurance Recoverable
In 1996, T&N Ltd. (formerly T&N, plc) purchased for itself and its then defined global subsidiaries a £500 million layer of insurance which will be triggered should the aggregate costs of claims made or brought after June 30, 1996,
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where the exposure occurred prior to that date, exceed £690 million. During 2000, the Company concluded that the aggregate cost of the claims filed after June 30, 1996 would exceed the trigger point and recorded an insurance recoverable asset under the T&N policy of $577 million. As of December 31, 2004, the recorded insurance recoverable was $687.7 million. In December 2001, one of the three reinsurers, European International Reinsurance Company Ltd. (“EIR”), filed suit in a London, England court to challenge the validity of its insurance contract with the T&N Companies. As a result of this lawsuit, a claim was made against the broker (Sedgwick) that assisted in procuring this policy for breach of its duties as a broker. This trial commenced in October 2003. Prior to the conclusion of the trial, the parties were able to reach a settlement. As a result of this settlement, the Company recorded a $38.9 million asbestos charge during the fourth quarter of 2003. Under the terms of the settlement, EIR would be liable for 65.5% of its one-third share of the reinsurance policy. By separate agreement, Sedgwick agreed to be liable for an additional 17.25% of the EIR share of the reinsurance policy. T&N Ltd. has also agreed to indemnify the insurer for sums paid under the policy for which the insurer is liable to T&N Ltd. for which the insurer has no recovery from the reinsurers or Sedgwick. The settlement agreements referenced above are being held in escrow pending approval by the Bankruptcy Court and the Administrators of T&N Ltd. of those portions of the above-described settlement agreements that affect the Debtors. A motion seeking the Bankruptcy Court’s approval of the settlement was filed on March 1, 2004.
Subsequent to this motion, the other two reinsurers, Munchener Ruckversicherungs-Gesellschaft AG (“Munich Re”) and Centre Reinsurance International Co. (“CRIC”), a subsidiary of the Zurich Financial Services Group, notified the Company of their belief that the settlements with EIR and Sedgwick may breach one or more provisions of the Reinsurance Agreement. The hearing to review the March 1, 2004 motion has been adjourned without date as the parties attempt to resolve the issues raised by the two reinsurers. However, these efforts have been unsuccessful, prompting the Administrators to file an action in the London High Court seeking a declaration that the settlements with EIR and Sedgwick do not breach provisions of the Reinsurance Agreement.
In October 2004, the other two reinsurers initiated an action against the Company in the High Court in London alleging that the Company’s proposed Plan may breach provisions of the applicable insurance policies, relieving the reinsurers of their obligations. On November 26, 2004, the court issued its judgement generally finding that the Plan as written does not provide any basis to relieve the reinsurers of their obligations. The court indicated that it could not address at this time issues arising from subsequent implementation of the Plan. This judgement has not been appealed.
The ultimate realization of insurance proceeds is directly related to the amount of related covered claims paid by the Company. If the ultimate asbestos claims are higher than the recorded liability, the Company expects the ultimate insurance recoverable to be higher than the recorded amount, up to the cap of the insurance layer. If the ultimate asbestos claims are lower than the recorded liability, the Company expects the ultimate insurance recoverable to be lower than the recorded amount. While the Restructuring Proceedings will impact the timing and amount of the asbestos claims and the insurance recoverable, there has been no change, other than to reflect the settlement discussed above and foreign exchange translation, to the recorded amounts since the Company initiated the Restructuring Proceedings. Accordingly, the recorded amounts for this insurance recoverable asset could change significantly based upon events that occur from the Restructuring Proceedings.
During the first quarter of 2004, the security rating of Centre Reinsurance International Co. was downgraded by several major credit rating providers. As a result of the downgrade, the Company obtained a guarantee of all CRIC’s obligations under the policy from Centre Reinsurance (US) Limited (“CRUS”), an affiliate of CRIC. The security rating of CRUS has not been affected by the downgrade of CRIC and remains unchanged since the inception of the policy. If the reinsurers and/or the related affiliate are not able to meet their obligations under the policy, the Company’s results of operations and financial condition could be materially affected.
The Company has reviewed the financial viability and legal obligations of the three reinsurance companies involved and has concluded that there is little risk that the reinsurers will not be able to meet their obligations under the policy based upon their financial condition. The U.S. claims’ costs applied against this policy are converted at a fixed exchange rate of $1.69/£. As such, if the market exchange rate is greater than $1.69/£, the Company will effectively have a premium on 100% recovery on claims paid. As of December 31, 2004, the $687.7 million insurance recoverable asset includes an exchange rate premium of approximately $76 million.
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Abex and Wagner Asbestos Litigation
Background
Two of the Company’s businesses formerly owned by Cooper Industries, Inc., known as Abex and Wagner, are involved as defendants in numerous court actions in the U.S. alleging personal injury from exposure to asbestos or asbestos-containing products. These claims mainly involve friction products. As of the Petition Date, Abex and Wagner were defendants in approximately 66,000 and 33,000 pending claims, respectively. As a result of the Restructuring Proceedings, the Company includes as a pending claim open served claims, settled but not documented claims and settled but not paid claims. Notices of complaints continue to be received post-petition and are in violation of the automatic stay.
The liability of the Company with respect to claims alleging exposure to Wagner products arises from the 1998 stock purchase from Cooper Industries, Inc. of the corporate successor by merger to Wagner Electric Company; the purchased entity is now a wholly-owned subsidiary of the Company and one of the Debtors in the Restructuring Proceedings. As a consequence, all claims against the Debtors, including asbestos-related claims, have been stayed.
The liability of the Company with respect to claims alleging exposure to Abex products arises from a contractual liability entered into in 1994 by the predecessor to the Company whose stock the Company purchased in 1998. Pursuant to that contract, prior to the Restructuring Proceedings, the Company, through the relevant subsidiary, was liable for certain indemnity and defense payments incurred on behalf of an entity known as Pneumo Abex Corporation, the successor in interest to Abex Corporation. Effective as of the Petition Date, the Company has ceased making such payments and is currently considering whether to accept or reject the 1994 contractual liability.
As mentioned above, as of the Petition Date, pending asbestos litigation of Abex (as to the Company only) and Wagner is stayed (subject to certain exceptions in the case of governmental authorities), and no party may take action to pursue or collect on such asbestos claims absent specific authorization of the Bankruptcy Court or the High Court.
Recorded Liability
The liability (comprised of $129.5 million in Abex liabilities and $84.1 million in Wagner liabilities as of December 31, 2004) represented the Company’s estimate prior to the Restructuring Proceedings for claims currently pending and those which were reasonably estimated to be asserted and paid through 2012. The Company did not provide a liability for claims that may be brought subsequent to this period as it could not reasonably estimate such claims. In estimating the liability prior to the Restructuring Proceedings, the Company made assumptions regarding the total number of claims anticipated to be received in a future period, the typical cost of settlement (which is sensitive to the industry in which the plaintiff claims exposure, the alleged disease type and the jurisdiction in which the action is being brought), the rate of receipt of claims, the settlement strategy in dealing with outstanding claims and the timing of settlements.
As a result of the Restructuring Proceedings, pending asbestos-related litigation is stayed. The Company issued various letters of credit in connection with asbestos lawsuits that had resulted in verdicts against the Company prior to its filing for bankruptcy protection. The letters of credit were issued as security for judgments entered against the Company to permit the Company to pursue appeals to these judgments. The Bankruptcy Court has lifted the automatic stay with respect to one letter of credit for the Company where the letter of credit was in place to allow the appeal of this case to proceed. During 2004, the final appeal in this case was denied and a net draw was made upon this letter of credit of approximately $1 million.
While the Company believes that the liability recorded was appropriate as of October 1, 2001 for anticipated losses arising from asbestos-related claims related to Abex and Wagner through 2012, it is the Company’s view that, as a result of the Restructuring Proceedings, there is even greater uncertainty in estimating the timing and amount of future asbestos liability and related insurance recovery for pending and future claims. There are significant differences in the treatment of asbestos claims in a bankruptcy proceeding as compared to the tort litigation system. Among other things, it is uncertain at this time as to the number of asbestos-related claims that will be filed in the proceeding, the number of future claims that will be included in a plan of reorganization, how claims for punitive damages and claims by persons with no asbestos-related physical impairment will be treated and whether such
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claims will be allowed, and the impact historical settlement values for asbestos claims may have on the estimation of asbestos liability in the Restructuring Proceedings.
No assurance can be given that the Company will not be subject to material additional liabilities and significant additional litigation relating to Abex and Wagner asbestos matters through 2012 or thereafter. In the event that such liabilities exceed the amounts recorded by the Company or the remaining insurance coverage, the Company’s results of operations and financial condition could be materially affected.
Insurance Recoverable
Abex maintained product liability insurance coverage for most of the time that it manufactured products that contained asbestos. This coverage is shared with other third-party companies. The subsidiary of the Company that may be liable for certain indemnity and defense payments with respect to Abex has the benefit of that insurance up to the extent of that liability. Abex has been in litigation since 1982 with the insurance carriers of its primary layer of liability concerning coverage for asbestos claims. Abex also has substantial excess layer liability insurance coverage that is shared with other companies that, barring unforeseen insolvencies of excess carriers or other adverse events, should provide coverage for asbestos claims against Abex. The Abex insurance recoverable was $112.6 million as of December 31, 2004.
Wagner also maintained product liability insurance coverage for some of the time that it manufactured products that contained asbestos. This coverage is shared with other third-party companies. One of the companies, Dresser Industries, Inc. (“Dresser”) initiated an adversary action against the Debtors and a number of insurance carriers in the Company’s Restructuring Proceedings. In its complaint, Dresser alleged that it has rights under certain primary and excess general liability insurance policies that may be shared with one of the Debtors, Federal-Mogul Products (“FMP”) as the successor to Wagner Electric Corporation. Dresser seeks, among other things, a declaration of the parties respective rights and obligations under the policies and a partition of the competing rights of Dresser and FMP under the policies. FMP answered Dresser’s complaint and filed cross-claims against all of the defendant-insurers seeking a declaration of FMP’s rights to the policies. The subsidiary of the Company that may be liable for asbestos claims against Wagner has the benefit of that insurance, subject to the rights of other potential insureds under the policies. Primary layer liability insurance coverage for asbestos claims against Wagner is the subject of an agreement with Wagner’s solvent primary carriers. The agreement provides for partial reimbursement of indemnity and defense costs for Wagner asbestos claims until exhaustion of aggregate limits. Wagner also has substantial excess layer liability insurance coverage which, barring unforeseen insolvencies of excess carriers or other adverse events, should provide coverage for asbestos claims against Wagner. The Wagner insurance recoverable was $53.5 million as of December 31, 2004. On November 4, 2004, FMP, Dresser and Cooper Industries, Inc. (“Cooper”) and certain of the insurers (“Parties”) entered into a partitioning agreement, by which the Parties agreed as to the manner in which the limits of liability, self-insured retention’s, deductibles and any other self-insurance features, and the erosion thereof, are to be partitioned among FMP, Dresser and Cooper. The portioning agreement effectively disposes of Dresser’s claims in the Dresser adversary proceeding. However, FMP’s cross claim against the defendant-insurers remain.
The ultimate realization of insurance proceeds is directly related to the amount of related covered claims paid by the Company. If the ultimate asbestos claims are higher than the recorded liability, the Company expects the ultimate insurance recoverable to be higher than the recorded amount. If the ultimate asbestos claims are lower than the recorded liability, the Company expects the ultimate insurance recoverable to be lower than the recorded amount. While the Restructuring Proceedings will impact the timing and amount of the asbestos claims and the insurance recoverable, there has been no change to the recorded amounts due to the uncertainties created by the Restructuring Proceedings. Accordingly, the recorded amounts for this insurance recoverable asset could change materially based upon events that occur from the Restructuring Proceedings.
The Company believes that based on its review of the insurance policies, the financial viability of the insurance carriers, and advice from outside legal counsel, it is probable that Abex and Wagner will realize an insurance recoverable correlating with the respective liability.
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Federal-Mogul and Fel-Pro Asbestos Litigation
Prior to the Restructuring Proceedings, the Company was sued in its own name as one of a large number of defendants in multiple lawsuits brought by claimants alleging injury from exposure to asbestos due to its ownership of certain assets involved in gasket making. As of the Petition Date, the Company was a defendant in approximately 61,500 pre-petition pending claims. Over 40,000 of these claims were transferred to a federal court, where, prior to the Restructuring Proceedings, they were pending. Notices of complaints continue to be received post-petition and are in violation of the automatic stay.
Prior to the Restructuring Proceedings, the Company’s Fel-Pro subsidiary also was named as a defendant in a number of product liability cases involving asbestos, primarily involving gasket or packing products. Fel-Pro was a defendant in approximately 34,000 pending claims as of the Petition Date. Over 32,000 of these claims were transferred to a federal court where, prior to the Restructuring Proceedings, they were pending. The Company was defending all such claims vigorously and believed that it and Fel-Pro had substantial defenses to liability and insurance coverage for defense and indemnity.
All claims alleging exposure to the products of the Company and of Fel-Pro have been stayed as a result of the Restructuring Proceedings.
Aggregate of Asbestos Liability and Insurance Recoverable Asset
The following is a summary of the asbestos liability subject to compromise and the insurance recoverable asset as of December 31, 2003 and December 31, 2004:
T&N Companies | Abex | Wagner | Other | Total | |||||||||||||||
| (Millions of Dollars) | |||||||||||||||||||
Liability: | |||||||||||||||||||
Balance at December 31, 2003 | $ | 1,351.2 | $ | 129.5 | $ | 85.0 | $ | 2.7 | $ | 1,568.4 | |||||||||
Judgments rendered | — | — | (0.9 | ) | — | (0.9 | ) | ||||||||||||
Foreign exchange | 16.5 | — | — | — | 16.5 | ||||||||||||||
Balance at December 31, 2004 | $ | 1,367.7 | $ | 129.5 | $ | 84.1 | $ | 2.7 | $ | 1,584.0 | |||||||||
Asset: | |||||||||||||||||||
Balance at December 31, 2003 | $ | 636.9 | $ | 115.7 | $ | 53.5 | $ | — | $ | 806.1 | |||||||||
Cash receipts | (2.0 | ) | (3.1 | ) | — | — | (5.1 | ) | |||||||||||
Foreign exchange | 52.8 | — | — | — | 52.8 | ||||||||||||||
Balance at December 31, 2004 | $ | 687.7 | $ | 112.6 | $ | 53.5 | $ | — | $ | 853.8 | |||||||||
The Company’s estimate of asbestos-related liabilities for pending and expected future asbestos claims is subject to considerable uncertainty because such liabilities are influenced by numerous variables that are inherently difficult to predict. The Restructuring Proceedings significantly increase the inherent difficulties and uncertainties involved in estimating the number and cost of resolution of present and future asbestos-related claims against the Company and may have the effect of increasing the ultimate cost of the resolution of such claims.
Other Matters
In January 2005, the Company was notified by a customer that it experienced a quality problem with one of its products allegedly due to component parts supplied by the Company. The merits of this allegation are still under investigation by both the Company and its customer. Until further investigation is completed, any responsibility and related liability cannot be determined. However, based upon investigations performed to date, the Company believes its component parts are in accordance to customer specifications and are not the root cause of the quality problem. Accordingly, no reserve has been provided as of December 31, 2004.
The Company is involved in other legal actions and claims, directly and through its subsidiaries. After taking into consideration legal counsel’s evaluation of such actions, management is of the opinion that the outcomes are not likely to have a material adverse effect on the Company’s financial position, operating results, or cash flows.
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Environmental Matters
The Company is a defendant in lawsuits filed, or the recipient of administrative orders issued, in various jurisdictions pursuant to the Federal Comprehensive Environmental Response Compensation and Liability Act of 1980 (“CERCLA”) or other similar national or state environmental laws. These laws require responsible parties to pay for remediating contamination resulting from hazardous substances that were discharged into the environment by them, or by others to whom they sent such substances for treatment or other disposition. In addition, the Company has been notified by the United States Environmental Protection Agency, other national environmental agencies, and various state agencies that it may be a potentially responsible party (“PRP”) under such laws for the cost of remediating hazardous substances pursuant to CERCLA and other national and state or provincial environmental laws. PRP designation requires the funding of site investigations and subsequent remedial activities.
At most of the sites that are likely to be the costliest to remediate, which are often current or former commercial waste disposal facilities to which numerous companies sent waste, the Company’s exposure is expected to be limited. Despite the joint and several liability which might be imposed on the Company under CERCLA and some of the other laws pertaining to these sites, the Company’s share of the total waste has generally been small. The other companies, which also sent wastes, often numbering in the hundreds or more, generally include large, solvent publicly owned companies, and in most such situations the government agencies and courts have imposed liability in some reasonable relationship to contribution of waste.
The Company has identified certain present and former properties at which it may be responsible for cleaning up environmental contamination, in some cases as a result of contractual commitments. The Company is actively seeking to resolve these matters.
Although difficult to quantify based on the complexity of the issues, the Company has accrued amounts corresponding to its best estimate of the costs associated with such regulatory and contractual matters based upon current available information from site investigations and consultants.
Environmental reserves were $61.0 million and $66.0 million at December 31, 2004 and 2003, respectively, and are included in the consolidated balance sheets as follows:
| December 31 | ||||||
| 2004 | 2003 | |||||
| (Millions of Dollars) | ||||||
Current liabilities | $ | 11.5 | $ | 15.1 | ||
Long-term accrued liabilities | 25.9 | 27.1 | ||||
Liabilities subject to compromise | 23.6 | 23.8 | ||||
| $ | 61.0 | $ | 66.0 | |||
The decrease in the reserves during 2004 resulted primarily from expenditures against the reserves, downward adjustment of certain reserves based on new and more accurate estimates of remaining costs, sale of certain sites to purchasers who assumed the remaining environmental liabilities, court-approved settlement of certain contractual and governmental cleanup claims with creditors in the company’s pending Chapter 11 bankruptcy proceeding, and other factors. Management believes that its December 31, 2004 accruals will be adequate to cover the Company’s estimated liability for its exposure in respect to such matters. In the event that such liabilities were to significantly exceed the amounts recorded by the Company, the Company’s results of operations and financial condition could be materially affected. At December 31, 2004, management estimates that reasonably possible material additional losses above and beyond management’s best estimate of required remediation costs as recorded approximates $40 million.
Environmental reserves subject to compromise include those that may be reduced in the Company’s bankruptcy proceeding because they may be determined to be “dischargeable debts” incurred prior to the Company’s filing for bankruptcy. Such liabilities generally arise at either (1) commercial waste disposal sites to which the Company and other companies sent wastes for disposal, or (2) sites in relation to which the Company has a contractual obligation to indemnify the current owner of a site for the costs of cleanup of contamination that was released into the environment before the Company sold the site.
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Environmental reserves determined not to be subject to compromise include those which arise from a legal obligation of the Company, under an administrative or judicial order, to perform cleanup at a site. Such obligations are normally associated with sites which the Company owns and either operates or formerly operated.
The best estimate of environmental liability at a site may change from time to time during a bankruptcy proceeding even though the liability relating to that site is subject to compromise and the Company’s responsibility to make payments is stayed. Notwithstanding the stay of legal proceedings against the Company regarding such a site, activities such as further site investigation and/or actual cleanup work often continue to be performed, generally by parties other than the Company. Such activities may produce new and better information that requires the Company to revise its best estimate of total site cleanup costs and its own share of such costs.
21. Operations by Reporting Segment and Geographic Area
The Company’s integrated operations are included in five reporting segments generally corresponding to major product groups: Powertrain, Sealing Systems and Systems Protection, Friction, Aftermarket and Other. Segment information for the years ended December 31, 2003 and 2002 has been reclassified to reflect organizational changes implemented during the second quarter of 2004.
Powertrain products are used primarily in automotive, light truck, heavy-duty, industrial, marine, agricultural, power generation and small air-cooled engine applications. The primary products of this segment include engine bearings, pistons, piston pins, rings, cylinder liners, camshafts, valve train and transmission products and connecting rods. These products are offered under the Federal-Mogul, Glyco, Goetze and Nural brand names. These products are either sold as individual components or, increasingly, offered to automotive manufacturers assembled in a power cylinder system. This strategic product offering adds value to the customer by simplifying the assembly process, lowering costs and reducing vehicle development time. Powertrain operates 46 manufacturing facilities in 12 countries, serving many major automotive, heavy-duty diesel and industrial customers worldwide.
Sealing Systems and Systems Protection products include dynamic seals, gaskets (static seals) and element resistant sleeving systems protection products. The products within this group are marketed under the brand names of Federal-Mogul, National, BCA, Fel-Pro, Payen and Glockler. Sealing Systems and Systems Protection operates 30 manufacturing facilities in 12 countries, serving many major automotive, heavy-duty diesel and industrial customers worldwide.
Friction products are used in automotive and heavy-duty applications and the primary products of this segment include brake disc pads, brake shoes, and brake linings and blocks. Federal-Mogul has a well-balanced portfolio of world-class brand names, including Abex, Beral, Wagner and Ferodo. Federal-Mogul supplies OEM friction products to all the major customers in the light vehicle, commercial vehicle and railway sectors and is also very active in the aftermarket. Friction operates 15 manufacturing facilities in 10 countries, serving many major automotive, railroad and industrial customers worldwide.
Aftermarket distributes products manufactured within the above segments, or purchased, to the independent automotive, heavy-duty and industrial aftermarkets. The segment also includes manufacturing operations for brake, chassis, ignition, lighting, fuel and wiper products. Federal-Mogul is a leader in several key aftermarket product lines. These products are marketed under the brand names Champion, Fel-Pro, Carter, ANCO, Moog, Wagner, Ferodo, Glyco and Sealed Power. Aftermarket operates 22 manufacturing facilities and 29 distribution centers in 19 countries, serving a diverse base of distributors and retail customers around the world. All product transferred into Aftermarket from other reporting segments is transferred at cost in the United States and at agreed-upon transfer prices internationally.
Corporate is comprised of headquarters and central support costs for information technology, human resources, finance and other corporate activities as well as certain health and welfare costs for pension and other postemployment benefits for the Company’s retirees. Current period service costs for active employees are included in the results of operations for each of the Company’s reporting segments.
The Company has aggregated certain individual product segments within its five reporting segments. The accounting policies of the segments are the same as that of the Company. Revenues related to Powertrain, Sealing
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Systems and Systems Protection, and Friction products sold to OE customers are recorded within the respective segments. Revenues from such products sold to aftermarket customers are recorded within the Aftermarket segment.
The Company evaluates segment performance principally on a non-GAAP Operational EBITDA basis. Operational EBITDA is defined as earnings before interest, income taxes, depreciation and amortization, cumulative effect of change in accounting principle and certain nonrecurring items such as restructuring and impairment charges, Chapter 11 and Administration related reorganization expenses, and gains or losses on the sales of businesses. Operational EBITDA for each segment is shown below, as it is most consistent with the corresponding consolidated financial statements.
Net sales and gross margin information by reporting segment is as follows:
| Net Sales | Gross Margin | ||||||||||||||||||||
| Year Ended December 31 | Year Ended December 31 | ||||||||||||||||||||
| 2004 | 2003 | 2002 | 2004 | 2003 | 2002 | ||||||||||||||||
| (Millions of Dollars) | |||||||||||||||||||||
Powertrain | $ | 2,146 | $ | 1,847 | $ | 1,651 | $ | 316 | $ | 260 | $ | 263 | |||||||||
Sealing Systems and Systems Protection | 682 | 622 | 641 | 114 | 104 | 124 | |||||||||||||||
Friction | 527 | 441 | 379 | 112 | 119 | 99 | |||||||||||||||
Aftermarket | 2,819 | 2,613 | 2,486 | 662 | 617 | 555 | |||||||||||||||
Corporate | — | — | — | (27 | ) | (13 | ) | (19 | ) | ||||||||||||
| $ | 6,174 | $ | 5,523 | $ | 5,157 | $ | 1,177 | $ | 1,087 | $ | 1,022 | ||||||||||
Operational EBITDA by reporting segment is as follows:
| Operational EBITDA | ||||||||||||
| Year Ended December 31 | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| (Millions of Dollars) | ||||||||||||
Powertrain | $ | 335 | $ | 281 | $ | 236 | ||||||
Sealing Systems and Systems Protection | 89 | 80 | 91 | |||||||||
Friction | 105 | 101 | 85 | |||||||||
Aftermarket | 496 | 406 | 354 | |||||||||
Corporate | (392 | ) | (311 | ) | (266 | ) | ||||||
Total Segments Operational EBITDA | 633 | 557 | 500 | |||||||||
Items required to reconcile Operational EBITDA to loss from continuing operations before income tax expense and cumulative effect of change in accounting principle: | ||||||||||||
Interest expense, net | (101 | ) | (98 | ) | (129 | ) | ||||||
Depreciation and Amortization | (336 | ) | (307 | ) | (277 | ) | ||||||
Restructuring charges, net | (18 | ) | (36 | ) | (43 | ) | ||||||
Adjustment of assets to fair value | (276 | ) | (94 | ) | (63 | ) | ||||||
Chapter 11 and Administration related reorganization costs | (100 | ) | (97 | ) | (107 | ) | ||||||
Asbestos Charge | — | (39 | ) | — | ||||||||
Discontinued Operations and other | 9 | (2 | ) | 13 | ||||||||
Loss From Continuing Operations Before Income Tax Expense and Cumulative Effect of Change in Accounting Principle | $ | (189 | ) | $ | (116 | ) | $ | (106 | ) | |||
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Total assets, capital expenditures, and depreciation and amortization information by reporting segment is as follows:
| Total Assets | Capital Expenditures | Depreciation and Amortization | ||||||||||||||||||||||
| December 31 | Year Ended December 31 | Year Ended December 31 | ||||||||||||||||||||||
| 2004 | 2003 | 2004 | 2003 | 2002 | 2004 | 2003 | 2002 | |||||||||||||||||
| (Millions of Dollars) | ||||||||||||||||||||||||
Powertrain | $ | 2,032 | $ | 2,039 | $ | 126 | $ | 146 | $ | 186 | $ | 156 | $ | 142 | $ | 121 | ||||||||
Sealing Systems and Systems Protection | 1,039 | 1,255 | 38 | 45 | 42 | 50 | 50 | 46 | ||||||||||||||||
Friction | 769 | 716 | 54 | 64 | 71 | 57 | 47 | 41 | ||||||||||||||||
Aftermarket | 3,057 | 2,954 | 44 | 35 | 31 | 57 | 54 | 56 | ||||||||||||||||
Corporate | 1,368 | 1,153 | 6 | 11 | 9 | 16 | 14 | 13 | ||||||||||||||||
| $ | 8,265 | $ | 8,117 | $ | 268 | $ | 301 | $ | 339 | $ | 336 | $ | 307 | $ | 277 | |||||||||
The following table shows geographic information:
| Net Sales | Net Property, Plant and Equipment | ||||||||||||||
| Year Ended December 31 | December 31 | ||||||||||||||
| 2004 | 2003 | 2002 | 2004 | 2003 | |||||||||||
| (Millions of Dollars) | |||||||||||||||
United States | $ | 2,888 | $ | 2,722 | $ | 2,824 | $ | 848 | $ | 911 | |||||
Germany | 994 | 795 | 642 | 576 | 552 | ||||||||||
France | 536 | 457 | 348 | 197 | 215 | ||||||||||
United Kingdom | 468 | 441 | 425 | 195 | 225 | ||||||||||
Other | 1,288 | 1,108 | 918 | 548 | 502 | ||||||||||
| $ | 6,174 | $ | 5,523 | $ | 5,157 | $ | 2,364 | $ | 2,405 | ||||||
102
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
22. Quarterly Financial Data (Unaudited)
The quarterly information below has been restated from the Quarterly Reports on Forms 10-Q for the impact of discontinued operations. Discontinued operations are further discussed in Note 7 to the consolidated financial statements, “Discontinued Operations.”
| First | Second | Third | Fourth(1) | Year | ||||||||||||||||
| (Amounts in millions, except per share amounts and stock prices) | ||||||||||||||||||||
Year ended December 31, 2004: | ||||||||||||||||||||
Net sales | $ | 1,546.5 | $ | 1,571.2 | $ | 1,508.0 | $ | 1,548.4 | $ | 6,174.1 | ||||||||||
Gross margin | 296.5 | 320.0 | 283.4 | 277.4 | 1,177.3 | |||||||||||||||
Loss from continuing operations | (19.2 | ) | (6.0 | ) | (25.8 | ) | (274.5 | ) | (325.5 | ) | ||||||||||
Earnings (loss) from discontinued operations | (1.2 | ) | (3.0 | ) | (8.4 | ) | 4.1 | (8.5 | ) | |||||||||||
Net loss | (20.4 | ) | (9.0 | ) | (34.2 | ) | (270.4 | ) | (334.0 | ) | ||||||||||
Diluted loss per share | (0.25 | ) | (0.11 | ) | (0.39 | ) | (3.08 | ) | (3.83 | ) | ||||||||||
Stock price: | ||||||||||||||||||||
High | $ | 0.46 | $ | 0.41 | $ | 0.29 | $ | 0.53 | ||||||||||||
Low | $ | 0.20 | $ | 0.24 | $ | 0.12 | $ | 0.15 | ||||||||||||
Dividend per share | — | — | — | — | ||||||||||||||||
| First | Second | Third | Fourth(2) | Year | ||||||||||||||||
Year ended December 31, 2003: | ||||||||||||||||||||
Net sales | $ | 1,362.9 | $ | 1,422.0 | $ | 1,331.5 | $ | 1,406.5 | $ | 5,522.9 | ||||||||||
Gross margin | 273.5 | 293.5 | 250.2 | 269.9 | 1,087.1 | |||||||||||||||
Loss from continuing operations | (35.4 | ) | (0.9 | ) | (25.7 | ) | (106.6 | ) | (168.6 | ) | ||||||||||
Loss from discontinued operations | 1.2 | (4.1 | ) | (3.9 | ) | (14.1 | ) | (20.9 | ) | |||||||||||
Net loss | (34.2 | ) | (5.0 | ) | (29.6 | ) | (120.7 | ) | (189.5 | ) | ||||||||||
Diluted loss per share | (0.39 | ) | (0.06 | ) | (0.33 | ) | (1.39 | ) | (2.17 | ) | ||||||||||
Stock price: | ||||||||||||||||||||
High | $ | 0.47 | $ | 0.44 | $ | 0.36 | $ | 0.40 | ||||||||||||
Low | $ | 0.07 | $ | 0.12 | $ | 0.10 | $ | 0.07 | ||||||||||||
Dividend per share | — | — | — | — | ||||||||||||||||
| (1) | Includes a $46.1 million gain on involuntary conversion and $240.4 million in charges for adjustments of assets to fair value. |
| (2) | Includes a $38.9 million asbestos charge and $89.4 million in charges for adjustment of assets to fair value. |
103
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
23. Consolidating Condensed Financial Information of Guarantor Subsidiaries
Certain subsidiaries of the Company (as listed below, collectively the “Guarantor Subsidiaries”) have guaranteed fully and unconditionally, on a joint and several basis, the obligation to pay principal and interest under the Company’s Senior Credit Agreements.
| Federal-Mogul Venture Corporation | Federal-Mogul Piston Rings, Inc. | Federal-Mogul Powertrain, Inc. | ||
| Federal-Mogul Global Properties Inc. | Federal-Mogul Dutch Holdings Inc. | Federal-Mogul Mystic, Inc. | ||
| Carter Automotive Company, Inc. | Federal-Mogul UK Holdings Inc. | Felt Products MFG. Co. | ||
| Federal-Mogul World Wide Inc. | F-M UK Holdings Limited | Ferodo America, Inc. | ||
| Federal-Mogul Ignition Company | Federal-Mogul Global Inc. | McCord Sealing, Inc. | ||
| Federal-Mogul Products, Inc. | T&N Industries, Inc. |
The Company issued notes in 1999 and 1998 that are guaranteed by the Guarantor Subsidiaries. The Guarantor Subsidiaries also guarantee the Company’s previously existing publicly registered Medium-term notes and Senior notes.
In lieu of providing separate audited financial statements for the Guarantor Subsidiaries, the Company has included the accompanying audited consolidating condensed financial statements based on the Company’s understanding of the Securities and Exchange Commission’s interpretation and application of Rule 3-10 of the Securities and Exchange Commission’s Regulation S-X and Staff Accounting Bulletin No. 53. Management does not believe that separate financial statements of the Guarantor Subsidiaries are material to investors. Therefore, separate financial statements and other disclosures concerning the Guarantor Subsidiaries are not presented.
Subsequent to the Restructuring Proceedings, no dividends have been paid to the Federal-Mogul parent company by any of its subsidiaries.
As a result of the Restructuring Proceedings (see Note 2, “Voluntary Reorganization Under Chapter 11 and Administration”) certain of the liabilities, as shown below, were liabilities subject to compromise as of the Petition date:
| Parent | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | Consolidated | |||||||||
| (Millions of Dollars) | ||||||||||||
Debt | $ | 4,025.9 | $ | 1.0 | $ | — | $ | 4,026.9 | ||||
Asbestos liabilities | 1.5 | 236.8 | 1,345.7 | 1,584.0 | ||||||||
Accounts payable | 59.1 | 114.6 | 30.8 | 204.5 | ||||||||
Company-obligated mandatorily redeemable preferred securities of subsidiary holding solely convertible subordinated debentures of the Company | — | — | 114.6 | 114.6 | ||||||||
Interest payable | 43.7 | 0.2 | — | 43.9 | ||||||||
Environmental liabilities | 23.6 | — | — | 23.6 | ||||||||
Other accrued liabilities | 9.6 | 0.9 | 10.5 | 21.0 | ||||||||
| $ | 4,163.4 | $ | 353.5 | $ | 1,501.6 | $ | 6,018.5 | |||||
104
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
FEDERAL-MOGUL CORPORATION
CONSOLIDATING CONDENSED STATEMENT OF OPERATIONS
Year Ended December 31, 2004
(Millions of Dollars)
| Unconsolidated | Eliminations | |||||||||||||||||||||||
| Parent | Guarantor Subsidiaries | Non Guarantor Subsidiaries | Discontinued Operations | Inter- Company | Consolidated | |||||||||||||||||||
Net sales | $ | 1,170.0 | $ | 1,702.4 | $ | 4,720.1 | $ | (17.0 | ) | $ | (1,401.4 | ) | $ | 6,174.1 | ||||||||||
Cost of products sold | 972.0 | 1,298.3 | 4,150.4 | (22.5 | ) | (1,401.4 | ) | 4,996.8 | ||||||||||||||||
Gross margin | 198.0 | 404.1 | 569.7 | 5.5 | — | 1,177.3 | ||||||||||||||||||
Selling, general and administrative expenses | 270.9 | 253.1 | 428.0 | (2.3 | ) | — | 949.7 | |||||||||||||||||
Adjustment of assets to fair value | 193.7 | 9.4 | 73.3 | — | — | 276.4 | ||||||||||||||||||
Interest expense (income), net | 107.9 | — | (6.8 | ) | 0.4 | — | 101.5 | |||||||||||||||||
Chapter 11 and Administration related reorganization expenses | 118.2 | (18.5 | ) | — | — | — | 99.7 | |||||||||||||||||
Equity earnings of unconsolidated affiliates | — | (6.4 | ) | (29.6 | ) | — | — | (36.0 | ) | |||||||||||||||
Gain on involuntary conversion | — | (46.1 | ) | — | — | — | (46.1 | ) | ||||||||||||||||
Other (income) expense, net | (138.7 | ) | (17.5 | ) | 180.7 | (3.0 | ) | — | 21.5 | |||||||||||||||
Earnings (loss) from continuing operations before income taxes and equity in loss of subsidiaries | (354.0 | ) | 230.1 | (75.9 | ) | 10.4 | — | (189.4 | ) | |||||||||||||||
Income tax expense | 9.0 | 4.4 | 120.8 | 1.9 | — | 136.1 | ||||||||||||||||||
Earnings (loss) from continuing operations before equity in loss of subsidiaries | (363.0 | ) | 225.7 | (196.7 | ) | 8.5 | — | (325.5 | ) | |||||||||||||||
Loss from discontinued operations, net of income taxes | — | — | — | (8.5 | ) | — | (8.5 | ) | ||||||||||||||||
Equity in earnings of subsidiaries | 29.0 | 24.8 | — | — | (53.8 | ) | — | |||||||||||||||||
Net income (loss) | $ | (334.0 | ) | $ | 250.5 | $ | (196.7 | ) | $ | — | $ | (53.8 | ) | $ | (334.0 | ) | ||||||||
105
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
FEDERAL-MOGUL CORPORATION
CONSOLIDATING CONDENSED STATEMENT OF OPERATIONS
Year Ended December 31, 2003
(Millions of Dollars)
| Unconsolidated | Eliminations | Consolidated | ||||||||||||||||||||||
| Parent | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | Discontinued Operations | Inter- Company | ||||||||||||||||||||
Net sales | $ | 1,085.1 | $ | 1,666.5 | $ | 3,939.1 | $ | (90.9 | ) | $ | (1,076.9 | ) | $ | 5,522.9 | ||||||||||
Cost of products sold | 894.4 | 1,284.9 | 3,415.9 | (82.5 | ) | (1,076.9 | ) | 4,435.8 | ||||||||||||||||
Gross margin | 190.7 | 381.6 | 523.2 | (8.4 | ) | — | 1,087.1 | |||||||||||||||||
Selling, general and administrative expenses | 283.6 | 216.5 | 374.8 | (5.6 | ) | — | 869.3 | |||||||||||||||||
Adjustment of assets to fair value | — | 28.4 | 77.6 | (12.1 | ) | — | 93.9 | |||||||||||||||||
Asbestos charge | — | — | 38.9 | — | — | 38.9 | ||||||||||||||||||
Interest expense (income), net | 100.7 | — | (2.7 | ) | 0.2 | — | 98.2 | |||||||||||||||||
Chapter 11 and Administration related reorganization expenses | 97.1 | — | — | — | — | 97.1 | ||||||||||||||||||
Equity earnings of unconsolidated affiliates | — | (6.7 | ) | (20.6 | ) | — | — | (27.3 | ) | |||||||||||||||
Other (income) expense, net | (116.3 | ) | 5.7 | 155.1 | (11.4 | ) | — | 33.1 | ||||||||||||||||
Earnings (loss) from continuing operations before income taxes and equity in loss of subsidiaries | (174.4 | ) | 137.7 | (99.9 | ) | 20.5 | — | (116.1 | ) | |||||||||||||||
Income tax expense (benefit) | (20.9 | ) | 4.0 | 69.8 | (0.4 | ) | — | 52.5 | ||||||||||||||||
Earnings (loss) from continuing operations before equity in loss of subsidiaries | (153.5 | ) | 133.7 | (169.7 | ) | 20.9 | — | (168.6 | ) | |||||||||||||||
Loss from discontinued operations, net of income taxes | — | — | — | (20.9 | ) | — | (20.9 | ) | ||||||||||||||||
Equity in loss of subsidiaries | (36.0 | ) | (0.8 | ) | — | — | 36.8 | — | ||||||||||||||||
Net Loss | $ | (189.5 | ) | $ | 132.9 | $ | (169.7 | ) | $ | — | $ | 36.8 | $ | (189.5 | ) | |||||||||
106
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
FEDERAL-MOGUL CORPORATION
CONSOLIDATING CONDENSED STATEMENT OF OPERATIONS
Year Ended December 31, 2002
(Millions of Dollars)
| Unconsolidated | Eliminations | Consolidated | ||||||||||||||||||||||
| Parent | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | Discontinued Operations | Inter- Company | ||||||||||||||||||||
Net sales | $ | 1,191.8 | $ | 1,783.9 | $ | 3,126.5 | $ | (265.1 | ) | $ | (679.8 | ) | $ | 5,157.3 | ||||||||||
Cost of products sold | 979.4 | 1,418.3 | 2,662.4 | (245.3 | ) | (679.8 | ) | 4,135.0 | ||||||||||||||||
Gross margin | 212.4 | 365.6 | 464.1 | (19.8 | ) | — | 1,022.3 | |||||||||||||||||
Selling, general and administrative expenses | 201.4 | 272.8 | 352.1 | (17.5 | ) | — | 808.8 | |||||||||||||||||
Adjustment of assets to fair value | 3.3 | 34.8 | 32.1 | (7.6 | ) | — | 62.6 | |||||||||||||||||
Interest expense (income), net | 128.3 | — | (5.5 | ) | 6.0 | — | 128.8 | |||||||||||||||||
Chapter 11 and Administration related reorganization expenses | 107.4 | — | — | — | — | 107.4 | ||||||||||||||||||
Equity earnings of unconsolidated affiliates | — | (4.8 | ) | (15.0 | ) | — | — | (19.8 | ) | |||||||||||||||
Other (income) expense, net | (120.2 | ) | 27.5 | 148.1 | (15.1 | ) | — | 40.3 | ||||||||||||||||
Earnings (loss) from continuing operations before income taxes, cumulative effect of change in accounting principle and equity in loss of subsidiaries | (107.8 | ) | 35.3 | (47.7 | ) | 14.4 | — | (105.8 | ) | |||||||||||||||
Income tax expense | 3.9 | 33.2 | 53.7 | (12.9 | ) | — | 77.9 | |||||||||||||||||
Earnings (loss) from continuing operations before cumulative effect of change in accounting principle and equity in loss of subsidiaries | (111.7 | ) | 2.1 | (101.4 | ) | 27.3 | — | (183.7 | ) | |||||||||||||||
Loss from discontinued operations, net of income taxes | — | — | — | (33.0 | ) | — | (33.0 | ) | ||||||||||||||||
Cumulative effect of change in accounting principle, continuing operations, net of income tax benefit | 3.8 | (432.8 | ) | (988.9 | ) | 5.7 | — | (1,412.2 | ) | |||||||||||||||
Equity in loss of subsidiaries | (1,521.0 | ) | (686.7 | ) | — | — | 2,207.7 | — | ||||||||||||||||
Net Loss | $ | (1,628.9 | ) | $ | (1,117.4 | ) | $ | (1,090.3 | ) | $ | — | $ | 2,207.7 | $ | (1,628.9 | ) | ||||||||
107
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
FEDERAL-MOGUL CORPORATION
CONSOLIDATING CONDENSED BALANCE SHEET
December 31, 2004
(Millions of Dollars)
| Unconsolidated | |||||||||||||||||||
| Parent | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
| ASSETS | |||||||||||||||||||
Current Assets: | |||||||||||||||||||
Cash and equivalents | $ | 8.9 | $ | — | $ | 691.7 | $ | — | $ | 700.6 | |||||||||
Accounts receivable, net | 201.8 | 291.0 | 556.7 | — | 1,049.5 | ||||||||||||||
Inventories, net | 143.9 | 292.8 | 516.2 | — | 952.9 | ||||||||||||||
Prepaid expenses | 50.4 | 31.9 | 148.6 | — | 230.9 | ||||||||||||||
Total Current Assets | 405.0 | 615.7 | 1,913.2 | — | 2,933.9 | ||||||||||||||
Property, plant and equipment, net | 259.7 | 577.0 | 1,527.2 | — | 2,363.9 | ||||||||||||||
Goodwill and indefinite-lived intangible assets | 300.9 | 641.4 | 341.4 | — | 1,283.7 | ||||||||||||||
Definite-lived intangible assets, net | 67.9 | 82.4 | 185.0 | — | 335.3 | ||||||||||||||
Investment in subsidiaries | 6,460.1 | 2,982.7 | — | (9,442.8 | ) | — | |||||||||||||
Intercompany accounts, net | (3,913.7 | ) | 3,278.9 | 634.8 | — | — | |||||||||||||
Asbestos-related insurance recoverable | — | 166.1 | 687.7 | — | 853.8 | ||||||||||||||
Prepaid pension costs | 5.1 | — | 252.3 | — | 257.4 | ||||||||||||||
Other noncurrent assets | 41.2 | 28.5 | 167.5 | — | 237.2 | ||||||||||||||
| $ | 3,626.2 | $ | 8,372.7 | $ | 5,709.1 | $ | (9,442.8 | ) | $ | 8,265.2 | |||||||||
| LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT) | |||||||||||||||||||
Current Liabilites: | |||||||||||||||||||
Short-term debt, including current portion of long-term debt | $ | 277.9 | $ | — | $ | 31.7 | $ | — | $ | 309.6 | |||||||||
Accounts payable | 65.7 | 81.7 | 288.5 | — | 435.9 | ||||||||||||||
Accrued liabilities | 120.7 | 51.5 | 387.5 | — | 559.7 | ||||||||||||||
Other current liabilities | 51.6 | 11.8 | 82.2 | — | 145.6 | ||||||||||||||
Total Current Liabilities | 515.9 | 145.0 | 789.9 | — | 1,450.8 | ||||||||||||||
Liabilities subject to compromise | 4,163.4 | 353.5 | 1,501.6 | — | 6,018.5 | ||||||||||||||
Long-term debt | — | — | 10.1 | — | 10.1 | ||||||||||||||
Postemployment benefits | 742.8 | — | 1,613.1 | — | 2,355.9 | ||||||||||||||
Long-term portion of deferred income taxes | — | — | 102.0 | — | 102.0 | ||||||||||||||
Other accrued liabilities | 102.6 | 0.2 | 118.4 | — | 221.2 | ||||||||||||||
Minority interest in consolidated subsidiaries | 27.2 | 5.6 | (0.4 | ) | — | 32.4 | |||||||||||||
Shareholders’ Equity (Deficit) | (1,925.7 | ) | 7,868.4 | 1,574.4 | (9,442.8 | ) | (1,925.7 | ) | |||||||||||
| $ | 3,626.2 | $ | 8,372.7 | $ | 5,709.1 | $ | (9,442.8 | ) | $ | 8,265.2 | |||||||||
108
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
FEDERAL-MOGUL CORPORATION
CONSOLIDATING CONDENSED BALANCE SHEET
December 31, 2003
(Millions of Dollars)
| Unconsolidated | ||||||||||||||||||
| Parent | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | Eliminations | Consolidated | ||||||||||||||
| ASSETS | ||||||||||||||||||
Current Assets: | ||||||||||||||||||
Cash and equivalents | $ | 21.7 | $ | — | $ | 450.7 | $ | — | $ | 472.4 | ||||||||
Accounts receivable, net | 180.3 | 290.1 | 506.1 | — | 976.5 | |||||||||||||
Inventories, net | 100.3 | 280.7 | 453.4 | — | 834.4 | |||||||||||||
Prepaid expenses | 65.3 | 29.3 | 162.9 | — | 257.5 | |||||||||||||
Total Current Assets | 367.6 | 600.1 | 1,573.1 | — | 2,540.8 | |||||||||||||
Property, plant and equipment, net | 277.9 | 625.0 | 1,501.9 | — | 2,404.8 | |||||||||||||
Goodwill and indefinite-lived intangible assets | 517.6 | 664.3 | 335.2 | — | 1,517.1 | |||||||||||||
Definite-lived intangible assets, net | 79.5 | 87.0 | 181.5 | — | 348.0 | |||||||||||||
Investment in subsidiaries | 6,461.0 | 2,991.0 | — | (9,452.0 | ) | — | ||||||||||||
Intercompany accounts, net | (3,539.2 | ) | 2,957.0 | 582.2 | — | — | ||||||||||||
Asbestos-related insurance recoverable | — | 171.3 | 634.8 | — | 806.1 | |||||||||||||
Prepaid pension costs | 22.9 | — | 286.3 | — | 309.2 | |||||||||||||
Other noncurrent assets | 21.0 | 29.2 | 140.5 | — | 190.7 | |||||||||||||
| $ | 4,208.3 | $ | 8,124.9 | $ | 5,235.5 | $ | (9,452.0 | ) | $ | 8,116.7 | ||||||||
| LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT) | ||||||||||||||||||
Current Liabilities: | ||||||||||||||||||
Short-term debt, including current portion of long-term debt | $ | 0.2 | $ | — | $ | 14.6 | $ | — | $ | 14.8 | ||||||||
Accounts payable | 44.1 | 54.2 | 234.0 | — | 332.3 | |||||||||||||
Accrued liabilities | 100.4 | 61.1 | 313.1 | — | 474.6 | |||||||||||||
Other current liabilities | 106.6 | 8.0 | 70.5 | — | 185.1 | |||||||||||||
Total Current Liabilities | 251.3 | 123.3 | 632.2 | — | 1,006.8 | |||||||||||||
Liabilities subject to compromise | 4,152.6 | 349.6 | 1,585.6 | — | 6,087.8 | |||||||||||||
Long-term debt | 320.0 | — | 11.2 | — | 331.2 | |||||||||||||
Postemployment benefits | 740.6 | — | 988.0 | — | 1,728.6 | |||||||||||||
Long-term portion of deferred income taxes | — | — | 70.4 | — | 70.4 | |||||||||||||
Other accrued liabilities | 91.3 | 0.1 | 123.0 | — | 214.4 | |||||||||||||
Minority interest in consolidated subsidiaries | 29.4 | 25.0 | — | — | 54.4 | |||||||||||||
Shareholders’ Equity (Deficit) | (1,376.9 | ) | 7,626.9 | 1,825.1 | (9,452.0 | ) | (1,376.9 | ) | ||||||||||
| $ | 4,208.3 | $ | 8,124.9 | $ | 5,235.5 | $ | (9,452.0 | ) | $ | 8,116.7 | ||||||||
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
FEDERAL-MOGUL CORPORATION
CONSOLIDATING CONDENSED STATEMENT OF CASH FLOWS
Year Ended December 31, 2004
(Millions of Dollars)
| Unconsolidated | |||||||||||||||||||
| Parent | Guarantor Subsidiaries | Non- Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Net Cash Provided From (Used By) Operating Activities | $ | 141.3 | $ | 381.0 | $ | (56.8 | ) | $ | — | $ | 465.5 | ||||||||
Expenditures for property, plant and equipment | (29.0 | ) | (49.6 | ) | (188.9 | ) | — | (267.5 | ) | ||||||||||
Net proceeds from sale of property, plant and equipment | — | — | 29.9 | — | 29.9 | ||||||||||||||
Net proceeds from sales of businesses | — | — | 10.7 | — | 10.7 | ||||||||||||||
Net Cash Used By Investing Activities | (29.0 | ) | (49.6 | ) | (148.3 | ) | — | (226.9 | ) | ||||||||||
Increase in short-term debt | — | — | 13.4 | — | 13.4 | ||||||||||||||
Proceeds from borrowings on DIP credit facility | 357.7 | — | — | — | 357.7 | ||||||||||||||
Principal payments on DIP credit facility | (400.0 | ) | — | — | — | (400.0 | ) | ||||||||||||
Principal payments on long-term debt | — | — | (2.0 | ) | — | (2.0 | ) | ||||||||||||
Debt issuance fees | — | — | (6.5 | ) | — | (6.5 | ) | ||||||||||||
Change in intercompany accounts | (109.8 | ) | (331.4 | ) | 441.2 | — | — | ||||||||||||
Net Cash (Used By) Provided From Financing Activities | (152.1 | ) | (331.4 | ) | 446.1 | — | (37.4 | ) | |||||||||||
Effect of foreign currency exchange rate fluctuations on cash | 27.0 | — | — | — | 27.0 | ||||||||||||||
Net Increase in Cash and Equivalents | $ | (12.8 | ) | $ | — | $ | 241.0 | $ | — | $ | 228.2 | ||||||||
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
FEDERAL-MOGUL CORPORATION
CONSOLIDATING CONDENSED STATEMENT OF CASH FLOWS
Year Ended December 31, 2003
(Millions of Dollars)
| Unconsolidated | Eliminations | Consolidated | |||||||||||||||||
| Parent | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | |||||||||||||||||
Net Cash Provided From (Used By) Operating Activities | $ | (197.6 | ) | $ | 333.4 | $ | 176.7 | $ | — | $ | 312.5 | ||||||||
Expenditures for property, plant and equipment | (46.1 | ) | (78.7 | ) | (176.1 | ) | — | (300.9 | ) | ||||||||||
Net proceeds from sale of property, plant and equipment | — | — | 6.5 | — | 6.5 | ||||||||||||||
Net proceeds from sales of businesses | — | 23.3 | 0.3 | — | 23.6 | ||||||||||||||
Net Cash Used By Investing Activities | (46.1 | ) | (55.4 | ) | (169.3 | ) | — | (270.8 | ) | ||||||||||
Increase (decrease) in short-term debt | 0.2 | — | (16.8 | ) | — | (16.6 | ) | ||||||||||||
Proceeds from borrowings on DIP credit facility | 125.5 | — | — | — | 125.5 | ||||||||||||||
Principal payments on DIP credit facility | (120.2 | ) | — | — | — | (120.2 | ) | ||||||||||||
Proceeds from borrowings on long-term debt | — | — | 1.2 | — | 1.2 | ||||||||||||||
Principal Payments on long-term debt | — | — | (4.3 | ) | — | (4.3 | ) | ||||||||||||
Change in intercompany accounts | 178.0 | (278.0 | ) | 100.0 | — | — | |||||||||||||
Net Cash (Used By) Provided From Financing Activities | 183.5 | (278.0 | ) | 80.1 | — | (14.4 | ) | ||||||||||||
Effect of foreign currency exchange rate fluctuations on cash | 50.0 | — | — | — | 50.0 | ||||||||||||||
Net Increase (Decrease) in Cash and Equivalents | $ | (10.2 | ) | $ | — | $ | 87.5 | $ | — | $ | 77.3 | ||||||||
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
FEDERAL-MOGUL CORPORATION
CONSOLIDATING CONDENSED STATEMENT OF CASH FLOWS
Year Ended December 31, 2002
(Millions of Dollars)
| Unconsolidated | Eliminations | Consolidated | |||||||||||||||||
| Parent | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | |||||||||||||||||
Net Cash Provided From (Used By) Operating Activities | $ | 181.8 | $ | 118.9 | $ | (44.2 | ) | $ | — | $ | 256.5 | ||||||||
Expenditures for property, plant and equipment | (41.6 | ) | (90.9 | ) | (206.6 | ) | — | (339.1 | ) | ||||||||||
Net proceeds from sale of businesses | 7.5 | 6.0 | 21.1 | — | 34.6 | ||||||||||||||
Net Cash Used By Investing Activities | (34.1 | ) | (84.9 | ) | (185.5 | ) | — | (304.5 | ) | ||||||||||
Increase (decrease) in short-term debt | — | (0.5 | ) | 7.0 | — | 6.5 | |||||||||||||
Proceeds from borrowings on DIP credit facility | 75.0 | — | — | — | 75.0 | ||||||||||||||
Principal payments on DIP credit facility | (10.3 | ) | — | — | — | (10.3 | ) | ||||||||||||
Proceeds from borrowings on long-term debt | — | — | 6.6 | — | 6.6 | ||||||||||||||
Principal payments on long-term debt | — | — | (2.4 | ) | — | (2.4 | ) | ||||||||||||
Change in intercompany accounts | (275.3 | ) | (37.0 | ) | 312.3 | — | — | ||||||||||||
Net Cash (Used By) Provided From Financing Activities | (210.6 | ) | (37.5 | ) | 323.5 | — | 75.4 | ||||||||||||
Effect of foreign currency exchange rate fluctuations on cash | 20.8 | — | — | — | 20.8 | ||||||||||||||
Net Increase (Decrease) in Cash and Equivalents | $ | (42.1 | ) | $ | (3.5 | ) | $ | 93.8 | $ | — | $ | 48.2 | |||||||
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| ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
None
| ITEM 9A. | CONTROLS AND PROCEDURES |
Disclosure 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 periodic Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’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 timely decisions regarding required disclosure.
A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.
As of December 31, 2004, an evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2004, at the reasonable assurance level previously described.
Robert S. Miller, Jr. was appointed as Chief Executive Officer of the Company on July 21, 2004. Prior to July 21, 2004, Charles G. McClure, Jr. served as Chief Executive Officer of the Company.
Internal Control over Financial Reporting
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, the Company included within this Form 10-K Management’s Report on Internal Control over Financial Reporting as of December 31, 2004. The Company’s independent registered public accounting firm also attested to, and reported on, Management’s Report on Internal Control over Financial Reporting. Management’s report and the independent registered public accounting firm’s report are included in Item 8 of this Form 10-K and incorporated by reference herein.
Changes in Internal Control over Financial Reporting
There has been no change in the Company’s internal control over financial reporting during the fourth quarter ended December 31, 2004 that has materially affected or is reasonably likely to materially effect the Company’s internal control on financial reporting.
On October 22, 2004, the Bankruptcy Court approved the Company’s motion to enter into an agreement with a third party to provide certain accounting and financial activities currently performed by the Company. Under the terms of the agreement, the Company expects to reduce its overall operating costs while increasing the efficiency of its accounting and financial activities. The Company began transition of its internal activities to this third party provider during February 2005 and expects to complete the transition in the second quarter of 2005.
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PART III
| ITEM 10. | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT |
Executive Officers:
David A. Bozynski Age 50 | Mr. Bozynski has served as vice president and treasurer since May 1996 and served as interim chief financial officer from March 2000 to July 2000. | |
Gerhard Boehm Age 47 | Mr. Boehm was appointed senior vice president, powertrain, for Federal-Mogul Corporation in September 2003. Previously, Boehm served as vice president, Pistons, vice president, technology—Europe and vice president, power cylinder systems engineering, technology and sales-Europe. He was also managing director, Piston operations - Europe. | |
Thomas B. Conaghan Age 54 | Mr. Conaghan is senior vice president, sealing systems and systems protection. Prior to this appointment, Conaghan held the position of vice president, systems protection, since 1996, European general manager from 1994 to 1996. Conaghan has held a number of functional and operational management assignments in the U.S. and Europe during his 26 years with Federal-Mogul Corporation. | |
Rene L. F. Dalleur Age 51 | Mr. Dalleur was appointed senior vice president, global friction products in June 2001. Dalleur was named vice president, ignition/wipers, Europe in September 2000, with responsibilities for sealing systems, Europe, added in November 2000. Upon joining the Company by the acquisition of the automotive segment of Cooper Industries in 1998, he was director and general manager for wipers/filters, Europe. Dalleur has held various positions in engineering, purchasing, and plant and general management in the automotive and aerospace industries. | |
Joseph P. Felicelli Age 58 | Mr. Felicelli has served as senior vice president – worldwide aftermarket since October 2001. | |
Charles Grant Age 60 | Mr. Grant has served as vice president-corporate development since 1992, with strategic planning added in December 2000. Prior to this position, Grant served as vice president and controller from May 1988 to December 1992. | |
Alan Haughie Age 40 | Mr. Haughie was appointed as vice president and controller effective January 1, 2005. Prior to this appointment, Mr. Haughie served as director, corporate finance since 2000 and previously worked as controller in the Company’s aftermarket business located in Manchester, U.K. from 1999 to 2000. | |
Ramzi Hermiz Age 39 | Beginning in 2004, Mr. Hermiz became the vice president - European aftermarket. Previously, he was vice president, global supply chain from 2001 through 2003. | |
Rainer Jueckstock Age 45 | Mr. Jueckstock was appointed to senior vice president, pistons, rings, and liners in October 2003. Prior to this he was vice president, Rings and Liners. Jueckstock, who joined Federal-Mogul in 1990, also served as a piston ring operations director in Europe, as well as managing director of the company’s Friedberg, Germany, operation, sales director for rings and liners in Europe; finance controller in Burscheid, Germany; and finance manager in Dresden, Germany. | |
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G. Michael Lynch Age 61 | Mr. Lynch joined the Company in June 2000 as Executive vice president and chief financial officer. | |
Dale R. Pilger Age 50 | Mr. Pilger joined the Company in June 2003 as senior vice president, global original equipment sales application engineering and marketing and Asia Pacific operations. | |
Richard P. Randazzo Age 61 | Mr. Randazzo has served as senior vice president, human resources since February 1998 and was vice president, human resources from January 1997 through February 1998. | |
Wilhelm Schmelzer Age 64 | Mr. Schmelzer has served as executive vice president, Europe, South Africa and South America since January 2004. Prior to his appointment, Mr. Schmelzer served as executive vice president, bearings, with regional responsibility for Europe, Africa, and South America, executive vice president, powertrain systems, with regional responsibilities for Europe, Africa and South America, executive vice president Europe and Africa, senior vice president-sealing systems, and vice president and group executive-engine and transmission products. | |
Michael J. Widgren Age 36 | Mr. Widgren was appointed as the Company’s chief accounting officer effective January 1, 2005. Prior to this appointment he served as the Company’s director, accounting and reporting from October 2002. Mr. Widgren joined the Company in January 1999 and served as the Company’s director of internal audit until his appointment as director, corporate accounting and reporting. | |
The Company has adopted the “Federal-Mogul Corporation Financial Code of Ethics” (“Code of Ethics”), which applies to the Company’s Chief Executive Officer, Chief Financial Officer, Controller and Chief Accounting Officer, other Executive Officers and certain members of the Company’s financial functions. The Code of Ethics is publicly available on the Company’s internet website at www.federal-mogul.com. The Company intends to disclose any change to or waiver from the Code of Ethics, including any implicit waiver, on its internet website, or in a report on Form 8-K.
Directors:
José Maria Alapont Director since 2005 Age 54 | Mr. Alapont was appointed as a director of the Company effective February 25, 2005, and will commence employment with the Company on March 1, 2005. Upon obtaining the appropriate work visa, Mr. Alapont will become President and Chief Executive Officer of the Company. Since October 1, 2003, Mr. Alapont was Chief Executive Officer and a member of the Board of Directors of IVECO, the commercial vehicle company of the Fiat Group. From 1997 until October 1, 2003, Mr. Alapont served in various key positions at Delphi Automotive Systems. From 1990 to 1997, Mr. Alapont served in several leadership roles at Valeo, a global automotive supplier. Mr. Alapont began his automotive career in 1974 with Form Motor Company and over the course of 15 years worked in increasingly more responsible positions – from engineer at Ford Spain to power train manager at Ford Europe. | |
John J. Fannon Director since 1986 Age 71 | Mr. Fannon has served as a director of the Company since 1986. He retired as vice chairman of Simpson Paper Company in 1998, a privately held global forest products company, a position he had held since 1993. From 1980 until 1993, Mr. Fannon served as president of Simpson Paper. Mr. Fannon is currently a business consultant. | |
| * | bearings, with regional responsibility for Europe, Africa, and South America, executive vice president |
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Paul S. Lewis Director since 1998 Age 68 | Mr. Lewis has served as a director of the Company since May 1998. He served as chairman of Terranova Foods plc, a European based supplier of convenience and frozen foods, from October 1998 until June 1999, when the Company was acquired by Uniq plc. He joined Tate & Lyle plc, a multi-national processor of sugar and starch products, as group finance director in 1988 and served as its deputy chairman from 1993 until 1998. He is a former non-executive director of T&N plc and is a non-executive director of Dairy Crest Group plc. | |
Frank E. Macher Director since 2001 Age 64 | Mr. Macher served as the chairman of the board of the Company from July 2003 through January 2004. Previously he served as chairman and chief executive officer since October 2001 and served as chief executive officer from January 2001 until September 2001. Prior thereto, Mr. Macher served as president and chief executive officer of ITT Automotive, a global automotive parts supplier, from July 1997 until January 1999. Previously, he served as the vice president and general manager of the Automotive Components Division of Ford Motor Company. Mr. Macher is also a director of Decoma International and Tenneco Automotive and is a trustee of Kettering University. | |
Robert S. Miller, Jr. Director since 1993 Age 63 | Mr. Miller became chairman of the board of the Company in January 2004. He served as the chairman and chief executive officer of Bethlehem Steel Corporation, a global steel manufacturer, from September 2001 until December 2003, when Bethlehem Steel ceased to exist. Mr. Miller served as chairman of the board of the Company from September 2000 until October 2001 and was chief executive officer from September 2000 until January 2001. He served as special advisor to Aetna, Inc., a health insurer, from February 2000 until September 2000. From November 1999 until February 2000, Mr. Miller served as president and a director of Reliance Group Holdings, Inc., a property and casualty insurance company. He served as president and chief executive officer of Waste Management, Inc., a waste transporter, from August 1999 until November 1999 and as chairman of the board of Waste Management from July 1998 until May 1999. Mr. Miller serves as a director of Pope & Talbot, Inc., Reynolds American, Inc. (tobacco) Tobacco Holdings, Symantec Corp., UAL and Waste Management, Inc. | |
Shirley D. Peterson Director since 2002 Age 63 | Ms. Peterson was president of Hood College, an independent liberal arts college, from 1995-2000. From 1989-93, she served in the U.S. government, first appointed by President Bush as assistant attorney general in the Tax Division of the Department of Justice, then as commissioner of the Internal Revenue Service. She also was a partner in the law firm of Steptoe & Johnson, where she spent a total of 22 years from 1969-89 and 1993-94. Ms. Peterson has been an independent trustee of Scudder Mutual Funds since 1995. Ms. Peterson serves as a director of AK Steel Corporation, she is also a trustee of Champion Enterprise and Goodyear Tire & Rubber Company. She is also a trustee of Bryn Mawr College Board of Trustees (on leave this academic year). | |
John C. Pope Director Since 1987 Age 55 | Mr. Pope has served as chairman of PFI Group, a private investment firm, since 1999. He served as chairman of the board of MotivePower Industries, Inc., a manufacturer and remanufacturer of locomotives and locomotive components from January 1996 to November 1999 and he is also a director of CNF, Inc., Dollar Thrifty Automotive Group, Inc., Kraft Foods Inc. and RR Donnelley & Sons Company and Waste Management, Inc., where he is currently the chairman of the board. | |
Geoffrey H. Whalen C.B.E. Director since 1998 Age 69 | Sir Geoffrey retired in 1995 as managing director and deputy chairman of Peugeot Motor Company, plc, an automotive manufacturer, positions he held since 1984 and 1990, respectively. He also served as president of the Society of Motor Manufacturers & Traders, the trade association representing vehicle and component makers in the United Kingdom, from 1988-1990 and 1993-1994. Sir Geoffrey is also a director of Coventry Building Society, Camden Motors Ltd. and Novar plc. | |
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The Board of Directors has the following four standing committees: Audit, Governance and Nominating, Compensation and Pension. The membership and chairman of each of the committees is set forth in the table below.
Board Committees
Board Member | Audit | Governance and Nominating | Compensation | Pension | ||||
José Maria Alapont | ||||||||
John J. Fannon | X | X | X* | X | ||||
Paul S. Lewis | X | X | X | X* | ||||
Frank E. Macher | ||||||||
Robert S. Miller, Jr. | X | |||||||
Shirley D. Peterson | X | X | X | X | ||||
John C. Pope | X* | X | X | X | ||||
Geoffrey H. Whalen | X | X* | X | X |
| * | denotes Committee Chairman |
The Board of Directors has determined that Paul S. Lewis and John C. Pope are audit committee financial experts as such term is defined in rules of the Securities and Exchange Commission implementing requirements of the Sarbanes-Oxley Act of 2002. Both Mr. Lewis and Mr. Pope are independent of the Company’s management as defined inItem 7(d)(3)(iv) of Schedule 14A under the Securities Exchange Act of 1934.
During 2004 there were 25 meetings of the Board of Directors. Each of the directors attended 75% or more of the meetings of the Board of Directors and the standing committees on which he or she serves.
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ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table
| Annual Compensation | Long-Term Compensation | |||||||||||||
Name and Principal Position | Year | Salary ($) | Bonus ($) | Other Annual Compensation | Securities (No.) | All Other ($) | ||||||||
Robert (Steve) Miller(2) Chairman of the Board and Chief Executive Officer | 2004 | 499,231 | 1,030,664 | (4) | ||||||||||
Frank E. Macher(2) Former Chairman of the Board and Chief Executive Officer | 2004 2003 2002 | 19,231 1,038,470 1,000,000 | — 2,190,000 2,200,000 | (5) (6) | — 72,402 67,742 | (7) (7) | — — — | 3,250 — — | ||||||
Charles G. McClure, Jr.(3) Former Chairman of the Board and Chief Executive Officer | 2004 2003 2002 | 597,308 882,701 850,000 | — 1,861,500 1,870,000 | (5) (6) | — — — | | — — — | 3,250 — — | ||||||
G. Michael Lynch Executive Vice President and Chief Financial Officer | 2004 2003 2002 | 530,231 519,231 500,000 | 1,128,900 1,095,000 1,100,000 | (4) (5) (6) | 51,049 — | (7) | — — — | 9,225 — — | ||||||
Wilhelm A. Schmelzer Executive Vice President Bearings | 2004 2003 2002 | 507,500 519,231 500,000 | 1,070,825 965,000 1,075,000 | (4) (5) (6) | — — — | | — — — | — — — | ||||||
Richard P. Randazzo Senior Vice President Human Resources | 2004 2003 2002 | 404,146 399,804 385,000 | 860,520 958,150 962,000 | (4) (5) (6) | — — — | | — — — | 9,225 — — | ||||||
Joseph Felicelli Executive Vice President World Wide Aftermarket | 2004 2003 2002 | 387,746 363,462 350,000 | 788,340 626,850 629,200 | (4) (5) (6) | — — — | | — — — | 3,250 — — | ||||||
| (1) | Mr. Miller was appointed interim Chairman and Chief Executive Officer upon the resignation of Mr. McClure August 8, 2004. He is being compensated at a rate equivalent to $1,100,000 annually. |
| (2) | Mr. Macher served as Chairman and Chief Executive Officer through July 11, 2003. He continued as an employee and Chairman through January 11, 2004. Mr. Macher continues as a non-executive member of the Board of Directors. |
| (3) | Mr. McClure served as President and Chief Operating Officer through July 11, 2003. He was appointed Chief Executive Officer and President, effective July 11, 2003. He resigned on August 8, 2004. |
| (4) | Two incentive compensation plans were available in 2004; (i) the regular annual management incentive plan and (ii) the second, in lieu of a long term plan, was based on corporate wide EBITDA and corporate wire Free Cash Flow. Mr. Miller received a $687,109 incentive bonus under the first plan and $343,555 under the second plan. Mr. Lynch received $752,600 under the first plan and $376,300 under the second. Mr. Schmelzer received $710,500 under the first plan and $360,325 under the second plan. Mr. Randazzo received $573,680 under the first plan and $286,840 under the second. Mr. Felicelli received $579,600 under the first and $208,740 under the second plan. |
| (5) | Mr. Macher received (i) a $1,190,000 incentive bonus and (ii) a $1,000,000 retention payment for 2003 services. |
| Mr. McClure received (i) a $1,011,500 incentive bonus and (ii) a $850,000 retention payment for 2003 services. |
| Mr. Lynch received (i) a $595,000 incentive bonus and (ii) a $500,000 retention payment for 2003 services. |
| Mr. Schmelzer received (i) a $565,000 incentive bonus and (ii) a $400,000 retention payment for 2003 services. |
| Mr. Randazzo received (i) a $458,000 incentive bonus and (ii) a $500,000 retention payment for 2003 services. |
| Mr. Felicelli received (i) a $276,850 incentive bonus and (ii) a $350,000 retention payment for 2003 services. |
| (6) | Mr. Macher received (i) a $1,200,000 incentive bonus and (ii) a 1,000,000 retention payment for 2002 services. |
| Mr. McClure received (i) a $1,020,000 incentive bonus and (ii) a $850,000 retention payment for 2002 services. |
| Mr. Lynch received (i) a $600,000 incentive bonus and (ii) a $500,000 retention payment for 2002 services. |
| Mr. Schmelzer received (i) a $550,000 incentive bonus and (ii) a $500,000 retention payment for 2002 services. |
| Mr. Randazzo received (i) a $462,000 incentive bonus, and (ii) a $500,000 retention payment for 2002 services. |
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| Mr. Felicelli received (i) a $279,200 incentive bonus and (ii) a $350,000 retention payment for 2002 services. |
| (7) | Includes transportation expenses for Mr. Macher of $71,032 in 2003 and $58,433 in 2002, and transportation expenses for Mr. Lynch of $43,756 in 2003. |
| (8) | Includes contributions in 2004 of $3,250, $4,100, $3,250, $3,250 and $4,100 for Messrs. Felicelli, Lynch, Macher, McClure and Randazzo, respectively to the Salaried Employees’ Investment Program (a tax qualified 401k plan) and %5,125 and $5,125 to the Match Reinstatement Plan (a non-qualified plan) for Mr. Lynch and Randazzo, respectively. Company contributions to both programs were suspended in November 2001 and reinstated at one-half the former schedule in January 2004. |
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Compensation of Directors
Non-employee directors receive a retainer of $8,750 for each calendar quarter. In addition, they are paid $1,500 for each meeting of the Board of Directors they attend and $1,000 for each Committee meeting they attend. Mr. Miller receives an additional annual retainer of $100,000 for his service as Chairman of the Board. The Chairmen of the Governance and Nominating Committee and the Pension Committee receive an additional annual retainer of $5,000. The Chairman of the Compensation Committee receives an additional annual retainer of $10,000, and the Chairman of the Audit Committee receives an additional annual retainer of $20,000.
Directors’ Deferred Compensation
Prior to 2002, non-employee directors could elect to defer all or a portion of their cash compensation. Deferred amounts were hypothetically invested in either an interest bearing account, an account whose value was tied to the Company’s common stock or an account whose value was tied to the Company’s publicly traded debt, or a combination of the three. Amounts deferred in the common stock account or bond account were credited in the form of units of the Company’s common stock or bonds based on the fair market value on the date of the deferral. The Units credited to all non-employee directors’ deferred common stock accounts are included in the Share Ownership Table set forth below in Item 12.
Aggregated Option/SAR Exercises in 2004 and Year End Option/SAR Values
The following table shows, for the Named Executive Officers, the amount and values of unexercised stock options as of December 31, 2004. No stock appreciation rights are outstanding and no stock options were exercised by the Named Executive Officers in 2004.
Name | Number of Securities Underlying Unexercised Options/SARs at Fiscal Year End (#) Exercisable/Unexercisable | Value of Unexercised In-the-Money Options/SARs at Fiscal Year-End ($) Exercisable/Unexercisable | ||
Robert S. Miller, Jr. | 101,500/0 | 0/0 | ||
Joseph P. Felicelli | 30,000/0 | 0/0 | ||
Frank E. Macher | 150,000/0 | 0/0 | ||
Charles G. McClure | 0/0 | 0/0 | ||
G. Michael Lynch | 132,000/0 | 0/0 | ||
Wilhelm A. Schmelzer | 71,800/0 | 0/0 | ||
Richard P. Randazzo | 43,000/0 | 0/0 |
No stock options were granted in 2004. Each option was awarded with an exercise price equal to the average of the high and low market price of the Company’s common stock on the date of grant. All stock options expire five years after the date of grant, three years after the date of retirement or 90 days after termination of employment. All options granted by the Company vest immediately upon change in control. The Company did not grant any stock appreciation rights in 2004.
Retirement Plans
Under the Company’s tax-qualified defined benefit pension plan (DB Plan), benefits are payable upon retirement to salaried employees in the form of a lump sum or annuity, at the employee’s election. Accrued pension benefits for participants are expressed as an account balance. Annual credits as of January 1, 2004 range from 1.5% to 9.0% of earnings that are made to participants’ accounts based upon the employee’s age. Earnings are defined as an employee’s base pay plus overtime, commissions, incentive compensation, bonuses and other variable compensation up to a maximum permitted by law of $205,000 in 2004. Benefits are vested based on a graded five-year schedule for those hired before January 1, 2002. For those hired on or after January 1, 2002, benefits are vested on a five-year cliff schedule.
Estimated annual retirement benefits that may be provided by the DB Plan to the Named Executive Officers eligible to participate in the DB Plan upon retirement at age 65, which is the normal retirement age for officers, assuming conversion of the combined account balances into a single monthly life annuity, are as follows: Mr. Lynch—$18,169; Mr. Schmelzer—$46,085; Mr. Randazzo—$24,001 and Mr. Felicelli—$37,561.
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As terminated employees, Mr. Macher received a lump-sum distribution of $19,918 in February 2005 and Mr McClure received a lump-sum distribution of $6,363 in December 2004. Mr. Miller is not expected to vest in this benefit
Non-Qualified Pension Plan
Under the Company’s non-qualified defined benefit pension plan (NQ Plan), benefits are payable upon retirement to certain executives in the form of a lump-sum. Accrued pension benefits for participants are expressed as an account balance. Annual credits as of January 1, 2005 range from 1.5% to 9.0% of earnings thar are made to participants’ accounts based on the employee’s age. Earnings are defined as an employee’s base pay plus overtime, commissions, incentive compensation, bonuses and other variable compensation in excess of $205,000 in 2004. Benefits are vested based upon attainment of age 55 and satisfiying a five-year ciiff vesting schedule.
Estimated annual retirement benefits that may be provided by the NQ Plan to the Named Executive Officers eligible to participate in the NQ Plan upon retirement at age 65, which is the normal retirement age for officers, assuming conversion of the account balances into a single monthly life annuity, are as follows: Mr Lynch—$70,763; Mr. Schmelzer—$65,193; Mr. Randazzo—$65,234; Mr. Felicelli—$60,477.
Mr. Macher and Mr. McClure were vested under the NQ Plan under the terms of their employment agreements Mr. Macher received a lump-sum distribution of $587,509 in February 2005 and Mr. McClure received a lump-sum distribution of $407,890 in December 2004.
Mr. Miller is not expected to vest in this benefit.
Supplemental Key Executive Pension Plan
In addition to the DB Plan and NQ Plan, the Company maintains a Supplemental Key Executive Pension Plan (SKEPP). The SKEPP is a non-tax qualified pension plan, the purpose of which is to provide a pension benefit for a limited number of senior executives that is competitive with pension benefits provided to senior executives at peer group companies. The SKEPP targets a pension benefit equal to 50% of an executive’s average compensation for the highest consecutive three-year period of the last five years before retirement. An executive must have worked at the Company for a minimum of five years to receive a benefit under the SKEPP. In order to receive the maximum SKEPP benefit, an executive must attain a minimum of 20 years of service with the Company and be at least age 62 upon retirement. A reduced benefit will be paid to executives who have not attained these minimal levels. The target benefits are calculated taking into account benefits paid under the Company’s DB Plan, NQ Plan and certain predecessor plans.
The following table indicates estimated total annual benefits payable as a single life annuity beginning at age 65 for various compensation levels and years of service under the SKEPP, taking into account the DB Plan and NQ Plan. Generally, annual compensation used for the pension formula purposes includes salary and annual incentive compensation, as reported in the Summary Compensation Table.
Supplemental Key Executive Pension Plan Table
Average Pay During Final Three Years Before Retirement | Years of Service For Years of Service Shown Below) | ||||||||||||
| 10 | 15 | 20 | 25 | ||||||||||
| $ | 400,000 | $ | 100,000 | $ | 150,000 | $ | 200,000 | $ | 200,000 | ||||
| 600,000 | 150,000 | 225,000 | 300,000 | 300,000 | |||||||||
| 800,000 | 200,000 | 300,000 | 400,000 | 400,000 | |||||||||
| 1,000,000 | 250,000 | 375,000 | 500,000 | 500,000 | |||||||||
| 1,200,000 | 300,000 | 450,000 | 600,000 | 600,000 | |||||||||
| 1,400,000 | 350,000 | 525,000 | 700,000 | 700,000 | |||||||||
| 1,600,000 | 400,000 | 600,000 | 800,000 | 800,000 | |||||||||
| 1,800,000 | 450,000 | 675,000 | 900,000 | 900,000 | |||||||||
| 2,000,000 | 500,000 | 750,000 | 1,000,000 | 1,000,000 | |||||||||
| 2,200,000 | 550,000 | 825,000 | 1,100,000 | 1,100,000 | |||||||||
| 2,400,000 | 600,000 | 900,000 | 1,200,000 | 1,200,000 | |||||||||
The SKEPP grants credit for all years of pension service with the Company and under certain predecessor plans. The Named Executive Officers who are eligible to participate in the SKEPP have the following years of credited pension service as of December 31, 2004: Mr. Lynch — 7.98 years (including 3.40 years of service credited from his prior employer); Mr. Schmelzer — 35.5 years (subject to the 20 year maximum); and Mr. Randazzo — 10.08 years (including 2.08 years of service credited from his prior employer).
Mr. Macher commenced receiving a monthly benefit of $24,693 effective February 2004. Mr. McClure was not vested in the SKEPP at the time of his termination of employment. Mr. Miller and Mr. Felicelli are not participants of the SKEPP.
Change of Control Agreements
The Company has entered into Change of Control Agreements with each of the Named Executive Officers which provide that, if following a change of control, the Named Executive Officer is terminated by the Company without “Cause” or the Named Executive Officer terminates the agreement for “Good Reason”, he will receive the following benefits: (i) a lump-sum cash amount equal to three times his base salary and three times the Named Executive Officer’s target bonus as of the termination date or, if greater, the Named Executive Officer’s target bonus as of the date of the change of control, (ii) the excess of the actuarial equivalent of the benefit he would receive under the PRA and any supplemental retirement plan, including the SKEPP, if his employment continued for three years after the date of termination or such longer period, if any, as would have been credited to the Named Executive Officer under the change-in-control provisions of the SKEPP (assuming full vesting) over the actuarial equivalent of any amount paid or payable under the PRA or such supplemental retirement plans as of the date of termination, (iii) the continuation of benefits under the employee benefit plans, programs, practices and policies of the Company for three years, and (iv) outplacement services of up to $60,000. A “change of control” does not include events that occur during the Company’s pending bankruptcy proceeding or upon the effective date of a confirmed plan of
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reorganization. Subject to certain exceptions, the Named Executive Officer will also receive a “gross-up” payment as reimbursement of any federal excise taxes payable. As part of the Change of Control Agreement, the Named Executive Officer has agreed to a noncompetition covenant applicable for one year following the termination of his employment.
Severance Agreements
The Company has entered into Severance Agreements with each of the Named Executive Officers. Under these agreements, if a Named Executive Officer is terminated by the Company without “Cause,” he will receive the following benefits: (i) a lump-sum cash amount equal to between 15 and 24 months of base salary and to between 15 and 24 months of the Named Executive Officer’s target bonus as of the date of termination or, if greater, the Named Executive Officer’s target bonus as of the date of the agreement, and (ii) the continuation of benefits under the Company welfare benefit plans, practices, policies and programs for between 15 and 24 months. As a condition to the receipt of such benefits, each of the Named Executive Officers would be required to provide the Company with a general release and agree not to compete with the Company during the one-year period following the effective date of the required release and noncompetition agreement. A termination of the Named Executive Officer’s employment that gives rise to an obligation of the Company to make payments or provide benefits under a Change of Control Agreement will not also entitle the Named Executive Officer to any payments or benefits under these agreements. If the net after-tax benefit to the Named Executive Officer of all payments or distributions by the Company is not greater than the net after-tax benefit of a reduction of the benefits to prevent the imposition of any applicable federal excise tax, the benefits under the Severance Agreement will be reduced to prevent the imposition of the excise tax.
Employment Agreement with José Maria Alapont
On February 2, 2005, the Company entered into an employment agreement with José Maria Alapont (the “Employment Agreement”). As previously announced Mr. Alapont has been chosen to be the President and Chief Executive Officer of the Company and has been elected to serve as a Director of the Company. Mr. Alapont is expected to commerce employment under the Employment Agreement on or about March 1, 2004. Until Mr. Alapont obtains an appropriate work visa from the United States of America, Mr. Alapont cannot be employed by a U.S. company. Therefore, until such date that he has an appropriate visa permitting him to be employed by the Company (the “Effective Date”), Mr. Alapont will be employed in accordance with the terms of the Employment Agreement by one of the Company’s foreign affiliates that is not a filing entity in the Company’s Chapter 11 proceedings. Upon the Effective Date, Mr. Alapont will be employed by the Company as its President and Chief Executive Officer.
The Company and Mr. Alapont have also entered into a Change of Control Agreement, which agreement is identical to the change of control agreements between the Company and the Named Executive Officers described above. Any payments and benefits provided to Mr. Alapont under the Employment Agreement will be offset and credited against as payment and benefits under his Change of Control Agreement.
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| ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT |
The following table shows the amount of common stock, stock units and Series C ESOP Stock beneficially owned by the Company’s directors, the Named Executive Officers, and the directors and officers as a group, as of January 31, 2005. The number of shares shown includes shares that are individually or jointly owned, as well as shares over which the individual has either sole or shared investment or voting authority. No one Named Executive Officer owns 1% of the Company’s outstanding stock. In the aggregate, all directors and executive officers of the Company as a group own less than 1% of the Company’s outstanding stock.
Name | Beneficial Ownership | (1) | Percent of Class | ||||
John J. Fannon | 32,424 | (2 | ) | * | |||
Joseph P. Felicelli | 30,000 | (3 | ) | * | |||
Paul S. Lewis | 19,237 | (4 | ) | * | |||
G. Michael Lynch | 135,121 | (5 | ) | * | |||
Frank E. Macher | 151,517 | (6 | ) | * | |||
Charles G. McClure | 4,000 | (7 | ) | * | |||
Robert S. Miller, Jr. | 104,735 | (8 | ) | * | |||
Shirley D. Peterson | — | * | |||||
John C. Pope | 26,891 | (9 | ) | * | |||
Richard P. Randazzo | 43,421 | (10 | ) | * | |||
Wilhelm A. Schmelzer | 72,425 | (11 | ) | * | |||
Geoffrey H. Whalen | 18,237 | (12 | ) | * | |||
All directors and executive officers as a group, 22 persons | 869,632 | ||||||
| * | Represents less than 1% of the outstanding common stock |
| (1) | Except as otherwise noted, each beneficial owner identified in this table has sole investment power with respect to the shares shown in the table. For executive officers, the numbers include Series C ESOP shares held in the Company’s Salaried Employee Investment Plan (“SEIP”) with respect to which participants have voting power but no investment rights. |
| (2) | Includes (i) 1,286 shares and 1,235 stock units owned directly and (ii) 29,903 options that are fully vested. |
| (3) | Includes 30,000 shares that are fully vested. |
| (4) | Includes (i) 2,000 shares and 237 stock units owned directly and (ii) 17,000 options that are fully vested. |
| (5) | Includes (i) 3,073 shares in the Company’s SEIP, (ii) 48 shares of the Company’s Series C ESOP Stock, and (iii) 132,000 options that are fully vested. |
| (6) | Includes (i) 1,517 shares in the Company’s SEIP and (ii) 150,000 options that are fully vested. |
| (7) | Includes 4,000 shares in a trust. |
| (8) | Includes (i) 2,000 shares and 1,235 stock units owned directly and (ii) 101,500 options that are fully vested. |
| (9) | Includes (i) 5,700 shares and 1,235 stock units owned directly, (ii) 400 shares owned jointly with his wife and (iii) 19,556 options that are fully vested. |
| (10) | Includes (i) 421 shares of the Company’s Series C ESOP stock and (ii) 43,000 options that are fully vested. |
| (11) | Includes (i) 625 shares of the Company’s Series C ESOP stock and (ii) 71,800 options that are fully vested. |
| (12) | Includes (i) 1,000 shares and 237 stock units owned directly and (ii) 17,000 options that are fully vested. |
Ownership of Stock by Principal Owners
To the best of the Company’s knowledge and based on public reports filed with the Securities and Exchange Commission, the Company did not have any beneficial owners of five percent or more of the outstanding shares of the Company’s common stock as of February 22, 2005.
| ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS |
No items to be reported.
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| ITEM 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES |
Principal Accountant Fees and Services:
| Year Ended December 31 | ||||||
| 2004 | 2003 | |||||
| (Millions of Dollars) | ||||||
Audit fees(1) | $ | 8.7 | $ | 4.6 | ||
Audit-related fees(2) | 1.1 | 2.9 | ||||
Tax fees(3) | 6.4 | 5.5 | ||||
All other fees(4) | — | 0.2 | ||||
Total | $ | 16.2 | $ | 13.2 | ||
| (1) | Audit Fees: Services under this caption include consolidated financial statement audit fees, internal control over financial reporting audit fees, domestic subsidiary financial statement audit fees and international statutory audit fees. |
| (2) | Audit-related Fees: Services under this caption include accounting assistance, employee benefit plan audits and due diligence activities. |
| (3) | Tax Fees: Services under this caption include statutory compliance, transaction structuring, bankruptcy structuring, expatriate compliance and tax advisory services. |
| (4) | All Other Fees: Services under this caption include corporate advisory services in connection with the sale of certain businesses. |
Audit Committee’s Pre-Approval Policies and Procedures:
The Company’s independent accountants are directly accountable to the audit committee pursuant to its charter. Accordingly, the audit committee’s responsibilities include pre-approving the services of the independent accountant. The audit committee’s policy is to review and pre-approve all audit and permissible non-audit services, as deemed appropriate. For the year ended December 31, 2004, all audit, audit related, tax and other fees provided by the Company’s independent accountants were pre-approved by the audit committee.
Audit committee pre-approval is granted based upon the nature of the service and the related cost to provide such service. Pre-approval for services is generally not extended for periods in excess of one year. In assessing pre-approval requests, the audit committee considers whether such services are consistent with the auditor’s independence; whether the independent accountant may provide a higher quality or more efficient service based upon their understanding and familiarity with the Company’s business; and whether performing the service would enhance the independent accountant’s audit quality. The audit committee chairman may individually pre-approve such services between scheduled meetings of the audit committee up to a threshold of $200,000, provided that the full audit committee reviews and approves the service at the next scheduled meeting. Full Audit Committee pre-approval is required for proposed services in excess of $200,000.
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PART IV
| ITEM 15. | FINANCIAL STATEMENT SCHEDULE AND EXHIBITS |
(a) The following documents are filed as part of this report:
| 1. | Financial Statements |
Financial statements filed as part of this Annual Report on Form 10-K are listed under Part II, Item 8 hereof.
| 2. | Financial Statement Schedules |
Schedule II — Valuation and Qualifying Accounts
Financial Statements and Schedules Omitted
Schedules other than the schedule listed above are omitted because they are not required or applicable under instructions contained in Regulation S-X or because the information called for is shown in the financial statements and notes thereto.
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SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS
FEDERAL-MOGUL CORPORATION AND SUBSIDIARIES
Column A | Column B | Column C | Column D | Column E | ||||||||||
| Additions | ||||||||||||||
Description | Balance at Beginning of Period | Charged to Costs and Expenses | Charged to Other Accounts | Deductions | Balance at End of Period | |||||||||
| (Millions of Dollars) | ||||||||||||||
Year ended December 31, 2004: | ||||||||||||||
Valuation allowance for trade receivables | $ | 67.4 | (1.4 | ) | — | 8.1 | (1) | $ | 57.9 | |||||
Reserve for inventory valuation | 67.8 | 4.2 | — | 1.3 | (2) | 70.7 | ||||||||
Valuation allowance for deferred tax assets | 892.3 | 230.6 | — | — | 1,122.9 | |||||||||
Year ended December 31, 2003 | ||||||||||||||
Valuation allowance for trade receivables | $ | 74.6 | 14.4 | — | 21.6 | (1) | $ | 67.4 | ||||||
Reserve for inventory valuation | 68.1 | 13.2 | — | 13.5 | (2) | 67.8 | ||||||||
Valuation allowance for deferred tax assets | 722.5 | 169.8 | — | — | 892.3 | |||||||||
Year ended December 31, 2002: | ||||||||||||||
Valuation allowance for trade receivables | $ | 61.3 | 13.6 | — | 0.3 | (1) | $ | 74.6 | ||||||
Reserve for inventory valuation | 49.8 | 20.6 | — | 2.3 | (2) | 68.1 | ||||||||
Valuation allowance for deferred tax assets | 496.8 | 225.7 | — | — | 722.5 | |||||||||
| (1) | Uncollectable accounts charged off net of recoveries. |
| (2) | Obsolete inventory charged off. |
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15(b). Exhibits
The Company will furnish upon request any of the following exhibits upon payment of the Company’s reasonable expenses for furnishing such exhibit.
| 2.1 | Purchase and Sale Agreement between Cooper Industries, Inc. and Federal-Mogul Corporation, dated August 17, 1998. (Incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed October 26, 1998.) | |
| 3.1 | The Company’s Restated Articles of Incorporation. (Incorporated by reference to Exhibit 3.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 1999. (the “1999 10-K”) | |
| 3.2 | The Company’s Bylaws, as amended. (Incorporated by reference to Exhibit 3.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001. (the “2002 10-K”) | |
| 4.1 | Rights Agreement dated as of February 24, 1999, between the Company and The Bank of New York, as Rights Agent. (Incorporated by reference to Exhibit 4 to the Company’s Current Report on Form 8-K filed February 25, 1999.) | |
| 4.2 | Purchase Agreement for 10,000,000 Trust Convertible Preferred Securities of Federal-Mogul Financing Trust, dated as of November 24, 1997. (Incorporated by reference to Exhibit 4.6 to the Company’s Annual Report on Form 10-K for the year ended December 31, 1997. (the “1997 10-K”) | |
| 4.3 | Registration Rights Agreement, dated as of December 1, 1997, by and among the Company, Federal-Mogul Financing Trust and Morgan Stanley & Co. Inc. as Initial Purchaser. (Incorporated by reference to Exhibit 4.7 to the Company’s 1997 10-K.) | |
| 4.4 | Indenture between Federal-Mogul Corporation and The Bank of New York, dated as of December 1, 1997, with respect to the Subordinated Debentures. (Incorporated by reference to Exhibit 4.8 to the Company’s 1997 10-K.) | |
| 4.5 | First Supplemental Indenture dated as of December 1, 1999 to the Indenture between Federal-Mogul Corporation and The Bank of New York, dated as of December 1, 1997, with respect to the Subordinated Debentures. (Incorporated by reference to Exhibit 4.9 to the Company’s 1997 10-K.) | |
| 4.6 | Indenture among Federal-Mogul Corporation and The Bank of New York, dated as of January 20, 1999. (Incorporated by reference to Exhibit 4.8 to the Company’s Annual Report on Form 10-K for the year ended December 31, 1998. | |
| 4.7 | First Supplemental Indenture dated as of December 29, 2000 to the Indenture dated as of January 20, 1999 among Federal-Mogul Corporation, certain subsidiaries as guarantors and The Bank of New York, as trustee. (Incorporated by reference to Exhibit 4.3 to the Company’s January 17, 2001 8-K.) | |
| 4.8 | Indenture among Federal-Mogul Corporation and Continental Bank, dated as of August 12, 1994. (Incorporated by reference to Exhibit 4.14 to the Company’s Current Report on Form 8-K filed August 19, 1994.) | |
| 4.9 | First Supplemental Indenture dated as of July 8, 1998 to the Indenture dated as of August 12, 1994 among Federal-Mogul Corporation, certain subsidiaries as guarantors, and U.S. Bank Trust National Association (as successor to Continental Bank), as trustee. (Incorporated by reference to Exhibit 4.9 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2000 (the “2000 10-K”.) | |
| 4.10 | Second Supplemental Indenture dated as of October 9, 1998 to the Indenture dated as of August 12, 1994 among Federal-Mogul Corporation, certain subsidiaries as guarantors, and U.S. Bank Trust National Association (as successor to Continental Bank), as trustee. (Incorporated by reference to Exhibit 4.10 to the Company’s 2000 10-K.) | |
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| 4.11 | Third Supplemental Indenture dated as of December 29, 2000 to the Indenture dated as of August 12, 1994 among Federal-Mogul Corporation, certain subsidiaries as guarantors, and U.S. Bank Trust National Association (as successor to Continental Bank), as trustee. (Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed January 17, 2001 (the “January 17, 2001 8-K”). | |
| 4.12 | Indenture among Federal-Mogul Corporation and The Bank of New York, dated as of June 29, 1998. (Incorporated by reference to Exhibit 4.8 to the Company’s 1999 10-K.) | |
| 4.13 | First Supplemental Indenture dated as of June 30, 1998 to the Indenture dated as of June 29, 1998 among Federal-Mogul Corporation and The Bank of New York. (Incorporated by reference to Exhibit 4.9 to the Company’s 1999 10-K.) | |
| 4.14 | Second Supplemental Indenture dated as of July 21, 1998 to the Indenture dated as of June 29, 1998 among Federal-Mogul Corporation and The Bank of New York. (Incorporated by reference to Exhibit 4.14 to the Company’s 2000 10-K.) | |
| 4.15 | Third Supplemental Indenture dated as of October 9, 1998 to the Indenture dated as of June 29, 1998 among Federal-Mogul Corporation and The Bank of New York. (Incorporated by reference to Exhibit 4.15 to the Company’s 2000 10-K.) | |
| 4.16 | Fourth Supplemental Indenture dated as of December 29, 2000 to the Indenture dated as of June 29, 1998 among Federal-Mogul Corporation, certain subsidiaries as guarantors and The Bank of New York, as trustee. (Incorporated by reference to Exhibit 4.2 to the Company’s January 17, 2001 8-K.) | |
| 10.1 | Federal-Mogul Corporation 1997 Amended and Restated Long-Term Incentive Plan, as adopted by the Shareholders of the Company on May 20, 1998. (Incorporated by reference to the Company’s 1998 Definitive Proxy Statement on Form 14A.) | |
| 10.2 | Amended and Restated Deferred Compensation Plan for Corporate Directors. (Incorporated by reference to Exhibit 10.7 to the Company’s Annual Report on Form 10-K for the year ended December 31, 1990 (the “1990 10-K”.) | |
| 10.3 | Supplemental Executive Retirement Plan, as amended. (Incorporated by reference to Exhibit 10.10 to the Company’s 1992 10-K.) | |
| 10.4 | Description of Umbrella Excess Liability Insurance for the Senior Management Team. (Incorporated by reference to Exhibit 10.11 to the Company’s 1990 10-K.) | |
| 10.5 | Amended and Restated Declaration of Trust of Federal-Mogul Financing Trust, dated as of December 1, 1997. (Incorporated by reference to Exhibit 10.34 to the Company’s 1997 10-K.) | |
| 10.6 | Amended and Restated Revolving Credit, Term Loan and Guaranty Agreement dated August 7, 2003 by and among the Company and certain of its subsidiaries, Debtors and Debtors-in-Possession under Chapter 11 of the Bankruptcy Code, as Borrowers, and The Lenders Party Hereto, and JPMorgan Chase Bank, formerly known as The Chase Manhattan Bank, as Administrative Agent (Incorporated by reference to Exhibit 10.6 to the Company’s 2003 10-K.) | |
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| 10.7 | Fourth Amended and Restated Credit Agreement dated as of December 29, 2000 among the Company, certain foreign subsidiaries, certain banks and other financial institutions and The Chase Manhattan Bank, as administrative agent. (Incorporated by reference to Exhibit 10.1 to the Company’s January 17, 2001 8-K.) | |
| 10.8 | Amended and Restated Domestic Subsidiary Guarantee dated as of December 29, 2000 by certain subsidiaries of the Company in favor of The Chase Manhattan Bank, as administrative agent. (Incorporated by reference to Exhibit 10.2 to the Company’s January 17, 2001 8-K.) | |
| 10.9 | Guarantee by F-M UK Holding Limited in favor of The Chase Manhattan Bank, as administrative agent. (Incorporated by reference to Exhibit 10.3 to the Company’s January 17, 2001 8-K.) | |
| 10.10 | Trust Agreement dated as of December 29, 2000 among the Company, certain subsidiaries and Wilmington Trust Company, as trustee. (Incorporated by reference to Exhibit 10.4 to the Company’s January 17, 2001 8-K.) | |
| 10.11 | Second Amended and Restated Trust Agreement dated as of December 29, 2000 among the Company, certain subsidiaries and First Union National Bank, as trustee. (Incorporated by reference to Exhibit 10.5 to the Company’s January 17, 2001 8-K.) | |
| 10.12 | Second Amended and Restated Trust Agreement dated as of December 29, 2000 among the Company, certain subsidiaries and ABN AMRO Trust Company (Jersey) Limited, as trustee, (Incorporated by reference to Exhibit 10.6 to the Company’s January 17, 2001 8-K.) | |
| 10.13 | Second Amended and Restated Domestic Pledge Agreement among the Company and certain subsidiaries in favor of First Union National Bank, as trustee. (Incorporated by reference to Exhibit 10.7 to the Company’s January 17, 2001 8-K.) | |
| 10.14 | Security Agreement dated as of December 29, 2000 by the Company and certain subsidiaries in favor of Wilmington Trust Company, as trustee. (Incorporated by reference to Exhibit 10.8 to the Company’s January 17, 2001 8-K.) | |
| 10.15 | Form of Mortgage or Deed of Trust prepared for execution by the Company or any applicable subsidiaries. (Incorporated by reference to Exhibit 10.9 to the Company’s January 17, 2001 8-K.) | |
| 10.16 | Contract of Indemnity dated as of December 29, 2000 by the Company and certain subsidiaries with respect to a surety bond issued by Travelers Casualty & Surety Company of America. (Incorporated by reference to Exhibit 10.10 to the Company’s January 17, 2001 8-K.) | |
| 10.17 | Contract of Indemnity dated as of December 29, 2000 by the Company and certain subsidiaries with respect to a surety bond issued by Travelers Casualty & Surety Company of America. (Incorporated by reference to Exhibit 10.11 to the Company’s January 17, 2001 8-K.) | |
| 10.18 | Contract of Indemnity dated as of December 29, 2000 by the Company and certain subsidiaries with respect to a surety bond issued by SAFECO Insurance Company of America. (Incorporated by reference to Exhibit 10.12 to the Company’s January 17, 2001 8-K.) | |
| 10.19 | Contract of Indemnity dated as of December 29, 2000 by the Company and certain subsidiaries with respect to a surety bond issued by National Fire Insurance Company of Hartford and Continental Casualty Company. (Incorporated by reference to Exhibit 10.13 to the Company’s January 17, 2001 8-K.) | |
| 10.20 | Amended and Restated Federal-Mogul Supplemental Key Executive Pension Plan dated January 1, 1999 and Restated February 2004 (Incorporated by reference to Exhibit 10.20 to the Company’s 2003 10-K.) | |
| 10.21 | Master Services Agreement for Finance & Accounting Services dated September 30, 2004 between the Company and International Business Machines Corporations (Incorporated by reference to Exhibit 10.25 to the Company’s October 29, 2004 10-Q.) | |
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| *10.22 | Revolving Credit and Guaranty Agreement dated as of December 9, 2004 among the Company, certain of its subsidiaries, certain banks and other financial institutions and Citicorp USA, Inc., as administrative agent. | |
| *10.23 | Security and Pledge Agreement dated as of December 9, 2004 by the Company and certain subsidiaries in favor of Citicorp USA, Inc. as administrative agent. | |
| *21 | Subsidiaries of the Registrant. | |
| *23 | Consent of Ernst & Young LLP. | |
| *24 | Powers of Attorney. | |
| *31.1 | Certification by the Company’s Chief Executive Officer pursuant to Rule 13a-14 | |
| *31.2 | Certification by the Company’s Chief Financial Officer pursuant to Rule 13a-14 | |
| *32 | Certification by the Company’s Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 and Rule 13a-14(b) | |
| * | Filed Herewith |
15(c). Separate financial statements of affiliates whose securities are pledged as collateral.
| 1) | Financial statements of Federal-Mogul Products, Inc. and subsidiaries including consolidated balance sheets as of December 31, 2004 and 2003, and the related statements of operations and cash flows for each of the three years in the period ended December 31, 2004. |
| 2) | Financial statements of Federal-Mogul Ignition Company and subsidiaries including consolidated balance sheets as of December 31, 2004 and 2003, and the related statements of operations and comprehensive income and cash flows for each of the three years in the period ended December 31, 2004. |
| 3) | Financial statements of Federal-Mogul Powertrain, Inc. and subsidiaries including consolidated balance sheets as of December 31, 2004 and 2003, and the related statements of operations and cash flows for each of the three years in the period ended December 31, 2004. |
| 4) | Financial statements of Federal-Mogul Piston Rings, Inc. and subsidiaries including consolidated balance sheets as of December 31, 2004 and 2003, and the related statements of operations and cash flows for each of the three years in the period ended December 31, 2004. |
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
Federal-Mogul Corporation
We have audited the accompanying consolidated balance sheets of Federal-Mogul Products, Inc. and subsidiaries, a wholly-owned subsidiary of Federal-Mogul Corporation, as of December 31, 2004 and 2003 and the related consolidated statements of operations and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Federal-Mogul Products, Inc. and subsidiaries at December 31, 2004 and 2003, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with U.S. generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming that Federal-Mogul Products, Inc. and subsidiaries will continue as a going concern. As more fully described in the notes to the consolidated financial statements, on October 1, 2001, Federal-Mogul Corporation and its wholly-owned United States subsidiaries, which includes Federal-Mogul Products, Inc., filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy Code. Uncertainties inherent in the bankruptcy process raise substantial doubt about Federal-Mogul Products, Inc.’s ability to continue as a going concern. Management’s intentions with respect to these matters are also described in the notes. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
As discussed in Note 5 to the consolidated financial statements, Federal-Mogul Products, Inc. changed its method of accounting for goodwill and indefinite-lived intangible assets in 2002.
/s/ ERNST & YOUNG LLP |
Detroit, Michigan |
February 25, 2005 |
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CONSOLIDATED STATEMENTS OF OPERATIONS
| Year Ended December 31 | |||||||||||
| 2004 | 2003 | 2002 | |||||||||
| (Millions of Dollars) | |||||||||||
Third party sales | $ | 707.8 | $ | 648.9 | $ | 600.2 | |||||
Affiliate sales | 103.5 | 91.8 | 63.7 | ||||||||
Total net sales | 811.3 | 740.7 | 663.9 | ||||||||
Cost of products sold | 633.0 | 588.5 | 545.9 | ||||||||
Gross margin | 178.3 | 152.2 | 118.0 | ||||||||
Selling, general and administrative expenses | 110.2 | 103.4 | 87.9 | ||||||||
Gain on involuntary conversion | (46.1 | ) | — | — | |||||||
Other expense, net | 16.5 | 11.1 | 12.9 | ||||||||
Earnings before income taxes and cumulative effect of change in accounting principle | 97.7 | 37.7 | 17.2 | ||||||||
Income tax expense | 10.3 | — | 15.0 | ||||||||
Earnings before cumulative effect of change in accounting principle | 87.4 | 37.7 | 2.2 | ||||||||
Cumulative effect of change in accounting principle, net of applicable income tax benefit | — | — | (437.0 | ) | |||||||
Net Income (Loss) | $ | 87.4 | $ | 37.7 | $ | (434.8 | ) | ||||
See accompanying notes to consolidated financial statements.
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FEDERAL-MOGUL PRODUCTS, INC.
CONSOLIDATED BALANCE SHEETS
| December 31 | ||||||||
| 2004 | 2003 | |||||||
| (Millions of Dollars) | ||||||||
| ASSETS | ||||||||
Current Assets: | ||||||||
Accounts receivable, net | $ | 124.3 | $ | 120.1 | ||||
Inventories, net | 166.4 | 146.4 | ||||||
Other | 14.7 | 12.3 | ||||||
Total Current Assets | 305.4 | 278.8 | ||||||
Property, plant and equipment, net | 246.2 | 258.2 | ||||||
Definite-lived intangible assets, net | 49.8 | 52.6 | ||||||
Asbestos-related insurance recoverable | 166.1 | 169.3 | ||||||
Other noncurrent assets | 13.1 | 16.3 | ||||||
| $ | 780.6 | $ | 775.2 | |||||
| LIABILITIES AND NET PARENT INVESTMENT | ||||||||
Current Liabilities: | ||||||||
Accounts payable | $ | 44.4 | $ | 22.0 | ||||
Accrued compensation | 7.8 | 10.1 | ||||||
Accrued rebates | 7.1 | 6.6 | ||||||
Other accrued liabilities | 18.3 | 17.1 | ||||||
Total Current Liabilities | 77.6 | 55.8 | ||||||
Liabilities subject to compromise | 776.8 | 778.2 | ||||||
Other long-term liabilities | 2.7 | 3.8 | ||||||
Net Parent Investment | (76.5 | ) | (62.6 | ) | ||||
| $ | 780.6 | $ | 775.2 | |||||
See accompanying notes to consolidated financial statements.
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CONSOLIDATED STATEMENTS OF CASH FLOWS
| Year Ended December 31 | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| (Millions of Dollars) | ||||||||||||
Cash Provided From (Used By) Operating Activities | ||||||||||||
Net income (loss) | $ | 87.4 | $ | 37.7 | $ | (434.8 | ) | |||||
Adjustments to reconcile net income (loss) to net cash provided from (used by) operating activities: | ||||||||||||
Cumulative effect of change in accounting principle | — | — | 447.8 | |||||||||
Depreciation and amortization | 30.8 | 28.9 | 30.7 | |||||||||
Payments against restructuring reserves | — | (3.8 | ) | (1.9 | ) | |||||||
Gain on involuntary conversion | (46.1 | ) | — | — | ||||||||
Insurance proceeds | 102.2 | — | — | |||||||||
(Increase) decrease in accounts receivable | (4.2 | ) | (27.0 | ) | 6.2 | |||||||
(Increase) decrease in inventories | (76.1 | ) | 31.4 | (38.0 | ) | |||||||
Increase (decrease) in accounts payable | 22.4 | (8.3 | ) | 5.2 | ||||||||
Decrease in liabilities subject to compromise | (1.4 | ) | (1.9 | ) | (9.5 | ) | ||||||
Changes in other assets and liabilities | 17.9 | 8.2 | 12.6 | |||||||||
Net Cash Provided From Operating Activities | 132.9 | 65.2 | 18.3 | |||||||||
Cash Used By Investing Activities | ||||||||||||
Expenditures for property, plant and equipment | (31.6 | ) | (41.6 | ) | (39.9 | ) | ||||||
Net Cash Used By Investing Activities | (31.6 | ) | (41.6 | ) | (39.9 | ) | ||||||
Cash Provided From (Used By) Financing Activities | ||||||||||||
Transfers (to) from parent | (101.3 | ) | (23.6 | ) | 21.6 | |||||||
Net Cash (Used By) Provided From Financing Activities | (101.3 | ) | (23.6 | ) | 21.6 | |||||||
Net change in cash | — | — | — | |||||||||
Cash at beginning of year | — | — | — | |||||||||
Cash at end of year | $ | — | $ | — | $ | — | ||||||
See accompanying notes to consolidated financial statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation and Summary of Significant Accounting Policies
The accompanying financial statements reflect the consolidated assets, liabilities and operations of Federal-Mogul Products, Inc. and subsidiaries (“Products”). Products is a wholly-owned subsidiary of Federal-Mogul Corporation (“Federal-Mogul”). Products manufactures friction products, including various brake pads and linings, and chassis products.
Products operates with financial and operational staff on a decentralized basis. Federal-Mogul provides certain centralized services for employee benefits administration, cash management, risk management, legal services, public relations, domestic tax reporting and internal and external audit. Federal-Mogul charges Products for all such direct expenses incurred on its behalf. General expenses, excluding Chapter 11 and Administration related reorganization expenses, that are not directly attributable to the operations of Products have been allocated based on management’s estimates, primarily driven by sales. Management believes that this allocation method is reasonable.
The accompanying consolidated financial statements are presented as if Products had existed as an entity separate from its parent during the periods presented and include the assets, liabilities, revenues and expenses that are directly related to Products’ operations.
Products’ separate debt and related interest expense have been included in the consolidated financial statements. Products is fully integrated into its parent’s cash management system and, as such, all cash requirements are provided by its parent and any excess cash generated by Products is transferred to its parent.
Principles of Consolidation:The consolidated financial statements include the accounts of Products and all majority-owned subsidiaries and other controlled entities. Intercompany accounts and transactions have been eliminated in consolidation. Investment in affiliates of not more than 20% are accounted for using the cost method.
Use of Estimates:The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported therein. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may be based upon amounts that differ from these estimates.
Trade Accounts Receivable and Allowance for Doubtful Accounts:Trade accounts receivable are stated at historical value, which approximates fair value. Products does not generally require collateral for its trade accounts receivable.
Accounts receivable have been reduced by an allowance for amounts that may become uncollectible in the future. This estimated allowance is based primarily on management’s evaluation of specific balances as the balances become past due, the financial condition of its customers and Product’s historical experience of write-offs. If not reserved through specific examination procedures, Product’s general policy for uncollectible accounts is to reserve based upon the aging categories of accounts receivable and upon whether the amounts are due from an OE customer or Aftermarket customer. Past due status is based upon the invoice date of the original amounts outstanding. The allowance for doubtful accounts was $6.9 million and $9.3 million at December 31, 2004 and 2003, respectively.
Inventories:Inventories are stated at the lower of cost or market. Cost is determined using the last-in, first-out method (“LIFO”). If inventories had been valued at current cost, amounts reported would have been increased by $15.4 million and $6.9 million as of December 31, 2004 and 2003, respectively. Inventories have also been reduced by an allowance for excess and obsolete inventories based on management’s review of on-hand inventories compared to estimated future sales and usage.
Long-Lived Assets:Long-lived assets, such as property, plant and equipment and definite-lived intangible assets, are stated at cost. Depreciation and amortization is computed principally by the straight-line method for financial reporting purposes and by accelerated methods for income tax purposes. Definite-lived assets are periodically reviewed for impairment indicators. If impairment indicators exist, Products performs the required analysis and records an impairment charge, as required, in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS No. 144). If the carrying value of a long-lived asset is considered impaired, an impairment charge is recorded for the amount by which the carrying value of the long-lived asset exceeds its fair value.
Revenue Recognition:Products records sales when products are shipped and title has transferred to the customer, the sales price is fixed or determinable, and the collectibility of revenue is reasonably assured. Affiliate sales are transferred at cost. Accruals for sales returns and other allowances are provided at the time of shipment based upon past experience. Adjustments to such returns and allowances are made as new information becomes available.
Shipping and Handling Costs:Products recognizes shipping and handling costs as a component of cost of products sold in the statement of operations.
Recoverable Customer Engineering and Tooling:Pre-production tooling and engineering costs that Products will not own and that will be used in producing products under long-term supply arrangements are expensed as incurred unless the supply arrangement provides Products the non-cancelable right to use the tools or the reimbursement of such costs is agreed to by the customer. Pre-production tooling and engineering costs that are owned by Products are capitalized as part of machinery and equipment, and are depreciated over the shorter of the toolings’ expected life or the duration of the related program.
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Research and Development Costs: Products expenses research and development costs as incurred. Research and development expense for 2004, 2003 and 2002 was $13.5 million, $11.4 million and $6.2 million, respectively.
Restructuring:Products defines restructuring expense to include charges incurred with exit or disposal activities accounted for in accordance with SFAS No. 146, employee severance costs incurred as a result of an exit or disposal activity accounted for in accordance with SFAS Nos. 88 and 112, and pension and other postemployment benefit costs incurred as a result of an exit or disposal activity accounted for in accordance with SFAS Nos. 87 and 106.
Rebates/Sales Incentives:Products accrues for rebates pursuant to specific arrangements with certain of its customers, primarily in the aftermarket. Rebates generally provide for price reductions based upon the achievement of specified purchase volumes and are recorded as a reduction of sales as they are earned by such customers.
Fair Value of Financial Instruments:The carrying amounts of certain financial instruments such as accounts payable approximate their fair value.
Net Parent Investment: The Net Parent Investment account reflects the balance of Products’ historical earnings, intercompany amounts, income taxes accrued and deferred, postemployment liabilities and other transactions between Products and Federal-Mogul.
Reclassifications:Certain items in the prior years financial statements have been reclassified to conform with the presentation used in 2004.
2. Voluntary Reorganization Under Chapter 11 and Administration
On October 1, 2001 (the “Petition Date”), Federal-Mogul Corporation (the “Company” or “Federal-Mogul”) and all of its wholly-owned United States subsidiaries filed voluntary petitions for reorganization (the “U.S. Restructuring”) under Chapter 11 of the United States Bankruptcy Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”). Also on October 1, 2001, certain of the Company’s United Kingdom subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the Bankruptcy Code and petitions for Administration (the “U.K. Restructuring”) under the United Kingdom Insolvency Act of 1986 (the “Act”) in the High Court of Justice, Chancery division in London, England (the “High Court”). The Company and its U.S. and U.K. subsidiaries included in the U.S. Restructuring and U.K. Restructuring are herein referred to as the “Debtors”. The U.S. Restructuring and U.K. Restructuring are herein referred to as the “Restructuring Proceedings”. The Chapter 11 cases of the Debtors (collectively, the “Chapter 11 Cases”) have been consolidated for purposes of
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joint administration asIn re: Federal-Mogul Global Inc., T&N Limited, et. al (Case No. 01-10578(RTL)). Subsidiaries outside of the aforementioned U.S. and U.K. subsidiaries are not party to the Chapter 11 Cases and, therefore, are not currently provided protection from creditors by any bankruptcy court and are operating in the normal course.
The Restructuring Proceedings were initiated in response to a sharply increasing number of asbestos-related claims and their demand on the Company’s cash flows and liquidity. Under the Restructuring Proceedings, the Debtors expect to develop and implement a plan for addressing the asbestos-related claims against them.
Consequences of the Restructuring Proceedings
The U.S. Debtors, including Products, are operating their businesses as debtors-in-possession subject to the provisions of the Bankruptcy Code. The U.K. Debtors are continuing to manage their operations under the supervision of Administrators approved by the High Court. All vendors will be paid for all goods furnished and services provided after the Petition Date. However, as a consequence of the Restructuring Proceedings, pending litigation against the Debtors as of the Petition Date is stayed (subject to certain exceptions in the case of governmental authorities), and no party may take any action to pursue or collect pre-petition claims except pursuant to an order of the Bankruptcy Court or the High Court as applicable. It is the Debtors’ intention to address all pending and future asbestos-related claims and all other pre-petition claims through a unified plan of reorganization under the Bankruptcy Code or scheme of arrangement under the Act.
In the U.S., four committees, representing asbestos claimants, asbestos property damage claimants, unsecured creditors and equity security holders (collectively, the “Committees”) have been appointed as official committees in the Chapter 11 Cases and, in accordance with the provisions of the Bankruptcy Code, have the right to be heard on all matters that come before the Bankruptcy Court. The Committees, together with the legal representative for the future asbestos claimants, play important roles in the Restructuring Proceedings. In the U.K., the Administrators have appointed a creditors committee, representing both asbestos claimants and general unsecured creditors.
On June 4, 2004, the Third Amended Joint Plan of Reorganization (the “Plan”) for Federal-Mogul and the other U.S. and U.K. Debtors was filed with the Bankruptcy Court. The Plan was jointly proposed by Federal-Mogul, the Unsecured Creditors Committee, the Asbestos Claimants Committee, the Future Asbestos Claimants Representative, the Agent for the Prepetition Bank Lenders and the Equity Security Holders Committee (collectively referred to as the “Plan Proponents”). Also on June 4, 2004, a Disclosure Statement to be used in soliciting votes to accept or reject the Plan (the “Disclosure Statement”) was approved by the Bankruptcy Court and a December 2004 hearing was scheduled to determine whether the Bankruptcy Court should approve the Plan. On December 7, 2004, the Bankruptcy Court delayed this confirmation hearing pending a hearing to estimate asbestos personal injury claims against the U.K. Debtors. Such estimation hearing has not yet been scheduled.
On July 12, 2004, solicitation packages containing the Plan and Disclosure Statement, various supporting documents and a ballot, if appropriate, were mailed to known creditors of the Company and holders of common and preferred stock interests in the Company. All votes were due by the close of business on November 3, 2004. Although the Plan Proponents have granted extensions of the November 3, 2004 voting deadline to a few significant claimants, the voting agent has confirmed that the overwhelming majority of the classes of claims and interests have voted to accept the Plan. For the few classes of claims that voted to reject the Plan, the Plan Proponents intend to either amend the Plan so as to obtain such classes accepting votes or seek to confirm the Plan over the objection of such classes.
The Plan provides that asbestos personal injury claimants, both present and future, will be permanently channeled to a trust or series of trusts established pursuant to Section 524(g) of the Bankruptcy Code, thereby protecting Federal-Mogul and its affiliates in the Chapter 11 Cases from existing and future asbestos liability. Although certain issues remain to be resolved, the Plan provides that all currently outstanding stock of Federal-Mogul will be cancelled, and 50.1% of newly authorized and issued common stock of reorganized Federal-Mogul will be distributed to the asbestos trusts, and 49.9% of the newly authorized and issued common stock will be distributed pro rata to the noteholders. If the classes of holders of common and preferred stock of Federal-Mogul vote in favor of the Plan, the holders of currently outstanding common and preferred stock of Federal-Mogul will receive warrants that may be used to purchase shares of reorganized Federal-Mogul at a predetermined exercise price.
Unsecured creditors, including trade creditors, of the U.S. Debtors are projected to receive cash distributions under the Plan equal to 35% of their allowed claims, payable in three annual installments, provided that the aggregate of all allowed unsecured claims against the U.S. Debtors does not exceed $258 million. Any excess above this amount
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could result in a reduction in the percentage distribution that the unsecured creditors of the U.S. Debtors ultimately receive. Unsecured creditors, including trade creditors, of the U.K. Debtors will receive distributions that vary according to terms specified within the Plan and Disclosure Statement.
There are two possible types of U.K. schemes of arrangements. The first is under Section 425 of the Companies Act of 1985, which may involve a scheme for the reconstruction of the Company. If a majority in number representing three-fourths in value of the creditors or members or any class of them agree to the compromise or arrangement, it is binding if sanctioned by the High Court. Section 425 may be invoked where there is an Administration order in force in relation to the Company. The other possible type of scheme arises under Section 1 of the Insolvency Act of 1986 in relation to Company Voluntary Arrangements (“CVA”). If a majority in value representing more than three-fourths of the creditors agrees to the compromise or arrangement set out in the CVA proposal, it will be approved.
Products is unable to predict with a high degree of certainty at this time what treatment will be accorded under any such plan of reorganization to claims arising from intercompany indebtedness, licenses, executory contracts, transfers of goods and services, and other intercompany arrangements, transactions and relationships that were entered into prior to the Petition Date. Various parties in the Chapter 11 Cases may challenge these arrangements, transactions, and relationships, and the outcome of those challenges, if any, may have an impact on the treatment of various claims under such plan of reorganization.
The Bankruptcy Court may confirm a plan of reorganization only upon making certain findings required by the Bankruptcy Code, and a plan may be confirmed over the dissent of non-accepting creditors and equity security holders if certain requirements of the Bankruptcy Code are met. The payment rights and other entitlements of pre-petition creditors and equity security holders may be substantially altered by any plan of reorganization confirmed in the Chapter 11 Cases. There is no assurance that there will be sufficient assets to satisfy the Debtors’ pre-petition liabilities in whole or in part, and the pre-petition creditors of some Debtors may be treated differently than those of other Debtors.
Chapter 11 Financing
In connection with the Restructuring Proceedings, Federal-Mogul entered into a DIP credit facility to supplement liquidity and fund operations during the restructuring proceedings. In December 2004, Federal-Mogul renegotiated its DIP credit facility. Prior to December 2004, Federal-Mogul’s DIP credit facility had an interest rate of either the alternate base rate (“ABR”) plus 2 percentage points or a formula based on the London Inter-Bank Offered Rate (“LIBOR”) plus 3 percentage points. The ABR is the greater of either the bank’s prime rate or the base CD rate plus 1 percentage point or the federal funds rate plus ½ percentage point.
The December 2004 DIP credit facility expires in December 2005, and the interest rate is either the alternate base rate (“ABR”) plus 1¼ percentage points or a formula based on the London Inter-Bank Offered Rate (“LIBOR”) plus 2¼ percentage points. The ABR is the greater of either the bank’s base rate or the federal funds rate plus ½ percentage point. In addition, the commitment available under the DIP credit facility is mandatorily reduced by a portion of proceeds received from future asset or business divestitures.
Financial Statement Presentation
The accompanying consolidated financial statements have been prepared in accordance with AICPA Statement of Position 90-7 (“SOP 90-7”), “Financial Reporting by Entities in Reorganization under the Bankruptcy Code” and on a going concern basis, which contemplates continuity of operations and realization of assets and liquidation of liabilities in the ordinary course of business. However, as a result of the Restructuring Proceedings, such realization of assets and liquidation of liabilities, without substantial adjustments and/or changes of ownership, is highly uncertain. Given this uncertainty, there is substantial doubt about the ability of Products to continue as a going concern. While operating as debtors-in-possession under the protection of Chapter 11 of the Bankruptcy Code and Administration under the Act, and subject to approval of the Bankruptcy Court, Administrators or the High Court or
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otherwise as permitted in the ordinary course of business, Products may sell or otherwise dispose of assets and liquidate or settle liabilities for some amounts other than those reflected in the consolidated financial statements. Further, a plan of reorganization or scheme of arrangement could materially change the amounts and classifications in the historical consolidated financial statements.
As reflected in the consolidated financial statements, “Liabilities subject to compromise” refers to liabilities of entities of Products included in the Restructuring Proceedings incurred prior to the Petition Date. The amounts of the various liabilities that are subject to compromise are set forth below. These amounts represent Products’ estimate of known or potential pre-petition claims to be resolved in connection with the Restructuring Proceedings. Such claims remain subject to future adjustments. Future adjustments may result from (i) negotiations; (ii) actions of the Bankruptcy Court, High Court or Administrators; (iii) further developments with respect to disputed claims; (iv) rejection of executory contracts and unexpired leases; (v) the determination as to the value of any collateral securing claims; (vi) proofs of claim; or (vii) other events. Payment terms for these claims will be established in connection with the Restructuring Proceedings.
| December 31 | ||||||
| 2004 | 2003 | |||||
| (Millions of Dollars) | ||||||
Loans payable to affiliated companies | $ | 314.8 | $ | 314.8 | ||
Asbestos liabilities | 213.6 | 214.5 | ||||
Accounts payable to affiliated companies | 164.1 | 164.1 | ||||
Accounts payable | 56.6 | 57.3 | ||||
Interest payable to affiliated companies | 27.3 | 27.3 | ||||
Environmental liabilities | 0.4 | 0.2 | ||||
Total | $ | 776.8 | $ | 778.2 | ||
The Debtors, including Products, have received approval from the Bankruptcy Court to pay or otherwise honor certain of their pre-petition obligations, including employee wages, salaries, benefits and other employee obligations and from limited available funds, pre-petition claims of certain critical vendors, certain customer programs and warranty claims and certain other pre-petition claims.
Pursuant to the Bankruptcy Code, Federal-Mogul has filed schedules with the Bankruptcy Court setting forth the assets and liabilities of the Debtors as of the Petition Date. On October 4, 2002, the Debtors issued approximately 100,000 proof of claim forms to its current and prior employees, known creditors, vendors and other parties with whom the Debtors have previously conducted business. To the extent that recipients disagree with the claims as quantified on these forms, the recipient may file discrepancies with the Bankruptcy Court. Differences between amounts recorded by the Debtors and claims filed by creditors will be investigated and resolved as part of the Restructuring Proceedings. The Bankruptcy Court ultimately will determine liability amounts that will be allowed for these claims in the Chapter 11 Cases. A March 3, 2003 bar date was set for the filing of proofs of claim against the Debtors. Because the Debtors have not completed evaluation of the claims received in connection with this process, the ultimate number and allowed amount of such claims are not presently known. The resolution of such claims could result in a material adjustment to the Company’s financial statements.
The Debtors, including Products, continue to review and analyze the proofs of claim filed to date. In addition, the Debtors continue to file objections and seek stipulations to certain claims. Additional claims may be filed after the general bar date, which could be allowed by the Bankruptcy Court. Accordingly, the ultimate number and allowed amount of such claims are not presently known and cannot be reasonably estimated at this time. The resolution of such claims could result in a material adjustment to the Company’s financial statements.
The appropriateness of using the going concern basis for the Products’ financial statements is dependent upon, among other things: (i) Federal-Mogul’s ability to comply with the terms of the DIP credit facility and any cash management order entered by the Bankruptcy Court in connection with the Chapter 11 Cases; (ii) the ability of Federal-Mogul to maintain adequate cash on hand; (iii) the ability of Federal-Mogul to generate cash from operations; (iv) confirmation of a plan(s) of reorganization under the Bankruptcy Code; (v) confirmation of a
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scheme(s) of arrangement in the U.K. under Administration; and (vi) Federal-Mogul’s ability to achieve profitability following such confirmations.
3. Inventory
Inventories consisted of the following:
| December 31 | ||||||||
| 2004 | 2003 | |||||||
| (Millions of Dollars) | ||||||||
Raw materials | $ | 36.8 | $ | 38.4 | ||||
Work-in-process | 19.1 | 18.4 | ||||||
Finished goods | 122.2 | 109.4 | ||||||
| 178.1 | 166.2 | |||||||
Valuation reserves | (11.7 | ) | (19.8 | ) | ||||
| $ | 166.4 | $ | 146.4 | |||||
4. Property, Plant and Equipment
Property, plant and equipment consisted of the following:
Estimated Useful Life | December 31 | |||||||||
| 2004 | 2003 | |||||||||
| (Millions of Dollars) | ||||||||||
Land | — | $ | 4.8 | $ | 6.4 | |||||
Buildings and building improvements | 24-40 years | 52.2 | 68.3 | |||||||
Machinery and equipment | 3-12 years | 273.1 | 261.6 | |||||||
| 330.1 | 336.3 | |||||||||
Accumulated depreciation | (83.9 | ) | (78.1 | ) | ||||||
| $ | 246.2 | $ | 258.2 | |||||||
Future minimum payments under noncancelable operating leases with initial or remaining terms of more than one year are as follows, in millions of dollars:
2005 | $ | 0.2 | |
2006 | 0.2 | ||
2007 | 0.2 | ||
2008 | 0.2 | ||
2009 | 0.5 |
Total rental expense under operating leases for the years ended December 31, 2004, 2003 and 2002 was $8.9 million, $7.8 million and $8.9 million, respectively, exclusive of property taxes, insurance and other occupancy costs generally payable by Federal-Mogul.
5. Goodwill and Other Intangible Assets
Effective January 1, 2002, Products adopted SFAS No. 142, resulting in the discontinuance of amortization of goodwill and indefinite-lived intangible assets. The adoption of this standard also required the reclassification of various intangible asset classes according to the measurability of their useful lives. Upon the adoption of SFAS No. 142, Products recorded a non-cash charge of $437.0 million to reduce the carrying value of its goodwill and
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indefinite-lived intangible assets to their estimated fair value as required by SFAS No. 142. The tax impact related to the charge was $10.8 million and was limited to the benefit derived from the impairment of certain intangible assets other than goodwill. The charge is presented as a cumulative effect of change in accounting principle in the consolidated statement of operations for the year ended December 31, 2002.
At December 31, 2004 and 2003, other intangible assets consists of the following:
| December 31, 2004 | December 31, 2003 | |||||||||||||||||||
Gross Amount | Accumulated Amortization | Net Carrying Amount | Gross Amount | Accumulated Amortization | Net Carrying Amount | |||||||||||||||
| (Millions of Dollars) | ||||||||||||||||||||
Definite-Lived Intangible Assets | ||||||||||||||||||||
Developed technology | $ | 67.2 | $ | (17.4 | ) | $ | 49.8 | $ | 67.2 | $ | (14.6 | ) | $ | 52.6 | ||||||
Products expects that amortization expense for its amortizable intangible assets for each of the years between 2005 and 2009 will be approximately $3 million.
6. Restructuring Charges
In 2000, Products recognized a $17.8 million restructuring charge related to severance and exit costs. Employee severance costs of $13.9 million and exit costs of $3.9 million resulted primarily from the planned reorganization of the America’s friction business. Cash payments made during 2003 and 2002 against these reserves were $3.8 million and $1.9 million, respectively. This reorganization was completed during 2003 and the remaining reserves of $5.9 million were reversed and are included in the statement of operations within “other expense, net”.
7. Commitments and Contingencies
Abex and Wagner Asbestos Litigation
Background
Two of Products’ businesses formerly owned by Cooper Industries, Inc., known as Abex and Wagner, are involved as defendants in numerous court actions in the U.S. alleging personal injury from exposure to asbestos or asbestos-containing products. These claims mainly involve friction products. As of the Petition Date, Abex and Wagner were defendants in approximately 66,000 and 33,000 pending claims, respectively. As a result of the Restructuring Proceedings, Products includes as a pending claim open served claims, settled but not documented claims and settled but not paid claims. Notices of complaints continue to be received post-petition and are in violation of the automatic stay.
The liability of Products with respect to claims alleging exposure to Wagner products arises from the 1998 stock purchase from Cooper Industries, Inc. of the corporate successor by merger to Wagner Electric Company; the purchased entity is now a wholly-owned subsidiary of Federal-Mogul and one of the Debtors in the Restructuring Proceedings. As a consequence, all claims against the Debtors, including asbestos-related claims, have been stayed.
The liability of Products with respect to claims alleging exposure to Abex products arises from a contractual liability entered into in 1994 by the predecessor to Products whose stock Federal-Mogul purchased in 1998. Pursuant to that contract, prior to the Restructuring Proceedings, Products was liable for certain indemnity and defense payments incurred on behalf of an entity known as Pneumo Abex Corporation, the successor in interest to Abex Corporation. Effective as of the Petition Date, Products has ceased making such payments and is currently considering whether to accept or reject the 1994 contractual liability.
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As mentioned above, as of the Petition Date, pending asbestos litigation of Abex (as to Federal-Mogul only) and Wagner is stayed (subject to certain exceptions in the case of governmental authorities), and no party may take action to pursue or collect on such asbestos claims absent specific authorization of the Bankruptcy Court or the High Court.
Recorded Liability
The liability (comprised of $129.5 million in Abex liabilities and $84.1 million in Wagner liabilities as of December 31, 2004) represented Products’ estimate prior to the Restructuring Proceedings for claims currently pending and those which were reasonably estimated to be asserted and paid through 2012. Products did not provide a liability for claims that may be brought subsequent to this period as it could not reasonably estimate such claims. In estimating the liability prior to the Restructuring Proceedings, Products made assumptions regarding the total number of claims anticipated to be received in a future period, the typical cost of settlement (which is sensitive to the industry in which the plaintiff claims exposure, the alleged disease type and the jurisdiction in which the action is being brought), the rate of receipt of claims, the settlement strategy in dealing with outstanding claims and the timing of settlements.
As a result of the Restructuring Proceedings, pending asbestos-related litigation is stayed.
While Products believes that the liability recorded was appropriate as of October 1, 2001 for anticipated losses arising from asbestos-related claims related to Abex and Wagner through 2012, it is Products’ view that, as a result of the Restructuring Proceedings, there is even greater uncertainty in estimating the timing and amount of future asbestos liability and related insurance recovery for pending and future claims. There are significant differences in the treatment of asbestos claims in a bankruptcy proceeding as compared to the tort litigation system. Among other things, it is uncertain at this time as to the number of asbestos-related claims that will be filed in the proceeding, the number of future claims that will be included in a plan of reorganization, how claims for punitive damages and claims by persons with no asbestos-related physical impairment will be treated and whether such claims will be allowed, and the impact historical settlement values for asbestos claims may have on the estimation of asbestos liability in the Restructuring Proceedings.
No assurance can be given that Products will not be subject to material additional liabilities and significant additional litigation relating to Abex and Wagner asbestos matters through 2012 or thereafter. In the event that such liabilities exceed the amounts recorded by Products or the remaining insurance coverage, Products’ results of operations and financial condition could be materially affected.
Insurance Recoverable
Abex maintained product liability insurance coverage for most of the time that it manufactured products that contained asbestos. This coverage is shared with other third-party companies. Products may be liable for certain indemnity and defense payments with respect to Abex has the benefit of that insurance up to the extent of that liability. Abex has been in litigation since 1982 with the insurance carriers of its primary layer of liability concerning coverage for asbestos claims. Abex also has substantial excess layer liability insurance coverage that is shared with other companies that, barring unforeseen insolvencies of excess carriers or other adverse events, should provide coverage for asbestos claims against Abex. The Abex insurance recoverable was $112.6 million as of December 31, 2004.
Wagner also maintained product liability insurance coverage for some of the time that it manufactured products that contained asbestos. This coverage is shared with other third-party companies. One of the companies, Dresser Industries, Inc. (“Dresser”) initiated an adversary action against the Debtors and a number of insurance carriers in Federal-Mogul’s Restructuring Proceedings. In its complaint, Dresser alleged that it has rights under certain primary and excess general liability insurance policies that may be shared with Products as the successor to Wagner Electric Corporation. Dresser seeks, among other things, a declaration of the parties respective rights and obligations under the policies and a partition of the competing rights of Dresser and Products under the policies. Products answered Dresser’s complaint and filed cross-claims against all of the defendant-insurers seeking a declaration of Products’
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
rights to the policies. Products may be liable for asbestos claims against Wagner and has the benefit of that insurance, subject to the rights of other potential insureds under the policies. Primary layer liability insurance coverage for asbestos claims against Wagner is the subject of an agreement with Wagner’s solvent primary carriers. The agreement provides for partial reimbursement of indemnity and defense costs for Wagner asbestos claims until exhaustion of aggregate limits. Wagner also has substantial excess layer liability insurance coverage which, barring unforeseen insolvencies of excess carriers or other adverse events, should provide coverage for asbestos claims against Wagner. The Wagner insurance recoverable was $53.5 million as of December 31, 2004. On November 4, 2004, FMP, Dresser and Cooper Industries, Inc. (“Cooper”) and certain of the insurers (“Parties”) entered into a partitioning agreement, by which the Parties agreed as to the manner in which the limits of liability, self-insured retention’s, deductibles and any other self-insurance features, and the erosion thereof, are to be partitioned among FMP, Dresser and Cooper. The portioning agreement effectively disposes of Dresser’s claims in the Dresser adversary proceeding. However, FMP’s cross claim against the defendant-insurers remain.
The ultimate realization of insurance proceeds is directly related to the amount of related covered claims paid by Products. If the ultimate asbestos claims are higher than the recorded liability, Products expects the ultimate insurance recoverable to be higher than the recorded amount. If the ultimate asbestos claims are lower than the recorded liability, Products expects the ultimate insurance recoverable to be lower than the recorded amount. While the Restructuring Proceedings will impact the timing and amount of the asbestos claims and the insurance recoverable, there has been no change to the recorded amounts due to the uncertainties created by the Restructuring Proceedings. Accordingly, the recorded amounts for this insurance recoverable asset could change materially based upon events that occur from the Restructuring Proceedings.
Products believes that based on its review of the insurance policies, the financial viability of the insurance carriers, and advice from outside legal counsel, it is probable that Abex and Wagner will realize an insurance recoverable correlating with the respective liability.
Environmental Liabilities
Products has identified certain present and former properties at which it may be responsible for cleaning up environmental contamination, in some cases as a result of contractual commitments. Products is actively seeking to resolve these matters. Although difficult to quantify based on the complexity of the issues, Products has accrued amounts corresponding to its best estimate of the costs associated with such matters based upon current available information from site investigations and consultants.
Environmental reserves were $5.1 million and $4.0 million at December 31, 2004 and 2003, respectively and are included in the consolidated balance sheets as follows:
| December 31 | ||||||
| 2004 | 2003 | |||||
| (Millions of Dollars) | ||||||
Current liabilities | $ | 2.0 | $ | — | ||
Long-term accrued liabilities | 2.7 | 3.8 | ||||
Liabilities subject to compromise | 0.4 | 0.2 | ||||
| $ | 5.1 | $ | 4.0 | |||
The increase in the reserve during 2004 resulted primarily from an increase of certain reserves based on new and more accurate estimates of expected costs. Management believes that such accruals will be adequate to cover Products’ estimated liability for its exposure in respect to such matters. In the event that such liabilities were to significantly exceed the amounts recorded by Products, Products’ results of operations and financial condition could be materially affected. At December 31, 2004, management estimates that reasonably possible material additional losses above and beyond management’s best estimate of required remediation costs as recorded approximates $4 million.
Environmental reserves subject to compromise include those that may be reduced in Federal Mogul’s bankruptcy proceeding because they may be determined to be “dischargeable debts” incurred prior to Federal Mogul’s filing for
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
bankruptcy. Such liabilities generally arise at either (1) commercial waste disposal sites to which Products and other companies sent wastes for disposal, or (2) sites in relation to which Products has a contractual obligation to indemnify the current owner of a site for the costs of cleanup of contamination that was released into the environment before Products sold the site.
Environmental reserves determined not to be subject to compromise include those which arise from a legal obligation of Products, under an administrative or judicial order, to perform cleanup at a site. Such obligations are normally associated with sites, which a bankrupt entity such as Products owns and either operates or formerly operated.
The best estimate of environmental liability at a site may change from time to time during a bankruptcy proceeding even though the liability relating to that site is subject to compromise and Products’ responsibility to make payments is stayed. Notwithstanding the stay of proceedings regarding such a site, activities such as further site investigation and/or actual cleanup work usually continue to be performed by other parties. Such activities may produce new and better information that requires Products to revise its best estimate of total site cleanup costs and its own share of such costs.
8. Long-Term Debt and Other Financing Arrangements
Products’ cash and indebtedness is managed by Federal-Mogul. The majority of the cash provided by or used by a particular division, including Products, is provided through a consolidated cash and debt management system. As a result, the amount of domestic cash or debt historically related to Products is not determinable.
Products has intercompany loans from Federal-Mogul in the amount of $270.8 million, which are included in liabilities subject to compromise at December 31, 2004 and 2003. Products’ contractual interest not accrued or paid for each of the years 2004, 2003 and 2002 for this note was $19.0 million. Since the petition date, Products has been relieved a total of $61.7 million of interest payable under this note.
Products has a note payable to another subsidiary of Federal-Mogul in the amount of $44.0 million for the transfer of certain assets and liabilities. Interest on this note is calculated at the stated rate of 6.154%. This note is included in Products’ balance sheet under the caption liabilities subject to compromise at December 31, 2004 and 2003. Products contractual interest not accrued or paid for this note was $2.7 million for each of the years ended December 31, 2004, 2003 and 2002. Since the petition date, Products has been relieved a total of $8.8 million of interest payable under this note.
Federal-Mogul has pledged 100% of Products’ capital stock and also provided collateral in the form of a pledge of inventories, property, plant and equipment, real property and intellectual properties to secure certain outstanding debt of Federal-Mogul. In addition, Products has guaranteed fully and unconditionally, on a joint and several basis, the obligation to pay principal and interest under Federal-Mogul’s Senior Credit Agreement and its publicly registered debt. Such pledges and guarantees have also been made by other subsidiaries of Federal-Mogul. Federal-Mogul is in default of the terms of such debt agreements. Borrowing outstanding on such agreements aggregates $4,026.9 million and $4,020.7 million as of December 31, 2004 and 2003, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
9. Net Parent Investment
Changes in net parent investment were as follows:
| (Millions of Dollars) | ||||
Balance at January 1, 2002 | $ | 336.5 | ||
Net loss | (434.8 | ) | ||
Intercompany transactions, net | 21.6 | |||
Balance at December 31, 2002 | (76.7 | ) | ||
Net income | 37.7 | |||
Intercompany transactions, net | (23.6 | ) | ||
Balance at December 31, 2003 | (62.6 | ) | ||
Net income | 87.4 | |||
Intercompany transactions, net | (101.3 | ) | ||
Balance at December 31, 2004 | $ | (76.5 | ) | |
10. Income Taxes
Products files a consolidated return with Federal-Mogul for U.S. federal income tax purposes. Federal income tax expense is calculated on a separate-return basis for financial reporting purposes.
| Year Ended December 31 | |||||||||
| 2004 | 2003 | 2002 | |||||||
| (Millions of Dollars) | |||||||||
Components of income tax expense (benefit) | |||||||||
Current | $ | 10.3 | $ | — | $ | 0.6 | |||
Deferred | — | — | 14.4 | ||||||
Income tax expense (benefit) | $ | 10.3 | $ | — | $ | 15.0 | |||
A reconciliation between the statutory federal income tax rate and the effective tax rate is as follows:
| Year Ended December 31 | |||||||||
| 2004 | 2003 | 2002 | |||||||
U.S. Federal statutory rate | 35 | % | 35 | % | 35 | % | |||
State and local taxes | 1 | 3 | 2 | ||||||
Nondeductible goodwill | — | — | — | ||||||
Valuation allowance | (25 | ) | (38 | ) | 50 | ||||
Effective tax rate | 11 | % | — | % | 87 | % | |||
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the related amounts used for income tax purposes. Significant components of Product’s net deferred tax asset are non-deductible accruals and amortization and depreciation timing differences.
| 2004 | 2003 | |||||||
| (Millions of Dollars) | ||||||||
Net current deferred tax assets | $ | 38.7 | $ | 34.9 | ||||
Net long-term deferred tax assets | 34.9 | 55.5 | ||||||
Gross deferred tax assets | 73.6 | 90.4 | ||||||
Valuation allowance | (73.6 | ) | (90.4 | ) | ||||
Net deferred tax assets | $ | — | $ | — | ||||
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
11. Pension Plans
Products is included in the Federal-Mogul Corporation Pension Plan. As such, the related pension liability is recorded in Net Parent Investment at December 31, 2004 and 2003.
The pension charge allocated to Products was $3.8 million, $3.6 million and $3.4 million for 2004, 2003 and 2002, respectively.
12. Postretirement Benefits Other Than Pensions
Benefits provided to employees of Products under various Federal-Mogul postretirement plans other than pensions, all of which are unfunded, include retiree medical care, dental care, prescription drugs and life insurance, with medical care accounting for approximately 60% of the total. The majority of participants under such plans are retirees. The expense related to such plans approximated $1.2 million, $1.1 million and $2.0 million for 2004, 2003 and 2002, respectively.
13. Concentrations of Credit Risk and Other
Products grants credit to their customers, which are primarily in the automotive industry. Credit risk with respect to trade receivables is generally diversified due to the large number of entities comprising Products’ customer base. Products performs periodic credit evaluations of their customers and generally does not require collateral.
Products operates in a single business segment. Products manufactures and distributes brake friction materials and other products for use by the automotive aftermarket and in automobile assemblies. In addition, Products manufactures and distributes suspension, steering drive-line and brake system components and material for the automotive aftermarket. No single customer accounted for 10% or more of revenues in 2004, 2003 or 2002. All revenues and assets of Products reside in the United States.
14. Smithville, Tennessee Distribution Center Fire
On March 5, 2004, a fire at the Company’s Smithville, Tennessee distribution center resulted in extensive damage to the facility and the loss of substantially all of its related equipment and inventory. The 244,000 square foot facility was the principal distribution center for Moog and TRW chassis aftermarket products in the United States. The Company resumed distribution operations at a new leased facility in Smyrna, Tennessee on March 12, 2004.
The Company has settled this claim with its insurance carrier, resulting in cash proceeds of $102.2 million and the recognition of a gain on involuntary conversion of $46.1 million.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
Federal-Mogul Corporation
We have audited the accompanying consolidated balance sheets of Federal-Mogul Ignition Company and subsidiaries, a wholly-owned subsidiary of Federal-Mogul Corporation, as of December 31, 2004 and 2003, and the related consolidated statements of operations and comprehensive income and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Federal-Mogul Ignition Company and subsidiaries at December 31, 2004 and 2003, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming that Federal-Mogul Ignition Company and subsidiaries will continue as a going concern. As more fully described in the notes to the consolidated financial statements, on October 1, 2001, Federal-Mogul Corporation and its wholly-owned United States subsidiaries, which includes Federal-Mogul Ignition Company, filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy Code. Uncertainties inherent in the bankruptcy process raise substantial doubt about Federal-Mogul Ignition Company’s ability to continue as a going concern. Management’s intentions with respect to these matters are also described in the notes. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ ERNST & YOUNG LLP
Detroit, Michigan
February 25, 2005
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CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
| Year Ended December 31 | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| (Millions of Dollars) | ||||||||||||
Third party sales | $ | 761.7 | $ | 714.3 | $ | 679.5 | ||||||
Affiliate sales | 200.4 | 126.1 | 136.5 | |||||||||
Total net sales | 962.1 | 840.4 | 816.0 | |||||||||
Cost of products sold | 746.0 | 640.6 | 622.5 | |||||||||
Gross margin | 216.1 | 199.8 | 193.5 | |||||||||
Selling, general and administrative expenses | 111.6 | 107.2 | 127.5 | |||||||||
Restructuring charges | 5.7 | 12.0 | — | |||||||||
Adjustment of long-lived assets to fair value | 3.0 | — | 0.3 | |||||||||
Interest income, net | (3.3 | ) | (3.3 | ) | (5.8 | ) | ||||||
Other expense, net | 12.2 | 15.1 | 6.5 | |||||||||
Earnings from continuing operations before income taxes | 86.9 | 68.8 | 65.0 | |||||||||
Income tax expense | 31.2 | 14.8 | 21.4 | |||||||||
Earnings from continuing operations | 55.7 | 54.0 | 43.6 | |||||||||
Loss from discontinued operations, net of income taxes | — | (0.3 | ) | (27.5 | ) | |||||||
Net income | 55.7 | 53.7 | 16.1 | |||||||||
Components of comprehensive income | ||||||||||||
Translation adjustments | 12.6 | (12.2 | ) | 5.4 | ||||||||
Comprehensive income | $ | 68.3 | $ | 41.5 | $ | 21.5 | ||||||
See accompanying notes to consolidated financial statements
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CONSOLIDATED BALANCE SHEETS
| December 31 | ||||||||
| 2004 | 2003 | |||||||
| (Millions of Dollars) | ||||||||
| ASSETS | ||||||||
Current Assets: | ||||||||
Cash and equivalents | $ | 51.6 | $ | 29.6 | ||||
Accounts receivable, net | 174.1 | 165.9 | ||||||
Inventories, net | 146.7 | 145.5 | ||||||
Supplies inventories | 20.1 | 20.4 | ||||||
Other | 9.3 | 6.2 | ||||||
Total Current Assets | 401.8 | 367.6 | ||||||
Property, plant and equipment, net | 277.9 | 274.7 | ||||||
Goodwill and indefinite-lived intangible assets | 247.4 | 247.4 | ||||||
Definite-lived intangible assets, net | 32.9 | 34.7 | ||||||
Other noncurrent assets | 3.1 | 2.0 | ||||||
| $ | 963.1 | $ | 926.4 | |||||
| LIABILITIES AND NET PARENT INVESTMENT | ||||||||
Current Liabilities: | ||||||||
Short-term debt | $ | 0.1 | $ | 2.0 | ||||
Accounts payable | 61.4 | 55.8 | ||||||
Accrued compensation | 23.2 | 18.6 | ||||||
Restructuring reserves | 1.8 | 4.2 | ||||||
Accrued rebates and customer incentives | 9.9 | 8.6 | ||||||
Other accrued liabilities | 18.1 | 17.7 | ||||||
Total Current Liabilities | 114.5 | 106.9 | ||||||
Other long-term liabilities | 19.4 | 17.3 | ||||||
Liabilities subject to compromise | 799.7 | 798.9 | ||||||
Minority interest in consolidated subsidiaries | 95.0 | 81.8 | ||||||
Net Parent Investment: | ||||||||
Accumulated other comprehensive loss | (49.7 | ) | (37.1 | ) | ||||
Intercompany transactions | (15.8 | ) | (41.4 | ) | ||||
Net Parent Investment | (65.5 | ) | (78.5 | ) | ||||
| $ | 963.1 | $ | 926.4 | |||||
See accompanying notes to consolidated financial statements.
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CONSOLIDATED STATEMENTS OF CASH FLOWS
| Year Ended December 31 | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| (Millions of Dollars) | ||||||||||||
Cash Provided From (Used By) Operating Activities | ||||||||||||
Net income | $ | 55.7 | $ | 53.7 | $ | 16.1 | ||||||
Adjustments to reconcile net earnings to net cash provided from operating activities | ||||||||||||
Gain on sale of businesses, net | — | (2.2 | ) | (2.8 | ) | |||||||
Depreciation and amortization | 37.4 | 33.1 | 33.1 | |||||||||
Restructuring charge | 5.7 | 13.7 | 5.4 | |||||||||
Payments against restructuring reserves | (8.1 | ) | (9.7 | ) | (6.7 | ) | ||||||
Adjustment of long-lived assets to fair value | 3.0 | — | 11.2 | |||||||||
(Increase) decrease in accounts receivable | (8.2 | ) | 11.9 | (5.9 | ) | |||||||
(Increase) decrease in inventories | (1.2 | ) | 9.4 | 3.1 | ||||||||
Increase in accounts payable | 5.6 | 12.4 | 3.2 | |||||||||
Changes in other assets and liabilities | 18.8 | (27.0 | ) | 11.4 | ||||||||
Net Cash Provided From Operating Activities | 108.7 | 95.3 | 68.1 | |||||||||
Cash Provided From (Used By) Investing Activities | ||||||||||||
Capital expenditures | (29.5 | ) | (26.4 | ) | (52.7 | ) | ||||||
Proceeds from sale of businesses | — | 20.2 | 33.0 | |||||||||
Net Cash Used By Investing Activities | (29.5 | ) | (6.2 | ) | (19.7 | ) | ||||||
Cash Provided From (Used By) Financing Activities | ||||||||||||
Borrowings (payments) on short-term debt | (1.9 | ) | 2.0 | — | ||||||||
Transfers to parent | (55.3 | ) | (81.9 | ) | (60.6 | ) | ||||||
Net Cash Used By Financing Activities | (57.2 | ) | (79.9 | ) | (60.6 | ) | ||||||
Increase (Decrease) in cash and equivalents | 22.0 | 9.2 | (12.2 | ) | ||||||||
Cash and equivalents at beginning of year | 29.6 | 20.4 | 32.6 | |||||||||
Cash and equivalents at end of year | $ | 51.6 | $ | 29.6 | $ | 20.4 | ||||||
See accompanying notes to consolidated financial statements.
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation and Summary of Significant Accounting Policies
The accompanying financial statements reflect the consolidated assets, liabilities and operations of Federal-Mogul Ignition Company and its subsidiaries (“Ignition”). Ignition is a wholly-owned subsidiary of Federal-Mogul Corporation (“Federal-Mogul”). Ignition manufactures wipers, spark plugs, glow plugs, and ignition coils.
Ignition operates with financial and operations staff on a decentralized basis. Federal-Mogul provides certain centralized services for employee benefits administration, cash management, risk management, legal services, public relations, domestic tax reporting and internal and external audit. Federal-Mogul charges Ignition for all such direct expenses incurred on its behalf. General expenses that are not directly attributable to the operations of Ignition have been allocated based on management’s estimates, primarily driven by sales. Management believes that this allocation method is reasonable.
The accompanying consolidated financial statements are presented as if Ignition had existed as an entity separate from its parent during the periods presented, and includes the assets, liabilities, revenues and expenses that are directly related to Ignition’s operations.
Ignition’s separate debt and related interest expense have been included in the consolidated financial statements. Ignition is fully integrated into its parent’s cash management system, as such, all of their domestic cash requirements are provided by its parent and any excess cash generated by Ignition is transferred to the parent.
Principles of Consolidation:The consolidated financial statements include the accounts of Ignition and all majority-owned subsidiaries and other controlled entities. Intercompany accounts and transactions have been eliminated in consolidation. Investments in affiliates of not more than 20% are accounted for using the cost method, while investments greater than 20% and not more than 50% are accounted for using the equity method.
Use of Estimates:The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported therein. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may be based upon amounts that differ from these estimates.
Cash and Equivalents:The Company considers all highly liquid investments with maturities of 90 days or less from the date of purchase to be cash equivalents.
Trade Accounts Receivable and Allowance for Doubtful Accounts:Trade accounts receivable are stated at historical value, which approximates fair value. Ignition does not generally require collateral for its trade accounts receivable.
Accounts receivable have been reduced by an allowance for amounts that may become uncollectible in the future. This estimated allowance is based primarily on management’s evaluation of specific balances as the balances become past due, the financial condition of its customers and Ignition’s historical experience of write-offs. If not reserved through specific examination procedures, Ignition general policy for uncollectible accounts is to reserve based upon the aging categories of accounts receivable and upon whether the amounts are due from an OE customer or Aftermarket customer. Past due status is based upon the invoice date of the original amounts outstanding. The allowance for doubtful accounts was $9.1 million and $10.1 million at December 31, 2004 and 2003, respectively.
Ignition subsidiaries in Italy have entered into factoring facilities. Accounts receivable factored or discounted under these facilities was $8.6 million at December 31, 2004. Losses related to receivables factored or discounted are recorded in the statement of operations as “other expense, net.”
Inventories:Inventories are carried at cost or, if lower, net realizable value. Cost is determined using the last-in, first-out (“LIFO”) method for approximately 55% and 54% of the inventory at December 31, 2004 and 2003, respectively. The remaining inventories are recorded using the first-in, first-out method. If inventories had been valued at current cost amounts reported would have increased by $8.6 million and $7.0 million at December 31, 2004 and 2003 respectively. Inventories have also been reduced by an allowance for excess and obsolete inventories based on management’s review of on-hand inventories compared to estimated future sales and usage.
Long-Lived Assets:Long-lived assets, such as property, plant and equipment and definite-lived intangible assets, are stated at cost. Depreciation and amortization is computed principally by the straight-line method for financial reporting purposes and by accelerated methods for income tax purposes. Definite-lived assets are periodically reviewed for impairment indicators. If impairment indicators exist, the Company performs the required analysis and records an impairment charge, as required, in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS No. 144). If the carrying value of a long-lived asset is considered impaired, an impairment charge is recorded for the amount by which the carrying value of the long-lived asset exceeds its fair value.
Indefinite-lived Intangible Assets: Indefinite-lived intangible assets, such as goodwill and trademarks, are carried at historical value and not amortized. Indefinite-lived intangible assets are reviewed for impairment annually as of October 1, or more frequently if impairment indicators exist. The impairment analysis compares the estimated fair value of these assets to the related carrying value, and an impairment charge is recorded for any excess of carrying value over estimated fair value. The estimated fair value is based upon consideration of various valuation
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
methodologies, including guideline transaction multiples, multiples of current earnings, and projected future cash flows discounted at rates commensurate with the risk involved.
Revenue Recognition:Ignition recognizes sales when products are shipped and title has transferred to the customer, the sales price is fixed or determinable, and the collectibility of revenue is reasonably assured. Affiliate sales are transferred at cost. Accruals for sales returns and other allowances are provided at the time of shipment based upon past experience. Adjustments to such returns and allowances are made as new information becomes available.
Shipping and Handling Costs:Ignition recognizes shipping and handling costs as a component of cost of products sold in the statement of operations.
Recoverable Customer Engineering and Tooling:Pre-production tooling and engineering costs that Ignition will not own and that will be used in producing products under long-term supply arrangements are expensed as incurred unless the supply arrangement provides Ignition the noncancelable right to use the tools or the reimbursement of such costs is agreed to by the customer. Pre-production tooling and engineering costs that are owned by Ignition are capitalized as part of machinery and equipment, and are depreciated over the shorter of the toolings’ expected life or the duration of the related program.
Research and Development and Advertising Costs: Ignition expenses research and development costs as incurred. Research and development expense for 2004, 2003 and 2002 was $15.2 million, $14.5 million and $14.5 million, respectively. Advertising and promotion expense was $3.1 million, $3.0 million and $3.0 million for 2004, 2003 and 2002, respectively.
Restructuring:Ignition defines restructuring expense to include charges incurred with exit or disposal activities accounted for in accordance with SFAS No. 146, employee severance costs incurred as a result of an exit or disposal activity accounted for in accordance with SFAS Nos. 88 and 112, and pension and other postemployment benefit costs incurred as a result of an exit or disposal activity accounted for in accordance with SFAS Nos. 87 and 106.
Rebates/Sales Incentives:Ignition accrues for rebates pursuant to specific arrangements with certain of its customers, primarily in the aftermarket. Rebates generally provide for price reductions based upon the achievement of specified purchase volumes and are recorded as a reduction of sales as they are earned by such customers.
Currency Translation: Exchange adjustments related to international currency transactions and translation adjustments for subsidiaries whose functional currency is the United States dollar (principally those located in highly inflationary economies) are reflected in the consolidated statements of operations. Translation adjustments of foreign subsidiaries for which the United States dollar is not the functional currency are reflected in the consolidated financial statements as a component of accumulated other comprehensive loss.
Net Parent Investment: The Net Parent Investment account reflects the balance of Ignition’s historical earnings, intercompany amounts, income taxes accrued and deferred, postemployment liabilities, other transactions between Ignition and Federal-Mogul, foreign currency translations and equity pension adjustments.
Reclassifications:Certain items in the prior years financial statements have been reclassified to conform with the presentation used in 2004.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
2. Voluntary Reorganization Under Chapter 11 and Administration
On October 1, 2001 (the “Petition Date”), Federal-Mogul Corporation (the “Company” or “Federal-Mogul”) and all of its wholly-owned United States subsidiaries filed voluntary petitions for reorganization (the “U.S. Restructuring”) under Chapter 11 of the United States Bankruptcy Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”). Also on October 1, 2001, certain of the Company’s United Kingdom subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the Bankruptcy Code and petitions for Administration (the “U.K. Restructuring”) under the United Kingdom Insolvency Act of 1986 (the “Act”) in the High Court of Justice, Chancery division in London, England (the “High Court”). The Company and its U.S. and U.K. subsidiaries included in the U.S. Restructuring and U.K. Restructuring are herein referred to as the “Debtors”. The U.S. Restructuring and U.K. Restructuring are herein referred to as the “Restructuring Proceedings”. The Chapter 11 cases of the Debtors (collectively, the “Chapter 11 Cases”) have been consolidated for purposes of joint administration asIn re: Federal-Mogul Global Inc., T&N Limited, et. al (Case No. 01-10578(RTL)). Subsidiaries outside of the aforementioned U.S. and U.K. subsidiaries are not party to the Chapter 11 Cases and, therefore, are not currently provided protection from creditors by any bankruptcy court and are operating in the normal course.
The Restructuring Proceedings were initiated in response to a sharply increasing number of asbestos-related claims and their demand on the Company’s cash flows and liquidity. Under the Restructuring Proceedings, the Debtors expect to develop and implement a plan for addressing the asbestos-related claims against them.
Consequences of the Restructuring Proceedings
The U.S. Debtors, including Ignition, are operating their businesses as debtors-in-possession subject to the provisions of the Bankruptcy Code. The U.K. Debtors are continuing to manage their operations under the supervision of Administrators approved by the High Court. All vendors will be paid for all goods furnished and services provided after the Petition Date. However, as a consequence of the Restructuring Proceedings, pending litigation against the Debtors as of the Petition Date is stayed (subject to certain exceptions in the case of governmental authorities), and no party may take any action to pursue or collect pre-petition claims except pursuant to an order of the Bankruptcy Court or the High Court as applicable. It is the Debtors’ intention to address all pending and future asbestos-related claims and all other pre-petition claims through a unified plan of reorganization under the Bankruptcy Code or scheme of arrangement under the Act.
In the U.S., four committees, representing asbestos claimants, asbestos property damage claimants, unsecured creditors and equity security holders (collectively, the “Committees”) have been appointed as official committees in the Chapter 11 Cases and, in accordance with the provisions of the Bankruptcy Code, have the right to be heard on all matters that come before the Bankruptcy Court. The Committees, together with the legal representative for the future asbestos claimants, play important roles in the Restructuring Proceedings. In the U.K., the Administrators have appointed a creditors committee, representing both asbestos claimants and general unsecured creditors.
On June 4, 2004, the Third Amended Joint Plan of Reorganization (the “Plan”) for Federal-Mogul and the other U.S. and U.K. Debtors was filed with the Bankruptcy Court. The Plan was jointly proposed by Federal-Mogul, the Unsecured Creditors Committee, the Asbestos Claimants Committee, the Future Asbestos Claimants Representative, the Agent for the Prepetition Bank Lenders and the Equity Security Holders Committee (collectively referred to as the “Plan Proponents”). Also on June 4, 2004, a Disclosure Statement to be used in soliciting votes to accept or reject the Plan (the “Disclosure Statement”) was approved by the Bankruptcy Court and a December 2004 hearing
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was scheduled to determine whether the Bankruptcy Court should approve the Plan. On December 7, 2004, the Bankruptcy Court delayed this confirmation hearing pending a hearing to estimate asbestos personal injury claims against the U.K. Debtors. Such estimation hearing has not yet been scheduled.
On July 12, 2004, solicitation packages containing the Plan and Disclosure Statement, various supporting documents and a ballot, if appropriate, were mailed to known creditors of Federal-Mogul and holders of common and preferred stock interests in Federal-Mogul. All votes were due by the close of business on November 3, 2004. Although the Plan Proponents have granted extensions of the November 3, 2004 voting deadline to a few significant claimants, the voting agent has confirmed that the overwhelming majority of the classes of claims and interests have voted to accept the Plan. For the few classes of claims that voted to reject the Plan, the Plan Proponents intend to either amend the Plan so as to obtain such classes’ accepting votes or seek to confirm the Plan over the objection of such classes.
The Plan provides that asbestos personal injury claimants, both present and future, will be permanently channeled to a trust or series of trusts established pursuant to Section 524(g) of the Bankruptcy Code, thereby protecting Federal-Mogul and its affiliates in the Chapter 11 Cases from existing and future asbestos liability. Although certain issues remain to be resolved, the Plan provides that all currently outstanding stock of Federal-Mogul will be cancelled, and 50.1% of newly authorized and issued common stock of reorganized Federal-Mogul will be distributed to the asbestos trusts, and 49.9% of the newly authorized and issued common stock will be distributed pro rata to the noteholders. If the classes of holders of common and preferred stock of Federal-Mogul vote in favor of the Plan, the holders of currently outstanding common and preferred stock of Federal-Mogul will receive warrants that may be used to purchase shares of reorganized Federal-Mogul at a predetermined exercise price.
Unsecured creditors, including trade creditors, of the U.S. Debtors are projected to receive cash distributions under the Plan equal to 35% of their allowed claims, payable in three annual installments, provided that the aggregate of all allowed unsecured claims against the U.S. Debtors does not exceed $258 million. Any excess above this amount could result in a reduction in the percentage distribution that the unsecured creditors of the U.S. Debtors ultimately receive. Unsecured creditors, including trade creditors, of the U.K. Debtors will receive distributions that vary according to terms specified within the Plan and Disclosure Statement.
There are two possible types of U.K. schemes of arrangements. The first is under Section 425 of the Companies Act of 1985, which may involve a scheme for the reconstruction of the Company. If a majority in number representing three-fourths in value of the creditors or members or any class of them agree to the compromise or arrangement, it is binding if sanctioned by the High Court. Section 425 may be invoked where there is an Administration order in force in relation to the Company. The other possible type of scheme arises under Section 1 of the Insolvency Act of 1986 in relation to Company Voluntary Arrangements (“CVA”). If a majority in value representing more than three-fourths of the creditors agrees to the compromise or arrangement set out in the CVA proposal, it will be approved.
Ignition is unable to predict with a high degree of certainty at this time what treatment will be accorded under any such plan of reorganization to claims arising from intercompany indebtedness, licenses, executory contracts, transfers of goods and services, and other intercompany arrangements, transactions and relationships that were entered into prior to the Petition Date. Various parties in the Chapter 11 Cases may challenge these arrangements, transactions, and relationships, and the outcome of those challenges, if any, may have an impact on the treatment of various claims under such plan of reorganization.
The Bankruptcy Court may confirm a plan of reorganization only upon making certain findings required by the Bankruptcy Code, and a plan may be confirmed over the dissent of non-accepting creditors and equity security holders if certain requirements of the Bankruptcy Code are met. The payment rights and other entitlements of pre-petition creditors and equity security holders may be substantially altered by any plan of reorganization confirmed in the Chapter 11 Cases. There is no assurance that there will be sufficient assets to satisfy the Debtors’ pre-petition liabilities in whole or in part, and the pre-petition creditors of some Debtors may be treated differently than those of other Debtors.
Chapter 11 Financing
In connection with the Restructuring Proceedings, Federal-Mogul entered into a DIP credit facility to supplement liquidity and fund operations during the restructuring proceedings. In December 2004, Federal-Mogul renegotiated its DIP credit facility. Prior to December 2004, Federal-Mogul’s DIP credit facility had an interest rate of either the
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alternate base rate (“ABR”) plus 2 percentage points or a formula based on the London Inter-Bank Offered Rate (“LIBOR”) plus 3 percentage points. The ABR is the greater of either the bank’s prime rate or the base CD rate plus 1 percentage point or the federal funds rate plus ½ percentage point.
The December 2004 DIP credit facility expires in December 2005, and the interest rate is either the alternate base rate (“ABR”) plus 1¼ percentage points or a formula based on the London Inter-Bank Offered Rate (“LIBOR”) plus 2¼ percentage points. The ABR is the greater of either the bank’s base rate or the federal funds rate plus ½ percentage point. In addition, the commitment available under the DIP credit facility is mandatorily reduced by a portion of proceeds received from future asset or business divestitures.
Financial Statement Presentation
The accompanying consolidated financial statements have been prepared in accordance with AICPA Statement of Position 90-7 (“SOP 90-7”), “Financial Reporting by Entities in Reorganization under the Bankruptcy Code” and on a going concern basis, which contemplates continuity of operations and realization of assets and liquidation of liabilities in the ordinary course of business. However, as a result of the Restructuring Proceedings, such realization of assets and liquidation of liabilities, without substantial adjustments and/or changes of ownership, is highly uncertain. Given this uncertainty, there is substantial doubt about the ability of Ignition to continue as a going concern. While operating as debtors-in-possession under the protection of Chapter 11 of the Bankruptcy Code and Administration under the Act, and subject to approval of the Bankruptcy Court, Administrators or the High Court or otherwise as permitted in the ordinary course of business, Ignition may sell or otherwise dispose of assets and liquidate or settle liabilities for some amounts other than those reflected in the consolidated financial statements. Further, a plan of reorganization or scheme of arrangement could materially change the amounts and classifications in the historical consolidated financial statements.
As reflected in the consolidated financial statements, “Liabilities subject to compromise” refers to liabilities of entities of Ignition included in the Restructuring Proceedings incurred prior to the Petition Date. The amounts of the various liabilities that are subject to compromise are set forth below. These amounts represent Ignition’s estimate of known or potential pre-petition claims to be resolved in connection with the Restructuring Proceedings. Such claims remain subject to future adjustments. Future adjustments may result from (i) negotiations; (ii) actions of the Bankruptcy Court, High Court or Administrators; (iii) further developments with respect to disputed claims; (iv) rejection of executory contracts and unexpired leases; (v) the determination as to the value of any collateral securing claims; (vi) proofs of claim; or (vii) other events. Payment terms for these claims will be established in connection with the Restructuring Proceedings.
| December 31 | ||||||
| 2004 | 2003 | |||||
Accounts payable | $ | 32.8 | $ | 32.7 | ||
Accounts payable to affiliated companies | 148.6 | 148.6 | ||||
Loans payable to affiliated companies | 447.5 | 447.5 | ||||
Interest payable to affiliated companies | 162.8 | 162.8 | ||||
Environmental liabilities | 8.0 | 7.3 | ||||
Total | $ | 799.7 | $ | 798.9 | ||
The Debtors, including Ignition, have received approval from the Bankruptcy Court to pay or otherwise honor certain of their pre-petition obligations, including employee wages, salaries, benefits and other employee obligations and from limited available funds, pre-petition claims of certain critical vendors, certain customer programs and warranty claims and certain other pre-petition claims.
Pursuant to the Bankruptcy Code, Federal-Mogul has filed schedules with the Bankruptcy Court setting forth the assets and liabilities of the Debtors as of the Petition Date. On October 4, 2002, the Debtors issued approximately 100,000 proof of claim forms to its current and prior employees, known creditors, vendors and other parties with whom the Debtors have previously conducted business. To the extent that recipients disagree with the claims as
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quantified on these forms, the recipient may file discrepancies with the Bankruptcy Court. Differences between amounts recorded by the Debtors and claims filed by creditors will be investigated and resolved as part of the Restructuring Proceedings. The Bankruptcy Court ultimately will determine liability amounts that will be allowed for these claims in the Chapter 11 Cases. A March 3, 2003 bar date was set for the filing of proofs of claim against the Debtors. Because the Debtors have not completed evaluation of the claims received in connection with this process, the ultimate number and allowed amount of such claims are not presently known. The resolution of such claims could result in a material adjustment to the Company’s financial statements.
The Debtors, including Ignition, continue to review and analyze the proofs of claim filed to date. In addition, the Debtors continue to file objections and seek stipulations to certain claims. Additional claims may be filed after the general bar date, which could be allowed by the Bankruptcy Court. Accordingly, the ultimate number and allowed amount of such claims are not presently known and cannot be reasonably estimated at this time. The resolution of such claims could result in a material adjustment to the Company’s financial statements.
The appropriateness of using the going concern basis for the Ignition’s financial statements is dependent upon, among other things: (i) Federal-Mogul’s ability to comply with the terms of the DIP credit facility and any cash management order entered by the Bankruptcy Court in connection with the Chapter 11 Cases; (ii) the ability of Federal-Mogul to maintain adequate cash on hand; (iii) the ability of Federal-Mogul to generate cash from operations; (iv) confirmation of a plan(s) of reorganization under the Bankruptcy Code; (v) confirmation of a scheme(s) of arrangement in the U.K. under Administration; and (vi) Federal-Mogul’s ability to achieve profitability following such confirmations.
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Debtors’ Financial Statements
The condensed consolidated financial statements of the Ignition entities included in the U.S. Restructuring are presented below. These statements reflect the financial position, results of operations and cash flows of the combined Ignition entities in the U.S. Restructuring, including certain amounts and activities between Debtors and non-Debtor subsidiaries of Ignition, which are eliminated in the consolidated Ignition financial statements.
Debtors’ Condensed Consolidated Statement of Operations
| Year Ended December 31 | ||||||||||
| 2004 | 2003 | 2002 | ||||||||
| (Millions of Dollars) | ||||||||||
Third party sales | $ | 439.1 | $ | 436.8 | $ | 425.1 | ||||
Affiliate sales | 44.5 | �� | 46.5 | 48.4 | ||||||
Total net sales | 483.6 | 483.3 | 473.5 | |||||||
Cost of products sold | 353.0 | 351.8 | 353.1 | |||||||
Gross margin | 130.6 | 131.5 | 120.4 | |||||||
Selling, general and administrative expenses | 72.0 | 70.7 | 89.1 | |||||||
Adjustment of long-lived assets to fair value | 0.4 | — | 0.6 | |||||||
Other expense, net | 11.0 | 13.7 | 7.2 | |||||||
Earnings from continuing operations before income taxes and equity loss of non-Debtor subsidiaries | 47.2 | 47.1 | 23.5 | |||||||
Income tax expense | 15.9 | 1.4 | 2.1 | |||||||
Earnings from continuing operations before equity earnings of non-Debtor subsidiaries | 31.3 | 45.7 | 21.4 | |||||||
Equity earnings from continuing operations of non-Debtor subsidiaries | 24.4 | 8.3 | 22.2 | |||||||
Earnings from continuing operations | 55.7 | 54.0 | 43.6 | |||||||
Loss from discontinued operations, net of income taxes, Debtors | — | 0.4 | 18.5 | |||||||
Loss (income) from discontinued operations, net of income taxes, non-Debtors | — | (0.1 | ) | 9.0 | ||||||
Net earnings | $ | 55.7 | $ | 53.7 | $ | 16.1 | ||||
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Debtors’ Condensed Consolidated Balance Sheet
| December 31 | ||||||||
| 2004 | 2003 | |||||||
| (Millions of Dollars) | ||||||||
| ASSETS | ||||||||
Current Assets: | ||||||||
Accounts receivable, net | $ | 96.0 | $ | 95.5 | ||||
Accounts receivable – non-Debtor affiliates | 10.9 | 10.8 | ||||||
Inventories, net | 82.4 | 87.5 | ||||||
Other | 12.1 | 11.1 | ||||||
Total Current Assets | 201.4 | 204.9 | ||||||
Property, plant and equipment, net | 108.1 | 110.5 | ||||||
Goodwill and indefinite-lived intangible assets | 230.2 | 230.4 | ||||||
Definite-lived intangible assets, net | 32.8 | 34.4 | ||||||
Investment in non-Debtor subsidiaries | 191.0 | 173.6 | ||||||
Loan receivable – non-Debtor affiliates | 24.6 | 22.7 | ||||||
Other noncurrent assets | 0.3 | 0.3 | ||||||
| $ | 788.4 | $ | 776.8 | |||||
| LIABILITIES AND NET PARENT INVESTMENT | ||||||||
Current Liabilities: | ||||||||
Accounts payable | $ | 19.7 | $ | 16.1 | ||||
Accounts payable – non-Debtors | 23.8 | 25.0 | ||||||
Other accrued liabilities | 9.6 | 14.1 | ||||||
Total Current Liabilities | 53.1 | 55.2 | ||||||
Other long-term liabilities | 1.1 | 1.2 | ||||||
Liabilities subject to compromise | 799.7 | 798.9 | ||||||
Net Parent Investment | (65.5 | ) | (78.5 | ) | ||||
| $ | 788.4 | $ | 776.8 | |||||
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Debtors’ Condensed Consolidated Statements of Cash Flows
| Year Ended December 31 | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| (Millions of Dollars) | ||||||||||||
Net cash provided from operating activities | $ | 29.2 | $ | 24.3 | $ | 22.5 | ||||||
Cash provided from (used by) investing activities: | ||||||||||||
Capital expenditures | (10.8 | ) | (8.2 | ) | (10.3 | ) | ||||||
Proceeds from sale of businesses | — | 2.7 | 2.6 | |||||||||
Net cash used by investing activities | (10.8 | ) | (5.5 | ) | (7.7 | ) | ||||||
Cash provided from (used by) financing activities: | ||||||||||||
Transfers to parent | (18.4 | ) | (18.8 | ) | (14.8 | ) | ||||||
Net cash used by financing activities | (18.4 | ) | (18.8 | ) | (14.8 | ) | ||||||
Net change in cash | — | — | — | |||||||||
Cash at beginning of year | — | — | — | |||||||||
Cash at end of year | $ | — | $ | — | $ | — | ||||||
3. Discontinued Operations
In connection with its strategic planning process, Federal-Mogul assesses its operations for market position, product technology and capability, and profitability. Those businesses determined by management not to have a sustainable competitive advantage are considered non-core and may be considered for divestiture or other exit activities. Over the past several years, Ignition has divested numerous non-core businesses. The elimination of these non-core businesses has freed up both human and capital resources which have been devoted to Federal-Mogul’s core businesses.
During 2003, Ignition completed the following divestitures of non-core businesses:
| • | During April 2003, Ignition completed the divestitures of substantially all of its original equipment lighting operations. The original equipment lighting divestitures include operations in Matamoros, Mexico; Brownsville, Texas; and Toledo, Ohio. |
During 2002, Ignition completed two divestitures of non-core businesses as follows:
| • | During the first quarter of 2002 Ignition completed the divestiture of its Signal-Stat Lighting Products business (“Signal-Stat”) to Truck-Lite Co., Inc. Signal-Stat produces exterior lighting and power distribution products primarily for heavy-duty and commercial vehicle markets. |
| • | In November 2002, Ignition completed the divestiture of Federal-Mogul Camshafts de Mexico S. de R.L. de C.V. (“Camshafts de Mexico”), to Linamar Corporation. Camshafts de Mexico manufactures camshafts for the North American original equipment market. |
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Further information related to Ignition’s discontinued operations is as follows:
| Year Ended December 31 | ||||||||
| 2003 | 2002 | |||||||
Net sales | $ | 46.8 | $ | 141.8 | ||||
Cost of products sold | 39.8 | 130.1 | ||||||
Gross margin | 7.0 | 11.7 | ||||||
Selling, general and administrative expenses | 2.8 | 13.7 | ||||||
Restructuring charges | 1.7 | 5.4 | ||||||
Adjustment of assets held for sale and other long-lived assets to fair value | — | 10.9 | ||||||
Net (gain) loss on divestitures | 2.1 | (2.8 | ) | |||||
Other expenses, net | 0.7 | (0.9 | ) | |||||
Loss before income taxes | (0.3 | ) | (14.6 | ) | ||||
Income tax expense (benefit) | — | 12.9 | ||||||
Loss from discontinued operations | $ | (0.3 | ) | $ | (27.5 | ) | ||
4. Inventories
Inventories consisted of the following:
| December 31 | ||||||||
| 2004 | 2003 | |||||||
| (Millions of Dollars) | ||||||||
Raw materials. | $ | 39.0 | $ | 36.4 | ||||
Work-in-process | 45.5 | 43.0 | ||||||
Finished goods | 84.0 | 87.7 | ||||||
| 168.5 | 167.1 | |||||||
Valuation reserves | (21.8 | ) | (21.6 | ) | ||||
| $ | 146.7 | $ | 145.5 | |||||
5. Property, Plant and Equipment
Property, plant and equipment consisted of the following:
Estimated Useful Life | December 31 | |||||||||
| 2004 | 2003 | |||||||||
| (Millions of Dollars) | ||||||||||
Land | — | $ | 5.5 | $ | 6.1 | |||||
Buildings and building improvements | 24-40 years | 61.5 | 62.7 | |||||||
Machinery and equipment | 3-12 years | 343.8 | 312.7 | |||||||
| 410.8 | 381.5 | |||||||||
Accumulated depreciation | (132.9 | ) | (106.8 | ) | ||||||
| $ | 277.9 | $ | 274.7 | |||||||
Total rental expense under operating leases for the years ended December 31, 2004, 2003 and 2002 was $9.0 million, $9.8 million and $8.3 million, respectively, exclusive of property taxes, insurance and other occupancy costs generally payable by Federal-Mogul.
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Future minimum payments under noncancelable operating leases with initial or remaining terms of more than one year are as follows, in millions:
2005 | $ | 3.7 | |
2006 | 2.4 | ||
2007 | 2.0 | ||
2008 | 1.8 | ||
2009 | 1.7 | ||
Thereafter | 1.7 |
6. Adjustment of Assets to Fair Value
Definite-Lived Long-Lived Assets
Ignition recorded impairment charges for the years ended December 31, 2004 and 2002 of $3.0 million and $0.6 million, respectively, to adjust long-lived tangible assets to their estimated fair values in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS No. 144). The charges were recorded to write-down property, plant and equipment at facilities that Ignition is closing or consolidating into other facilities. The fair value of property, plant and equipment was based upon estimated discounted future cash flows and estimates of salvage value. The impairment charges represent the difference between the estimated fair values and the carrying value of the subject assets. No impairment charge was required for the year ended December 31, 2003.
Goodwill and Other Indefinite-Lived Intangible Assets
Effective January 1, 2002, Ignition adopted SFAS No. 142, resulting in the discontinuance of amortization of goodwill and indefinite-lived intangible assets. The adoption of this standard also required the reclassification of various intangible asset classes according to the measurability of their useful lives. Ignition’s initial impairment test indicated that its carrying value did not exceed the corresponding fair values, which were determined by using discounted cash flows and market multiples. Therefore, no impairment charge was required. Ignition completed its required annual impairment analysis as of October 1, 2004 and, based upon this analysis, no impairment charge was required.
At December 31, 2004 and 2003, goodwill and other intangible assets consists of the following:
| December 31, 2004 | December 31, 2003 | |||||||||||||||||||
Gross Amount | Accumulated Amortization | Net Carrying Amount | Gross Amount | Accumulated Amortization | Net Carrying Amount | |||||||||||||||
| (Millions of Dollars) | ||||||||||||||||||||
Definite-Lived Intangible Assets | ||||||||||||||||||||
Developed technology | $ | 44.3 | $ | (11.4 | ) | $ | 32.9 | $ | 44.3 | $ | (9.6 | ) | $ | 34.7 | ||||||
Indefinite-Lived Intangible Assets | ||||||||||||||||||||
Goodwill | $ | 137.2 | $ | 137.2 | ||||||||||||||||
Trademarks | 110.2 | 110.2 | ||||||||||||||||||
Total Indefinite-Lived Intangible Assets | $ | 247.4 | $ | 247.4 | ||||||||||||||||
Ignition expects that amortization expense for its amortizable intangible assets for each of the years between 2005 and 2009 will be approximately $2 million.
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7. Restructuring Charges
Ignition recorded $5.7 million and $12.0 million in 2004 and 2003, respectively, of restructuring charges from continuing operations primarily related to severance costs resulting from salaried employee reductions in North America and Europe. There were no restructuring charges in 2002. Cash payments made during 2004, 2003 and 2002 were $8.1 million, $9.7 million, and $6.7 million, respectively.
8. Commitments and Contingencies
Ignition has identified certain present and former properties at which it may be responsible for cleaning up environmental contamination, in some cases as a result of contractual commitments. Ignition is actively seeking to resolve these matters. Although difficult to quantify based on the complexity of the issues, Ignition has accrued amounts corresponding to its best estimate of the costs associated with such matters based upon current available information from site investigations and consultants.
Environmental reserves were $9.2 million and $8.8 million at December 31, 2004 and 2003, respectively and are included in the consolidated balance sheets as follows:
| December 31 | ||||||
| 2004 | 2003 | |||||
| (Millions of Dollars) | ||||||
Current liabilities | $ | 0.2 | $ | 0.4 | ||
Long-term accrued liabilities | 1.0 | 1.1 | ||||
Liabilities subject to compromise | 8.0 | 7.3 | ||||
| $ | 9.2 | $ | 8.8 | |||
The increase in the reserve during 2004 resulted primarily from an increase of certain reserves based on new and more accurate estimates of expected costs. Management believes that such accruals will be adequate to cover Ignition’s estimated liability for its exposure in respect to such matters. In the event that such liabilities were to significantly exceed the amounts recorded by Ignition, Ignition’ results of operations and financial condition could be materially affected. At December 31, 2004, management estimates that reasonably possible material additional losses above and beyond management’s best estimate of required remediation costs as recorded approximates $1 million.
Environmental reserves subject to compromise include those that may be reduced in Federal-Mogul’s bankruptcy proceeding because they may be determined to be “dischargeable debts” incurred prior to Federal-Mogul’s filing for bankruptcy. Such liabilities generally arise at either (1) commercial waste disposal sites to which Ignition and other companies sent wastes for disposal, or (2) sites in relation to which Ignition has a contractual obligation to indemnify the current owner of a site for the costs of cleanup of contamination that was released into the environment before Ignition sold the site.
Environmental reserves determined not to be subject to compromise include those which arise from a legal obligation of Ignition, under an administrative or judicial order, to perform cleanup at a site. Such obligations are normally associated with sites, which a bankrupt entity such as Ignition owns and either operates or formerly operated.
The best estimate of environmental liability at a site may change from time to time during a bankruptcy proceeding even though the liability relating to that site is subject to compromise and Ignition’s responsibility to make payments is stayed. Notwithstanding the stay of proceedings regarding such a site, activities such as further site investigation and/or actual cleanup work usually continue to be performed by other parties. Such activities may produce new and better information that requires Ignition to revise its best estimate of total site cleanup costs and its own share of such costs.
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9. Long-Term Debt and Other Financing Arrangements
Ignition’s cash and indebtedness is managed by Federal-Mogul. The majority of the cash provided by or used by a particular division, including Ignition, is provided through a consolidated cash and debt management system. As a result, the amount of cash or debt historically related to Ignition is not determinable.
Ignition has an intercompany loan, including accrued interest, from Federal-Mogul in the amount of $610.3 million, which is included in liabilities subject to compromise at December 31, 2004 and 2003. Prior to October 1, 2001, Federal-Mogul charged interest on the intercompany loans based on the stated rate of 6.8%. In accordance with SOP 90-7, Ignition stopped recording interest expense on its outstanding notes effective October 1, 2001. As a result, Ignition was relieved of $32.4 million for each of the three years ended December 31, 2004, 2003, and 2002. Since the petition date, Ignition has been relieved a total of $105.3 million of interest payable under this note.
Federal-Mogul has pledged 100% of Ignition’s capital stock and also provided collateral in the form of a pledge of inventories, property, plant and equipment, real property and intellectual properties to secure certain outstanding debt of Federal-Mogul. In addition, Ignition has guaranteed fully and unconditionally, on a joint and several basis, the obligation to pay principal and interest under Federal-Mogul’s Senior Credit Agreement and its publicly registered debt. Such pledges and guarantees have also been made by other subsidiaries of Federal-Mogul. Federal-Mogul is in default of the terms of such debt agreements. Borrowings under such agreements aggregated $4,026.9 million and $4,020.7 million as of December 31, 2004 and 2003, respectively.
10. Net Parent Investment
Changes in net parent investment were as follows:
| (Millions of Dollars) | ||||
Balance at January 1, 2002 | $ | 1.0 | ||
Comprehensive income | 21.5 | |||
Intercompany transactions, net | (60.6 | ) | ||
Balance at December 31, 2002 | (38.1 | ) | ||
Comprehensive income | 41.5 | |||
Intercompany transactions, net | (81.9 | ) | ||
Balance at December 31, 2003 | (78.5 | ) | ||
Comprehensive income | 68.3 | |||
Intercompany transactions, net | (55.3 | ) | ||
Balance at December 31, 2004 | $ | (65.5 | ) | |
Ignition includes accumulated other comprehensive loss in Net Parent Investment. At December 31, 2004 accumulated other comprehensive loss included $53.8 million of foreign currency translation adjustments and $(4.1) million of minimum pension funding. At December 31, 2003 accumulated other comprehensive loss included $41.2 million of foreign currency translation adjustments and $(4.1) million of minimum pension funding.
11. Income Taxes
Ignition files a consolidated return with its parent for U.S. federal income tax purposes. Federal income tax expense is calculated on a separate-return basis for financial reporting purposes.
| Year Ended December 31 | ||||||||||
| 2004 | 2003 | 2002 | ||||||||
| (Millions of Dollars) | ||||||||||
Components of income tax expense (benefit) | ||||||||||
Current | $ | 29.9 | $ | (0.2 | ) | $ | 14.4 | |||
Deferred | 1.3 | 15.0 | 7.0 | |||||||
Income tax expense | $ | 31.2 | $ | 14.8 | $ | 21.4 | ||||
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A reconciliation between the statutory federal income tax rate and the effective tax rate is as follows:
| Year Ended December 31 | |||||||||
| 2004 | 2003 | 2002 | |||||||
Effective tax rate reconciliation: | |||||||||
U.S. Federal statutory rate | 35 | % | 35 | % | 35 | % | |||
State and local taxes | — | 1 | 1 | ||||||
Foreign operations | (7 | ) | 1 | (7 | ) | ||||
Goodwill amortization and other | 8 | 8 | 3 | ||||||
Valuation allowance | (2 | ) | (24 | ) | 4 | ||||
Effective tax rate | 34 | % | 21 | % | 36 | % | |||
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the related amounts used for income tax purposes. Significant components of the Ignition net deferred tax asset are non-deductible accruals and amortization and depreciation timing differences.
| December 31 | ||||||||
| 2004 | 2003 | |||||||
| (Millions of Dollars) | ||||||||
Net current deferred tax assets | $ | 25.2 | $ | 9.3 | ||||
Net long-term deferred tax assets | 89.4 | 97.7 | ||||||
Net deferred tax assets | 114.6 | 107.0 | ||||||
Valuation allowance | (124.8 | ) | (115.8 | ) | ||||
Net deferred tax liabilities | $ | (10.2 | ) | $ | (8.8 | ) | ||
As Ignition files a consolidated tax return with Federal-Mogul, the net deferred tax liabilities at December 31, 2004 and December 31, 2003 are components of the net parent investment.
12. Pension Plans
Ignition is included in the Federal-Mogul Corporation Pension Plan. As such, the related pension liability is recorded in Net Parent Investment at December 31, 2004 and 2003.
The pension charge allocated to Ignition was $1.7 million, $2.6 million and $5.0 million for the years ended December 31, 2004, 2003 and 2002, respectively.
13. Postretirement Benefits Other Than Pensions
Benefits provided to employees of Ignition under various Federal-Mogul postretirement plans other than pensions, all of which are unfunded, include retiree medical care, dental care, prescription drugs and life insurance, with medical care accounting for approximately 40% of the total. The majority of participants under such plans are retirees. The expense related to such plans approximated $13.5 million, $13.3 million and $12.5 million, for 2004, 2003 and 2002, respectively.
14. Concentrations of Credit Risk and Other
Financial instruments, which potentially subject Ignition to concentrations of credit risk, consist primarily of accounts receivable and cash investments. Ignition’s customer base is primarily in the automotive industry. Ignition’s credit evaluation process, reasonably short collection terms and the geographical dispersion of sales transactions help to mitigate any concentration of credit risk. Ignition requires placement of cash in financial
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FEDERAL-MOGUL IGNITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
institutions evaluated as highly creditworthy. Ignition performs periodic credit evaluations of their customers and generally does not require collateral.
Ignition operates in a single business segment. Ignition manufactures and distributes spark plugs, wiper blades, lamps, and other products for use by the automotive aftermarket and in automobile assemblies. No single customer accounted for 10% or more of revenues in 2004, 2003 or 2002. The following table shows geographic information:
| Third Party Sales | Net Property, Plant and Equipment | ||||||||||||||
| Year Ended December 31 | December 31 | ||||||||||||||
| 2004 | 2003 | 2002 | 2004 | 2003 | |||||||||||
| (Millions of Dollars) | |||||||||||||||
United States | $ | 428.0 | $ | 426.6 | $ | 438.9 | $ | 108.1 | $ | 110.6 | |||||
Mexico | 201.2 | 167.1 | 142.2 | 111.2 | 102.7 | ||||||||||
Europe | 107.5 | 99.7 | 82.9 | 57.6 | 60.4 | ||||||||||
Other | 25.0 | 20.9 | 17.1 | 1.0 | 1.0 | ||||||||||
| $ | 761.7 | $ | 714.3 | $ | 681.1 | $ | 277.9 | $ | 274.7 | ||||||
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
Federal-Mogul Corporation
We have audited the accompanying consolidated balance sheets of Federal-Mogul Powertrain, Inc. and subsidiaries, a wholly-owned subsidiary of Federal-Mogul Corporation, as of December 31, 2004 and 2003 and the related consolidated statements of operations and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Federal-Mogul Powertrain, Inc. and subsidiaries at December 31, 2004 and 2003 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with U.S generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming that Federal-Mogul Powertrain, Inc. and subsidiaries will continue as a going concern. As more fully described in the notes to the consolidated financial statements, on October 1, 2001, Federal-Mogul Corporation and its wholly-owned United States subsidiaries, which includes Federal-Mogul Powertrain, Inc. filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy Code. Uncertainties inherent in the bankruptcy process raise substantial doubt about Federal-Mogul Powertrain, Inc.’s ability to continue as a going concern. Management’s intentions with respect to these matters are also described in the notes. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
As discussed in Note 6 to the consolidated financial statements, Federal-Mogul Powertrain, Inc. and subsidiaries changed its method of accounting for goodwill and indefinite-lived intangible assets in 2002.
/s/ ERNST & YOUNG LLP
Detroit, Michigan
February 25, 2005
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FEDERAL-MOGUL POWERTRAIN, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
| Year Ended December 31 | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| (Millions of Dollars) | ||||||||||||
Third party sales | $ | 545.7 | $ | 522.8 | $ | 572.9 | ||||||
Affiliate sales | 38.7 | 35.5 | 41.2 | |||||||||
Total net sales | 584.4 | 558.3 | 614.1 | |||||||||
Cost of products sold | 486.0 | 469.3 | 502.9 | |||||||||
Gross margin | 98.4 | 89.0 | 111.2 | |||||||||
Selling, general and administrative expenses | 64.8 | 61.3 | 74.4 | |||||||||
Restructuring charges | 1.0 | 1.8 | 10.3 | |||||||||
Gain on settlement of outstanding claim | (18.5 | ) | — | — | ||||||||
Adjustment of long-lived assets to fair value | 9.0 | 0.2 | 25.3 | |||||||||
Other expense (income), net | 2.9 | (2.9 | ) | 0.9 | ||||||||
Earnings from continuing operations before income taxes and cumulative effect of change in accounting principle | 39.2 | 28.6 | 0.3 | |||||||||
Income tax expense | 0.2 | 0.1 | 3.7 | |||||||||
Earnings (loss) from continuing operations before cumulative effect of change in accounting principle | 39.0 | 28.5 | (3.4 | ) | ||||||||
Earnings (loss) from discontinued operations, net of income taxes | 0.8 | (17.0 | ) | (6.4 | ) | |||||||
Cumulative effect of change in accounting principle | — | — | (196.5 | ) | ||||||||
Net Income (Loss) | $ | 39.8 | $ | 11.5 | $ | (206.3 | ) | |||||
See accompanying notes to consolidated financial statements.
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FEDERAL-MOGUL POWERTRAIN, INC.
CONSOLIDATED BALANCE SHEETS
| December 31 | ||||||||
| 2004 | 2003 | |||||||
| (Millions of Dollars) | ||||||||
| ASSETS | ||||||||
Current Assets: | ||||||||
Accounts receivable, net | $ | 57.0 | $ | 59.1 | ||||
Inventories, net | 28.1 | 30.2 | ||||||
Other | 8.1 | 9.4 | ||||||
Total Current Assets | 93.2 | 98.7 | ||||||
Property, plant and equipment, net | 222.4 | 255.8 | ||||||
Goodwill and indefinite-lived intangible assets | 103.1 | 103.1 | ||||||
Other noncurrent assets | 18.5 | 16.7 | ||||||
| $ | 437.2 | $ | 474.3 | |||||
| LIABILITIES AND NET PARENT INVESTMENT | ||||||||
Current Liabilities: | ||||||||
Accounts payable | $ | 20.9 | $ | 19.1 | ||||
Accrued compensation | 13.0 | 13.8 | ||||||
Restructuring reserves | 1.6 | 4.6 | ||||||
Other accrued liabilities | 11.1 | 16.0 | ||||||
Total Current Liabilities | 46.6 | 53.5 | ||||||
Other long-term liabilities | 1.7 | 2.9 | ||||||
Liabilities subject to compromise | 650.1 | 650.0 | ||||||
Minority interest in consolidated subsidiaries | 0.4 | 20.4 | ||||||
Net Parent Investment | (261.6 | ) | (252.5 | ) | ||||
Total Liabilities and Net Parent Investment | $ | 437.2 | $ | 474.3 | ||||
See accompanying notes to consolidated financial statements.
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FEDERAL-MOGUL POWERTRAIN, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
| Year Ended December 31 | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| (Millions of Dollars) | ||||||||||||
Cash Provided From (Used By) Operating Activities | ||||||||||||
Net income (loss) | $ | 39.8 | $ | 11.5 | $ | (206.3 | ) | |||||
Adjustments to reconcile net earnings (loss) to net cash provided from operating activities | ||||||||||||
Cumulative effect of change in accounting principle | — | — | 202.2 | |||||||||
Depreciation and amortization | 32.6 | 33.6 | 59.5 | |||||||||
Settlement of outstanding claim | (18.5 | ) | — | — | ||||||||
Restructuring charges | 1.0 | 1.9 | 11.2 | |||||||||
Payments against restructuring reserves | (4.0 | ) | (4.9 | ) | — | |||||||
Adjustment of long-lived assets to fair value | 9.0 | 12.3 | 25.3 | |||||||||
(Increase) decrease in accounts receivable | 2.1 | 21.6 | (1.5 | ) | ||||||||
(Increase) decrease in inventories | 0.5 | 6.7 | (3.3 | ) | ||||||||
Increase (decrease) in accounts payable | 1.8 | (5.8 | ) | 4.0 | ||||||||
Changes in other assets and liabilities, net | (1.3 | ) | 27.5 | (30.0 | ) | |||||||
Net Cash Provided From Operating Activities | 63.0 | 104.4 | 61.1 | |||||||||
Cash Provided From (Used By) Investing Activities | ||||||||||||
Capital expenditures | (22.3 | ) | (29.1 | ) | (41.1 | ) | ||||||
Proceeds from sale of businesses | 8.2 | 14.7 | 1.6 | |||||||||
Net Cash Used By Investing Activities | (14.1 | ) | (14.4 | ) | (39.5 | ) | ||||||
Cash Used By Financing Activities | ||||||||||||
Transfers to parent | (48.9 | ) | (90.0 | ) | (21.6 | ) | ||||||
Net Cash Used By Financing Activities | (48.9 | ) | (90.0 | ) | (21.6 | ) | ||||||
Net change in cash | — | �� | — | — | ||||||||
Cash at beginning of year | — | — | — | |||||||||
Cash at end of year | $ | — | $ | — | $ | — | ||||||
See accompanying notes to consolidated financial statements.
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FEDERAL-MOGUL POWERTRAIN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
1. Basis of Presentation and Summary of Significant Accounting Policies
The accompanying financial statements reflect the consolidated assets, liabilities and operations of Federal-Mogul Powertrain, Inc. and its subsidiaries (“Powertrain”). Powertrain is a wholly-owned subsidiary of T&N Industries Inc., which is a wholly-owned subsidiary of Federal-Mogul Corporation (“Federal-Mogul”). Powertrain manufactures pistons, rings and liners.
Powertrain operates with financial and operational staff on a decentralized basis. Federal-Mogul provides certain centralized services for employee benefits administration, cash management, risk management, legal services, public relations, domestic tax reporting and internal and external audit. Federal-Mogul charges Powertrain for all such direct expenses incurred on its behalf. General expenses, excluding Chapter 11 and Administration related organization expenses, that are not directly attributable to the operations of Powertrain have been allocated based on management’s estimates, primarily driven by sales. Management believes that this allocation method is reasonable.
The accompanying consolidated financial statements are presented as if Powertrain had existed as an entity separate from its parent during the periods presented and include the assets, liabilities, revenues and expenses that are directly related to Powertrain’s operations.
Powertrain’s separate debt and related interest expense have been included in the consolidated financial statements. Powertrain is fully integrated into its parent’s cash management system, as such, all cash requirements are provided by its parent and any excess cash generated by Powertrain is transferred to its parent.
Principles of Consolidation:The consolidated financial statements include the accounts of Powertrain and all majority-owned subsidiaries and other controlled entities. Intercompany accounts and transactions have been eliminated in consolidation. Investment in affiliates of not more than 20% are accounted for using the cost method, while investments greater than 20% and not more than 50% are accounted for using the equity method.
Use of Estimates:The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported therein. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may be based upon amounts that differ from these estimates.
Trade Accounts Receivable and Allowance for Doubtful Accounts:Trade accounts receivable are stated at historical value, which approximates fair value. Powertrain does not generally require collateral for its trade accounts receivable.
Accounts receivable have been reduced by an allowance for amounts that may become uncollectible in the future. This estimated allowance is based primarily on management’s evaluation of specific balances as the balances become past due, the financial condition of its customers and Powertrain’s historical experience of write-offs. If not reserved through specific examination procedures, Powertrain’s general policy for uncollectible accounts is to reserve based upon the aging categories of accounts receivable and upon whether the amounts are due from an OE customer or Aftermarket customer. Past due status is based upon the invoice date of the original amounts outstanding. The allowance for doubtful accounts was $5.7 million and $9.3 million at December 31, 2004 and 2003, respectively.
Inventories:Inventories are stated at the lower of cost or market. Cost determined by the last-in, first-out (LIFO) method was used for 19% and 14% of the inventory at December 31, 2004 and 2003, respectively. The remaining inventories are recorded using the first-in, first out (FIFO) method. LIFO approximated FIFO cost at December 31, 2004 and 2003. Inventories have also been reduced by an allowance for excess and obsolete inventories based on management’s review of on-hand inventories compared to estimated future sales and usage.
Investments in non-consolidated entities:Equity investments that comprise more than 20% but less than 50% of the outstanding equity of the investee are accounted for by the equity investment method and are not consolidated. Such investments aggregated $15.6 million and $15.7 million at December 31, 2004 and 2003, respectively, and are included in the consolidated balance sheets as “other non-current assets”. Net income from non-consolidated equity investments was $6.2 million, $6.6 million and $4.5 million for 2004, 2003 and 2002, respectively, and is included in the statements of operations as “other expense, net”.
Long-Lived Assets:Long-lived assets, such as property, plant and equipment and definite-lived intangible assets, are stated at cost. Depreciation and amortization is computed principally by the straight-line method for financial reporting purposes and by accelerated methods for income tax purposes. Definite-lived assets are periodically reviewed for impairment indicators. If impairment indicators exist, the Company performs the required analysis and records an impairment charge, as required, in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS No. 144). If the carrying value of a long-lived asset is considered impaired, an impairment charge is recorded for the amount by which the carrying value of the long-lived asset exceeds its fair value.
Indefinite-lived Intangible Assets: Indefinite-lived intangible assets, such as goodwill and trademarks, are carried at historical value and not amortized. Indefinite-lived intangible assets are reviewed for impairment annually as of October 1, or more frequently if impairment indicators exist. The impairment analysis compares the estimated fair value of these assets to the related carrying value, and an impairment charge is recorded for any excess of carrying value over estimated fair value. The estimated fair value is based upon consideration of various valuation methodologies, including guideline transaction multiples, multiples of current earnings, and projected future cash flows discounted at rates commensurate with the risk involved.
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FEDERAL-MOGUL POWERTRAIN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Revenue Recognition:Powertrain records sales when products are shipped and title has transferred to the customer, the sales price is fixed or determinable and the collectibility of revenue is reasonably assured. Affiliate sales are transferred at cost. Accruals for sales returns and other allowances are provided at the time of shipment based upon past experience. Adjustments to such returns and allowances are made as new information becomes available.
Shipping and Handling Costs:Powertrain recognizes shipping and handling costs as a component of cost of products sold in the statement of operations.
Recoverable Customer Engineering and Tooling:Costs of pre-production tooling and engineering that Powertrain will not own and that will be used in producing products under long-term supply arrangements are expensed as incurred unless the supply arrangement provides Powertrain the noncancelable right to use the tools or the reimbursement of such costs is agreed to by the customer. Pre-production tooling and engineering costs that are owned by Powertrain are capitalized as part of machinery and equipment, and are depreciated over the shorter of the toolings’ expected life or the duration of the related program.
Research and Development Costs:Powertrain expenses research and development costs as incurred. Research and development expense was $3.2 million, $2.5 million and $3.0 million for 2004, 2003 and 2002, respectively.
Restructuring:Powertrain defines restructuring expense to include charges incurred with exit or disposal activities accounted for in accordance with SFAS No. 146, employee severance costs incurred as a result of an exit or disposal activity accounted for in accordance with SFAS Nos. 88 and 112, and pension and other postemployment benefit costs incurred as a result of an exit or disposal activity accounted for in accordance with SFAS Nos. 87 and 106.
Fair Value of Financial Instruments:The carrying amounts of certain financial instruments such as accounts receivable and accounts payable approximate their fair value.
Net Parent Investment: The Net Parent Investment account reflects the balance of Powertrain historical earnings, intercompany debt, income taxes accrued and deferred, postemployment liabilities and other transactions between Powertrain and Federal-Mogul.
Reclassifications:Certain items in the prior year financial statements have been reclassified to conform to the presentation used in 2004.
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FEDERAL-MOGUL POWERTRAIN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
2. Voluntary Reorganization Under Chapter 11 and Adminstration
On October 1, 2001 (the “Petition Date”), Federal-Mogul Corporation (the “Company” or “Federal-Mogul”) and all of its wholly-owned United States subsidiaries filed voluntary petitions for reorganization (the “U.S. Restructuring”) under Chapter 11 of the United States Bankruptcy Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”). Also on October 1, 2001, certain of the Company’s United Kingdom subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the Bankruptcy Code and petitions for Administration (the “U.K. Restructuring”) under the United Kingdom Insolvency Act of 1986 (the “Act”) in the High Court of Justice, Chancery division in London, England (the “High Court”). The Company and its U.S. and U.K. subsidiaries included in the U.S. Restructuring and U.K. Restructuring are herein referred to as the “Debtors”. The U.S. Restructuring and U.K. Restructuring are herein referred to as the “Restructuring Proceedings”. The Chapter 11 cases of the Debtors (collectively, the “Chapter 11 Cases”) have been consolidated for purposes of joint administration asIn re: Federal-Mogul Global Inc., T&N Limited, et. al (Case No. 01-10578(RTL)). Subsidiaries outside of the aforementioned U.S. and U.K. subsidiaries are not party to the Chapter 11 Cases and, therefore, are not currently provided protection from creditors by any bankruptcy court and are operating in the normal course.
The Restructuring Proceedings were initiated in response to a sharply increasing number of asbestos-related claims and their demand on the Company’s cash flows and liquidity. Under the Restructuring Proceedings, the Debtors expect to develop and implement a plan for addressing the asbestos-related claims against them.
Consequences of the Restructuring Proceedings
The, U.S. Debtors, including Powertrain, are operating their businesses as debtors-in-possession subject to the provisions of the Bankruptcy Code. The U.K. Debtors are continuing to manage their operations under the supervision of Administrators approved by the High Court. All vendors will be paid for all goods furnished and services provided after the Petition Date. However, as a consequence of the Restructuring Proceedings, pending litigation against the Debtors as of the Petition Date is stayed (subject to certain exceptions in the case of governmental authorities), and no party may take any action to pursue or collect pre-petition claims except pursuant to an order of the Bankruptcy Court or the High Court as applicable. It is the Debtors’ intention to address all pending and future asbestos-related claims and all other pre-petition claims through a unified plan of reorganization under the Bankruptcy Code or scheme of arrangement under the Act.
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FEDERAL-MOGUL POWERTRAIN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
In the U.S., four committees, representing asbestos claimants, asbestos property damage claimants, unsecured creditors and equity security holders (collectively, the “Committees”) have been appointed as official committees in the Chapter 11 Cases and, in accordance with the provisions of the Bankruptcy Code, have the right to be heard on all matters that come before the Bankruptcy Court. The Committees, together with the legal representative for the future asbestos claimants, play important roles in the Restructuring Proceedings. In the U.K., the Administrators have appointed a creditors committee, representing both asbestos claimants and general unsecured creditors.
On June 4, 2004, the Third Amended Joint Plan of Reorganization (the “Plan”) for Federal-Mogul and the other U.S. and U.K. Debtors was filed with the Bankruptcy Court. The Plan was jointly proposed by Federal-Mogul, the Unsecured Creditors Committee, the Asbestos Claimants Committee, the Future Asbestos Claimants Representative, the Agent for the Prepetition Bank Lenders and the Equity Security Holders Committee (collectively referred to as the “Plan Proponents”). Also on June 4, 2004, a Disclosure Statement to be used in soliciting votes to accept or reject the Plan (the “Disclosure Statement”) was approved by the Bankruptcy Court and a December 2004 hearing was scheduled to determine whether the Bankruptcy Court should approve the Plan. On December 7, 2004, the Bankruptcy Court delayed this confirmation hearing pending a hearing to estimate asbestos personal injury claims against the U.K. Debtors. Such estimation hearing has not yet been scheduled.
On July 12, 2004, solicitation packages containing the Plan and Disclosure Statement, various supporting documents and a ballot, if appropriate, were mailed to known creditors of Federal-Mogul and holders of common and preferred stock interests in Federal-Mogul. All votes were due by the close of business on November 3, 2004. Although the Plan Proponents have granted extensions of the November 3, 2004 voting deadline to a few significant claimants, the voting agent has confirmed that the overwhelming majority of the classes of claims and interests have voted to accept the Plan. For the few classes of claims that voted to reject the Plan, the Plan Proponents intend to either amend the Plan so as to obtain such classes’ accepting votes or seek to confirm the Plan over the objection of such classes.
The Plan provides that asbestos personal injury claimants, both present and future, will be permanently channeled to a trust or series of trusts established pursuant to Section 524(g) of the Bankruptcy Code, thereby protecting Federal-Mogul and its affiliates in the Chapter 11 Cases from existing and future asbestos liability. Although certain issues remain to be resolved, the Plan provides that all currently outstanding stock of Federal-Mogul will be cancelled, and 50.1% of newly authorized and issued common stock of reorganized Federal-Mogul will be distributed to the asbestos trusts, and 49.9% of the newly authorized and issued common stock will be distributed pro rata to the noteholders. If the classes of holders of common and preferred stock of Federal-Mogul vote in favor of the Plan, the holders of currently outstanding common and preferred stock of Federal-Mogul will receive warrants that may be used to purchase shares of reorganized Federal-Mogul at a predetermined exercise price.
Unsecured creditors, including trade creditors, of the U.S. Debtors are projected to receive cash distributions under the Plan equal to 35% of their allowed claims, payable in three annual installments, provided that the aggregate of all allowed unsecured claims against the U.S. Debtors does not exceed $258 million. Any excess above this amount could result in a reduction in the percentage distribution that the unsecured creditors of the U.S. Debtors ultimately receive. Unsecured creditors, including trade creditors, of the U.K. Debtors will receive distributions that vary according to terms specified within the Plan and Disclosure Statement.
There are two possible types of U.K. schemes of arrangements. The first is under Section 425 of the Companies Act of 1985, which may involve a scheme for the reconstruction of the Company. If a majority in number representing three-fourths in value of the creditors or members or any class of them agree to the compromise or arrangement, it is binding if sanctioned by the High Court. Section 425 may be invoked where there is an Administration order in force in relation to the Company. The other possible type of scheme arises under Section 1 of the Insolvency Act of 1986 in relation to Company Voluntary Arrangements (“CVA”). If a majority in value representing more than three-fourths of the creditors agrees to the compromise or arrangement set out in the CVA proposal, it will be approved.
Powertrain is unable to predict with a high degree of certainty at this time what treatment will be accorded under any such plan of reorganization to claims arising from intercompany indebtedness, licenses, executory contracts, transfers of goods and services, and other intercompany arrangements, transactions and relationships that were entered into prior to the Petition Date. Various parties in the Chapter 11 Cases may challenge these arrangements, transactions, and relationships, and the outcome of those challenges, if any, may have an impact on the treatment of various claims under such plan of reorganization.
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FEDERAL-MOGUL POWERTRAIN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
The Bankruptcy Court may confirm a plan of reorganization only upon making certain findings required by the Bankruptcy Code, and a plan may be confirmed over the dissent of non-accepting creditors and equity security holders if certain requirements of the Bankruptcy Code are met. The payment rights and other entitlements of pre-petition creditors and equity security holders may be substantially altered by any plan of reorganization confirmed in the Chapter 11 Cases. There is no assurance that there will be sufficient assets to satisfy the Debtors’ pre-petition liabilities in whole or in part, and the pre-petition creditors of some Debtors may be treated differently than those of other Debtors.
Chapter 11 Financing
In connection with the Restructuring Proceedings, Federal-Mogul entered into a DIP credit facility to supplement liquidity and fund operations during the restructuring proceedings. In December 2004, Federal-Mogul renegotiated its DIP credit facility. Prior to December 2004, Federal-Mogul’s DIP credit facility had an interest rate of either the alternate base rate (“ABR”) plus 2 percentage points or a formula based on the London Inter-Bank Offered Rate (“LIBOR”) plus 3 percentage points. The ABR is the greater of either the bank’s prime rate or the base CD rate plus 1 percentage point or the federal funds rate plus ½ percentage point.
The December 2004 DIP credit facility expires in December 2005, and the interest rate is either the alternate base rate (“ABR”) plus 1¼ percentage points or a formula based on the London Inter-Bank Offered Rate (“LIBOR”) plus 2¼ percentage points. The ABR is the greater of either the bank’s base rate or the federal funds rate plus ½ percentage point. In addition, the commitment available under the DIP credit facility is mandatorily reduced by a portion of proceeds received from future asset or business divestitures.
Financial Statement Presentation
The accompanying consolidated financial statements have been prepared in accordance with AICPA Statement of Position 90-7 (“SOP 90-7”), “Financial Reporting by Entities in Reorganization under the Bankruptcy Code” and on a going concern basis, which contemplates continuity of operations and realization of assets and liquidation of liabilities in the ordinary course of business. However, as a result of the Restructuring Proceedings, such realization of assets and liquidation of liabilities, without substantial adjustments and/or changes of ownership, is highly uncertain. Given this uncertainty, there is substantial doubt about the ability of Powertrain to continue as a going concern. While operating as debtors-in-possession under the protection of Chapter 11 of the Bankruptcy Code and Administration under the Act, and subject to approval of the Bankruptcy Court, Administrators or the High Court or otherwise as permitted in the ordinary course of business, Powertrain may sell or otherwise dispose of assets and liquidate or settle liabilities for some amounts other than those reflected in the consolidated financial statements. Further, a plan of reorganization or scheme of arrangement could materially change the amounts and classifications in the historical consolidated financial statements.
As reflected in the consolidated financial statements, “Liabilities subject to compromise” refers to liabilities of entities of Powertrain included in the Restructuring Proceedings incurred prior to the Petition Date. The amounts of the various liabilities that are subject to compromise are set forth below. These amounts represent Powertrain’s estimate of known or potential pre-petition claims to be resolved in connection with the Restructuring Proceedings. Such claims remain subject to future adjustments. Future adjustments may result from (i) negotiations; (ii) actions of the Bankruptcy Court, High Court or Administrators; (iii) further developments with respect to disputed claims; (iv) rejection of executory contracts and unexpired leases; (v) the determination as to the value of any collateral securing claims; (vi) proofs of claim; or (vii) other events. Payment terms for these claims will be established in connection with the Restructuring Proceedings.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
| December 31 | ||||||
| 2004 | 2003 | |||||
Accounts payable to affiliated companies | $ | 618.1 | $ | 618.1 | ||
Accounts payable | 26.8 | 26.5 | ||||
Environmental liabilities | 3.1 | 3.5 | ||||
Other accrued liabilities | 1.1 | 0.9 | ||||
Debt | 1.0 | 1.0 | ||||
| $ | 650.1 | $ | 650.0 | |||
The Debtors, including Powertrain, have received approval from the Bankruptcy Court to pay or otherwise honor certain of their pre-petition obligations, including employee wages, salaries, benefits and other employee obligations and from limited available funds, pre-petition claims of certain critical vendors, certain customer programs and warranty claims and certain other pre-petition claims.
Pursuant to the Bankruptcy Code, Federal-Mogul has filed schedules with the Bankruptcy Court setting forth the assets and liabilities of the Debtors as of the Petition Date. On October 4, 2002, the Debtors issued approximately 100,000 proof of claim forms to its current and prior employees, known creditors, vendors and other parties with whom the Debtors have previously conducted business. To the extent that recipients disagree with the claims as quantified on these forms, the recipient may file discrepancies with the Bankruptcy Court. Differences between amounts recorded by the Debtors and claims filed by creditors will be investigated and resolved as part of the Restructuring Proceedings. The Bankruptcy Court ultimately will determine liability amounts that will be allowed for these claims in the Chapter 11 Cases. A March 3, 2003 bar date was set for the filing of proofs of claim against the Debtors. Because the Debtors have not completed evaluation of the claims received in connection with this process, the ultimate number and allowed amount of such claims are not presently known. The resolution of such claims could result in a material adjustment to the Company’s financial statements.
The Debtors, including Powertrain, continue to review and analyze the proofs of claim filed to date. In addition, the Debtors continue to file objections and seek stipulations to certain claims. Additional claims may be filed after the general bar date, which could be allowed by the Bankruptcy Court. Accordingly, the ultimate number and allowed amount of such claims are not presently known and cannot be reasonably estimated at this time. The resolution of such claims could result in a material adjustment to the Company’s financial statements.
The appropriateness of using the going concern basis for the Powertrain’s financial statements is dependent upon, among other things: (i) Federal-Mogul’s ability to comply with the terms of the DIP credit facility and any cash management order entered by the Bankruptcy Court in connection with the Chapter 11 Cases; (ii) the ability of Federal-Mogul to maintain adequate cash on hand; (iii) the ability of Federal-Mogul to generate cash from operations; (iv) confirmation of a plan(s) of reorganization under the Bankruptcy Code; (v) confirmation of a scheme(s) of arrangement in the U.K. under Administration; and (vi) Federal-Mogul’s ability to achieve profitability following such confirmations.
3. Discontinued Operations
In connection with its strategic planning process, Federal-Mogul assesses its operations for market position, product technology and capability, and profitability. Those businesses determined by management not to have a sustainable competitive advantage are considered non-core and may be considered for divestiture or other exit activities. Over the past several years, Powertrain has divested numerous non-core businesses. The elimination of these non-core businesses has freed up both human and capital resources which have been devoted to Federal-Mogul’s core businesses.
During December 2004, Powertrain divested its transmission operations located in Dayton, Ohio. Powertrain received aggregate proceeds of $8.2 million. The sale resulted in a net gain of $2.8 million.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
During April 2003, Powertrain completed the divestitures of its U.S. camshaft operations, which include manufacturing operations in Grand Haven, Michigan and Orland, Indiana, as well as the Company’s share of an assembled camshaft joint venture operation in Grand Haven. Powertrain received aggregate proceeds of $14.7 million.
In July 2002, Powertrain completed the divestiture of its automotive camshaft manufacturing plant in Jackson, Michigan, to Camshaft Machine Company, a new company formed by the facility’s management. Powertrain also entered into a three-year supply agreement with Camshaft Machine Company, under which Powertrain will continue to market and sell aftermarket camshafts produced at the Jackson facility through its aftermarket business. This business employed approximately 90 employees and had 2001 net sales of $5.9 million. Powertrain received aggregate proceeds of $1.6 million. The sale did not result in a material gain or loss.
Further information related to Powertrain’s discontinued operations is as follows:
| Year Ended December 31 | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| (Millions of Dollars) | ||||||||||||
Net sales | $ | 10.0 | $ | 29.9 | $ | 97.1 | ||||||
Cost of products sold | 12.0 | 30.3 | 94.0 | |||||||||
Gross margin | (2.0 | ) | (0.4 | ) | 3.1 | |||||||
Restructuring charges | — | 0.1 | 0.9 | |||||||||
Adjustment of long-lived assets to fair value | — | 12.1 | — | |||||||||
Net loss (income) on divestitures | (2.8 | ) | 5.0 | 1.7 | ||||||||
Other (income) expense, net | — | (0.6 | ) | 1.0 | ||||||||
Income (loss) before income taxes | 0.8 | (17.0 | ) | (0.5 | ) | |||||||
Income tax expense | — | — | 0.2 | |||||||||
Income (loss) from discontinued operations before cumulative effect of change in accounting principle | 0.8 | (17.0 | ) | (0.7 | ) | |||||||
Cumulative effect of change in accounting principle | — | — | (5.7 | ) | ||||||||
Income (loss) from discontinued operations | $ | 0.8 | $ | (17.0 | ) | $ | (6.4 | ) | ||||
4. Inventories
Inventories consisted of the following:
| December 31 | ||||||||
| 2004 | 2003 | |||||||
| (Millions of Dollars) | ||||||||
Raw materials | $ | 7.5 | $ | 9.1 | ||||
Work-in-process | 10.3 | 9.9 | ||||||
Finished goods | 12.0 | 13.6 | ||||||
| 29.8 | 32.6 | |||||||
Valuation reserves | (1.7 | ) | (2.4 | ) | ||||
| $ | 28.1 | $ | 30.2 | |||||
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
5. Property, Plant and Equipment
Property, plant and equipment consisted of the following:
Estimated Useful Life | December 31 | |||||||||
| 2004 | 2003 | |||||||||
| (Millions of Dollars) | ||||||||||
Land | — | $ | 3.2 | $ | 3.9 | |||||
Buildings and building improvements | 24-40 years | 62.2 | 65.5 | |||||||
Machinery and equipment | 3-12 years | 323.0 | 349.5 | |||||||
| 388.4 | 418.9 | |||||||||
Accumulated depreciation | (166.0 | ) | (163.1 | ) | ||||||
| $ | 222.4 | $ | 255.8 | |||||||
Future minimum payments under noncancelable operating leases with initial or remaining terms of more than one year are as follows, in millions:
2005 | $ | 1.0 | |
2006 | 1.0 | ||
2007 | 1.0 | ||
2008 | 0.8 | ||
2009 | 0.8 | ||
Thereafter | 0.7 |
Total rental expense under operating leases for the years ended December 31, 2004, 2003 and 2002 was $2.2 million, $2.3 million and $2.5 million, respectively, exclusive of property taxes, insurance and other occupancy costs generally payable by Federal-Mogul.
6. Adjustment of Assets to Fair Value
Definite-Lived Long-Lived Assets
Powertrain recorded impairment charges for the years ended December 31, 2004, 2003 and 2002 of $9.0 million, $0.2 million and $25.3 million, respectively, to adjust long-lived tangible assets to their estimated fair values in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS No. 144). The charges were recorded to write-down property, plant and equipment at facilities that the Company is closing or consolidating into other facilities. The fair value of property, plant and equipment was based upon estimated discounted future cash flows and estimates of salvage value. The impairment charges represent the difference between the estimated fair values and the carrying value of the subject assets.
Goodwill and Other Indefinite-Lived Intangible Assets
Effective January 1, 2002, Powertrain adopted SFAS No. 142, “Goodwill and Other Intangible Assets” (SFAS No. 142) resulting in the discontinuance of amortization of goodwill and indefinite-lived intangible assets. The adoption of this standard also required the reclassification of various intangible asset classes according to the measurability of their useful lives. Upon the adoption of SFAS No. 142, Powertrain recorded a non-cash charge of $196.5 million to reduce the carrying value of its goodwill and indefinite-lived intangible assets to their estimated fair value as required by SFAS No. 142. The charge is presented as a cumulative effect of change in accounting principle in the consolidated statement of operations for the year ended December 31, 2002. Powertrain completed its required annual impairment analyses as of October 1, 2004 and, based upon these analyses, no impairment charge was required.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
7. Restructuring Charges
Powertrain recognized $1.0 million, $1.8 million, and $10.3 million of restructuring charges in 2004, 2003, and 2002, respectively, primarily related to severance costs associated with the continuing consolidation of operations to maximize production efficiencies and achieve economies of scale. Cash payments against these restructuring reserves during 2004 and 2003 were $4.0 and $4.9 million, respectively. There were no cash payments for restructuring charges in 2002.
8. Commitments and Contingencies
Environmental Liabilities
Powertrain has identified certain present and former properties at which it may be responsible for cleaning up environmental contamination, in some cases as a result of contractual commitments. Powertrain is actively seeking to resolve these matters. Although difficult to quantify based on the complexity of the issues, Powertrain has accrued amounts corresponding to its best estimate of the costs associated with such matters based upon current available information from site investigations and consultants.
Environmental reserves were $5.9 million and $6.4 million at December 31, 2004 and 2003, respectively and are included in the consolidated balance sheets as follows:
| December 31 | ||||||
| 2004 | 2003 | |||||
| (Millions of Dollars) | ||||||
Current liabilities | $ | 1.1 | $ | 1.4 | ||
Long-term accrued liabilities | 1.7 | 1.5 | ||||
Liabilities subject to compromise | 3.1 | 3.5 | ||||
| $ | 5.9 | $ | 6.4 | |||
The decrease in the reserve during 2004 resulted primarily from a downward adjustment of certain reserves based on new and more accurate estimates of expected costs. Management believes that such accruals will be adequate to cover Powertrain’s estimated liability for its exposure in respect to such matters. In the event that such liabilities were to significantly exceed the amounts recorded by Powertrain, Powertrain’ results of operations and financial condition could be materially affected. At December 31, 2004, management estimates that reasonably possible material additional losses above and beyond management’s best estimate of required remediation costs as recorded approximates $5 million.
Environmental reserves subject to compromise include those that may be reduced in Federal-Mogul’s bankruptcy proceeding because they may be determined to be “dischargeable debts” incurred prior to Federal-Mogul’s filing for bankruptcy. Such liabilities generally arise at either (1) commercial waste disposal sites to which Powertrain and other companies sent wastes for disposal, or (2) sites in relation to which Powertrain has a contractual obligation to indemnify the current owner of a site for the costs of cleanup of contamination that was released into the environment before Powertrain sold the site.
Environmental reserves determined not to be subject to compromise include those which arise from a legal obligation of Powertrain, under an administrative or judicial order, to perform cleanup at a site. Such obligations are normally associated with sites, which a bankrupt entity such as Powertrain owns and either operates or formerly operated.
The best estimate of environmental liability at a site may change from time to time during a bankruptcy proceeding even though the liability relating to that site is subject to compromise and Powertrain’s responsibility to make payments is stayed. Notwithstanding the stay of proceedings regarding such a site, activities such as further site investigation and/or actual cleanup work usually continue to be performed by other parties. Such activities may
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
produce new and better information that requires Powertrain to revise its best estimate of total site cleanup costs and its own share of such costs.
9. Redeemable Stock
In 1994, Federal-Mogul Piston Rings Inc., which is a wholly-owned subsidiary of Powertrain, issued 862 shares of class B common stock, redeemable at the option of the holder, to a minority investor. The shares of class B stock were redeemable for $23,201.85 per share plus accrued dividends. This redeemable stock is included in “minority interest in consolidated subsidiaries” in the consolidated balance sheet at December 31, 2003.
In July 2004, Federal-Mogul Piston Rings Inc. reached an agreement with the minority investor whereby the investor exchanged its shares of class B stock for a general unsecured claim of $1.5 million. The settlement agreement was approved by the Bankruptcy Court on July 30, 2004. As a result of this agreement, Powertrain recorded a gain of $18.5 million.
10. Long-Term Debt and Other Financing Arrangements
Powertrain’s cash and indebtedness is managed on a worldwide basis by Federal-Mogul. The majority of the cash provided by or used by a particular division, including Powertrain, is provided through this consolidated cash and debt management system. As a result, the amount of cash or debt historically related to Powertrain is not determinable.
Federal-Mogul allocated to Powertrain $666.1 million of the debt incurred to purchase T&N, plc. and calculated interest at a rate of 6% through the Petition date. In accordance with SOP 90-7, Powertrain stopped recording interest expense on its outstanding notes effective October 1, 2001. Powertrain’s contractual interest not accrued or paid for each of the years 2004, 2003 and 2002 for this note was $40.0 million. Since the petition date, Powertrain has been relieved a total of $130.0 million interest payable under this note.
Federal-Mogul has pledged 100% of Powertrain’s capital stock and also provided collateral in the form of a pledge of inventories, property, plant and equipment, real property and intellectual properties to secure certain outstanding debt of Federal-Mogul. In addition, Powertrain has guaranteed fully and unconditionally, on a joint and several basis, the obligation to pay principal and interest under Federal-Mogul’s Senior Credit Agreement and its publicly registered debt. Such pledges and guarantees have also been made by other subsidiaries of Federal-Mogul. Federal-Mogul is in default of the terms of such debt agreements. Borrowing outstanding on such agreements aggregated $4,026.9 million and $4,020.7 million as of December 31, 2004 and 2003, respectively.
11. Net Parent Investment
Changes in net parent investment were as follows (in millions of dollars):
Balance at January 1, 2002 | $ | 53.9 | ||
Net loss | (206.3 | ) | ||
Intercompany transactions, net | (21.6 | ) | ||
Balance at December 31, 2002 | (174.0 | ) | ||
Net income | 11.5 | |||
Intercompany transactions, net | (90.0 | ) | ||
Balance at December 31, 2003 | (252.5 | ) | ||
Net income | 39.8 | |||
Intercompany transactions, net | (48.9 | ) | ||
Balance at December 31, 2004 | $ | (261.6 | ) | |
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
12. Income Taxes
Powertrain files a consolidated return with Federal-Mogul for U.S. federal income tax purposes. Federal income tax expense is calculated on a separate-return basis for financial reporting purposes.
| Year Ended December 31 | |||||||||
| 2004 | 2003 | 2002 | |||||||
| (Millions of Dollars) | |||||||||
Components of income tax expense | |||||||||
Current | $ | 0.2 | $ | 0.1 | $ | 1.5 | |||
Deferred | — | — | 2.2 | ||||||
Income tax expense | $ | 0.2 | $ | 0.1 | $ | 3.7 | |||
A reconciliation between the statutory federal income tax rate and the effective tax rate is as follows:
| Year Ended December 31 | |||||||||
| 2004 | 2003 | 2002 | |||||||
U.S. Federal statutory rate | 35 | % | 35 | % | 35 | % | |||
State and local taxes | 1 | 5 | (39 | ) | |||||
Nondeductible goodwill and other | (16 | ) | (5 | ) | 34 | ||||
Valuation allowance | (19 | ) | (34 | ) | (120 | ) | |||
Effective tax rate | 1 | % | 1 | % | (90 | )% | |||
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the related amounts used for income tax purposes. Significant components of the Company’s net deferred tax asset are non-deductible accruals, intangible assets and depreciation timing differences.
| December 31 | ||||||||
| 2004 | 2003 | |||||||
| (Millions of Dollars) | ||||||||
Net current deferred tax liabilities | $ | 6.8 | $ | 9.5 | ||||
Net long-term deferred tax assets | 373.8 | 386.0 | ||||||
Gross deferred tax assets | 380.6 | 395.5 | ||||||
Valuation allowance | (380.6 | ) | (395.5 | ) | ||||
Net deferred tax assets | $ | — | $ | — | ||||
13. Pension Plans
Powertrain is included in the Federal-Mogul Corporation Pension Plan. As such the related pension liability is included in Net Parent Investment at December 31, 2004 and 2003. The pension charge allocated to Powertrain, was $5.1 million, $5.4 million and $6.4 million for 2004, 2003 and 2002, respectively.
14. Postretirement Benefits Other Than Pensions
Benefits provided to employees of Powertrain under various Federal-Mogul postretirement plans other than pensions, all of which are unfunded, include retiree medical care, dental care, prescriptions and life insurance, with medical care accounting for approximately 85% of the total. The majority of participants under such plans are retirees. The expense related to such plans approximated $3.1 million, $4.8 million and $4.9 million for 2004, 2003 and 2002, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
15. Concentrations of Credit Risk and Other
Powertrain grants credit to their customers, which are primarily in the automotive industry. Credit risk with respect to trade receivables is generally diversified due to the large number of entities comprising Powertrain customer base and their dispersion across many different countries. Powertrain performs periodic credit evaluations of their customers and generally does not require collateral.
Powertrain operates in a single business segment. Powertrain manufactures and distributes pistons, piston pins, rings, cylinder liners, engine bearings, valve train and transmission products and sealing systems. Powertrain’s largest customers are Ford Motor Co. and General Motors Corporation, which collectively accounted for 28%, 34% and 34%, of Powertrain’s net sales in 2004, 2003, and 2002, respectively. All revenues and assets of Powertrain reside in the United States.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
Federal-Mogul Corporation
We have audited the accompanying consolidated balance sheets of Federal-Mogul Piston Rings, Inc., a wholly-owned subsidiary of Federal-Mogul Corporation, as of December 31, 2004 and 2003, and the related statements of operations and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Federal-Mogul Piston Rings, Inc. at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with U.S. generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that Federal-Mogul Piston Rings, Inc. will continue as a going concern. As more fully described in the notes to the financial statements, on October 1, 2001, Federal-Mogul Corporation and its wholly-owned United States subsidiaries, which includes Federal-Mogul Piston Rings, Inc., filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy Code. Uncertainties inherent in the bankruptcy process raise substantial doubt about Federal-Mogul Piston Ring, Inc.’s ability to continue as a going concern. Management’s intentions with respect to these matters are also described in the notes. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.
As discussed in Note 6 to the consolidated financial statements, Federal-Mogul Piston Rings, Inc. changed its method of accounting for goodwill and indefinite-lived intangible assets in 2002.
/s/ ERNST & YOUNG LLP |
Detroit, Michigan |
February 25, 2005 |
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CONSOLIDATED STATEMENTS OF OPERATIONS
| Year Ended December 31 | |||||||||||
| 2004 | 2003 | 2002 | |||||||||
| (Millions of Dollars) | |||||||||||
Third party sales | $ | 105.3 | $ | 91.8 | $ | 93.6 | |||||
Affiliate sales | 13.3 | 12.2 | 11.5 | ||||||||
Total net sales | 118.6 | 104.0 | 105.1 | ||||||||
Cost of products sold | 105.7 | 93.1 | 93.8 | ||||||||
Gross margin | 12.9 | 10.9 | 11.3 | ||||||||
Selling, general and administrative expenses | 10.1 | 7.9 | 7.8 | ||||||||
Gain on settlement of outstanding claim | (18.5 | ) | — | — | |||||||
Other expense, net | 2.0 | 1.9 | 2.1 | ||||||||
Earnings before income taxes and cumulative effect of change in accounting principle | 19.3 | 1.1 | 1.4 | ||||||||
Income tax expense | 0.2 | 0.1 | 0.7 | ||||||||
Earnings before cumulative effect of change in accounting principle | 19.1 | 1.0 | 0.7 | ||||||||
Cumulative effect of change in accounting principle | — | — | (47.3 | ) | |||||||
Net Income (Loss) | $ | 19.1 | $ | 1.0 | $ | (46.6 | ) | ||||
See accompanying notes to consolidated financial statements.
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FEDERAL-MOGUL PISTON RINGS, INC.
CONSOLIDATED BALANCE SHEETS
| December 31 | ||||||||
| 2004 | 2003 | |||||||
| (Millions of Dollars) | ||||||||
| ASSETS | ||||||||
Current Assets: | ||||||||
Accounts receivable, net | $ | 10.2 | $ | 12.1 | ||||
Inventories, net | 7.2 | 6.1 | ||||||
Other | 0.7 | 0.7 | ||||||
Total Current Assets | 18.1 | 18.9 | ||||||
Property, plant and equipment, net | 58.5 | 62.9 | ||||||
Other noncurrent assets | 2.5 | — | ||||||
| $ | 79.1 | $ | 81.8 | |||||
| LIABILITIES AND NET PARENT INVESTMENT | ||||||||
Current Liabilities: | ||||||||
Accounts payable | $ | 3.3 | $ | 2.9 | ||||
Other accrued liabilities | 7.4 | 8.7 | ||||||
| 10.7 | 11.6 | |||||||
Liabilities subject to compromise | 153.8 | 152.2 | ||||||
Other long-term liabilities | 1.3 | 1.2 | ||||||
Redeemable stock | — | 20.0 | ||||||
Net Parent Investment | (86.7 | ) | (103.2 | ) | ||||
| $ | 79.1 | $ | 81.8 | |||||
See accompanying notes to consolidated financial statements.
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FEDERAL-MOGUL PISTON RINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
| Year Ended December 31 | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| (Millions of Dollars) | ||||||||||||
Cash Provided From (Used By) Operating Activities | ||||||||||||
Net income (loss) | $ | 19.1 | $ | 1.0 | $ | (46.6 | ) | |||||
Adjustments to reconcile net earnings (loss) to net cash provided from operating activities | ||||||||||||
Cumulative effect of change in accounting principle | — | — | 47.3 | |||||||||
Depreciation and amortization | 8.7 | 8.2 | 9.8 | |||||||||
Settlement of outstanding claim | (18.5 | ) | — | — | ||||||||
(Increase) decrease in accounts receivable | 1.9 | (4.4 | ) | 1.6 | ||||||||
(Increase) decrease in inventories | (1.1 | ) | 2.0 | (3.4 | ) | |||||||
Increase in accounts payable | 0.4 | — | 0.7 | |||||||||
Changes in other assets and liabilities | (3.4 | ) | 3.4 | (5.5 | ) | |||||||
Net Cash Provided From Operating Activities | 7.1 | 10.2 | 3.9 | |||||||||
Cash Used By Investing Activities | ||||||||||||
Capital expenditures | (4.5 | ) | (5.2 | ) | (9.1 | ) | ||||||
Net Cash Used By Investing Activities | (4.5 | ) | (5.2 | ) | (9.1 | ) | ||||||
Cash Provided From (Used By) Financing Activities | ||||||||||||
Transfers (to) from parent | (2.6 | ) | (5.0 | ) | 5.2 | |||||||
Net Cash Provided From (Used By) Financing Activities | (2.6 | ) | (5.0 | ) | 5.2 | |||||||
Net change in cash | — | — | — | |||||||||
Cash at beginning of year | — | — | — | |||||||||
Cash at end of year | $ | — | $ | — | $ | — | ||||||
See accompanying notes to consolidated financial statements.
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FEDERAL-MOGUL PISTON RINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation and Summary of Significant Accounting Policies
The accompanying financial statements reflect the consolidated assets, liabilities and operations of Federal-Mogul Piston Rings, Inc. (“Piston Rings”). Piston Rings is an indirect subsidiary of Federal-Mogul Corporation (“Federal-Mogul”). Piston Rings manufactures pistons, rings and liners.
Piston Rings operates with financial and operational staff on a decentralized basis. Federal-Mogul provides certain centralized services for employee benefits administration, cash management, risk management, legal services, public relations, tax reporting and internal and external audit. Federal-Mogul charges Piston Rings for all such direct expenses incurred on its behalf. General expenses that are not directly attributable to the operations of Piston Rings have been allocated based on management’s estimates, primarily driven by sales. Management believes that this allocation method is reasonable.
The accompanying consolidated financial statements are presented as if Piston Rings had existed as an entity separate from its parent during the period presented and include the assets, liabilities, revenues and expenses that are directly related to Piston Rings’ operations.
Piston Rings’ separate debt and related interest expense have been included in the consolidated financial statements. Piston Rings is fully integrated into its parent’s cash management system. As such, all cash requirements are provided by its parent and any excess cash generated by Piston Rings is transferred to its parent.
Principles of Consolidation:The consolidated financial statements include the accounts of Piston Rings and all majority-owned subsidiaries and other controlled entities. Intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates:The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported therein. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may be based upon amounts that differ from these estimates.
Trade Accounts Receivable and Allowance for Doubtful Accounts:Trade accounts receivable are stated at historical value, which approximates fair value. Piston Rings does not generally require collateral for its trade accounts receivable.
Accounts receivable have been reduced by an allowance for amounts that may become uncollectible in the future. This estimated allowance is based primarily on management’s evaluation of specific balances as the balances become past due, the financial condition of its customers and Piston Rings’ historical experience of write-offs. If not reserved through specific examination procedures, Piston Rings’ general policy for uncollectible accounts is to reserve based upon the aging categories of accounts receivable and upon whether the amounts are due from an OE customer or Aftermarket customer. Past due status is based upon the invoice date of the original amounts outstanding. The allowance for doubtful accounts was $0.7 million and $0.8 million at December 31, 2004 and 2003, respectively.
Inventories:Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out method (“FIFO”). Inventories have also been reduced by an allowance for excess and obsolete inventories based on management’s review of on-hand inventories compared to estimated future sales and usage.
Long-Lived Assets:Long-lived assets, such as property, plant and equipment and definite-lived intangible assets, are stated at cost. Depreciation and amortization is computed principally by the straight-line method for financial reporting purposes and by accelerated methods for income tax purposes. Definite-lived assets are periodically reviewed for impairment indicators. If impairment indicators exist, the Company performs the required analysis and records an impairment charge, as required, in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS No. 144). If the carrying value of a long-lived asset is considered impaired, an impairment charge is recorded for the amount by which the carrying value of the long-lived asset exceeds its fair value.
Revenue Recognition:Piston Rings records sales when products are shipped and title has transferred to the customer, the sales price is fixed or determinable and the collectibility of revenue is reasonably assured. Affiliate sales are transferred at cost. Accruals for sales returns and other allowances are provided at the time of shipment based upon past experience. Adjustments to such returns and allowances are made as new information becomes available.
Shipping and Handling Costs:Piston Rings recognizes shipping and handling costs as a component of cost of Piston Rings sold in the statement of operations.
Recoverable Customer Engineering and Tooling:Pre-production tooling and engineering costs that Piston Rings will not own and that will be used in producing Piston Rings under long-term supply arrangements are expensed as incurred unless the supply arrangement provides Piston Rings the non-cancelable right to use the tools or the reimbursement of such costs is agreed to by the customer. Pre-production tooling and engineering costs that are
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NOTE TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
owned by Piston Rings are capitalized as part of machinery and equipment, and are depreciated over the shorter of the toolings’ expected life or the duration of the related program.
Fair Value of Financial Instruments:The carrying amounts of certain financial instruments such as accounts payable approximate their fair value.
Net Parent Investment: The net parent investment account reflects the balance of Piston Rings’ historical earnings, intercompany amounts, income taxes accrued and deferred, postemployment liabilities and other transactions between Piston Rings and Federal-Mogul.
Reclassifications:Certain items in the prior years financial statements have been reclassified to conform with the presentation used in 2004.
2. Voluntary Reorganization Under Chapter 11 and Administration
On October 1, 2001 (the “Petition Date”), Federal-Mogul Corporation (the “Company” or “Federal-Mogul”) and all of its wholly-owned United States subsidiaries filed voluntary petitions for reorganization (the “U.S. Restructuring”) under Chapter 11 of the United States Bankruptcy Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”). Also on October 1, 2001, certain of the Company’s United Kingdom subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the Bankruptcy Code and petitions for Administration (the “U.K. Restructuring”) under the United Kingdom Insolvency Act of 1986 (the “Act”) in the High Court of Justice, Chancery division in London, England (the “High Court”). The Company and its U.S. and U.K. subsidiaries included in the U.S. Restructuring and U.K. Restructuring are herein referred to as the “Debtors”. The U.S. Restructuring and U.K. Restructuring are herein referred to as the “Restructuring Proceedings”. The Chapter 11 cases of the Debtors (collectively, the “Chapter 11 Cases”) have been consolidated for purposes of joint administration asIn re: Federal-Mogul Global Inc., T&N Limited, et. al (Case No. 01-10578(RTL)). Subsidiaries outside of the aforementioned U.S. and U.K. subsidiaries are not party to the Chapter 11 Cases and, therefore, are not currently provided protection from creditors by any bankruptcy court and are operating in the normal course.
The Restructuring Proceedings were initiated in response to a sharply increasing number of asbestos-related claims and their demand on the Company’s cash flows and liquidity. Under the Restructuring Proceedings, the Debtors expect to develop and implement a plan for addressing the asbestos-related claims against them.
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Consequences of the Restructuring Proceedings
The U.S. Debtors, including Piston Rings, are operating their businesses as debtors-in-possession subject to the provisions of the Bankruptcy Code. The U.K. Debtors are continuing to manage their operations under the supervision of Administrators approved by the High Court. All vendors will be paid for all goods furnished and services provided after the Petition Date. However, as a consequence of the Restructuring Proceedings, pending litigation against the Debtors as of the Petition Date is stayed (subject to certain exceptions in the case of governmental authorities), and no party may take any action to pursue or collect pre-petition claims except pursuant to an order of the Bankruptcy Court or the High Court as applicable. It is the Debtors’ intention to address all pending and future asbestos-related claims and all other pre-petition claims through a unified plan of reorganization under the Bankruptcy Code or scheme of arrangement under the Act.
In the U.S., four committees, representing asbestos claimants, asbestos property damage claimants, unsecured creditors and equity security holders (collectively, the “Committees”) have been appointed as official committees in the Chapter 11 Cases and, in accordance with the provisions of the Bankruptcy Code, have the right to be heard on all matters that come before the Bankruptcy Court. The Committees, together with the legal representative for the future asbestos claimants, play important roles in the Restructuring Proceedings. In the U.K., the Administrators have appointed a creditors committee, representing both asbestos claimants and general unsecured creditors.
On June 4, 2004, the Third Amended Joint Plan of Reorganization (the “Plan”) for Federal-Mogul and the other U.S. and U.K. Debtors was filed with the Bankruptcy Court. The Plan was jointly proposed by Federal-Mogul, the Unsecured Creditors Committee, the Asbestos Claimants Committee, the Future Asbestos Claimants Representative, the Agent for the Prepetition Bank Lenders and the Equity Security Holders Committee (collectively referred to as the “Plan Proponents”). Also on June 4, 2004, a Disclosure Statement to be used in soliciting votes to accept or reject the Plan (the “Disclosure Statement”) was approved by the Bankruptcy Court and a December 2004 hearing was scheduled to determine whether the Bankruptcy Court should approve the Plan. On December 7, 2004, the Bankruptcy Court delayed this confirmation hearing pending a hearing to estimate asbestos personal injury claims against the U.K. Debtors. Such estimation hearing has not yet been scheduled.
On July 12, 2004, solicitation packages containing the Plan and Disclosure Statement, various supporting documents and a ballot, if appropriate, were mailed to known creditors of Federal-Mogul and holders of common and preferred stock interests in Federal-Mogul. All votes were due by the close of business on November 3, 2004. Although the Plan Proponents have granted extensions of the November 3, 2004 voting deadline to a few significant claimants, the voting agent has confirmed that the overwhelming majority of the classes of claims and interests have voted to accept the Plan. For the few classes of claims that voted to reject the Plan, the Plan Proponents intend to either amend the Plan so as to obtain such classes’ accepting votes or seek to confirm the Plan over the objection of such classes.
The Plan provides that asbestos personal injury claimants, both present and future, will be permanently channeled to a trust or series of trusts established pursuant to Section 524(g) of the Bankruptcy Code, thereby protecting Federal-Mogul and its affiliates in the Chapter 11 Cases from existing and future asbestos liability. Although certain issues remain to be resolved, the Plan provides that all currently outstanding stock of Federal-Mogul will be cancelled, and 50.1% of newly authorized and issued common stock of reorganized Federal-Mogul will be distributed to the asbestos trusts, and 49.9% of the newly authorized and issued common stock will be distributed pro rata to the noteholders. If the classes of holders of common and preferred stock of Federal-Mogul vote in favor of the Plan, the holders of currently outstanding common and preferred stock of Federal-Mogul will receive warrants that may be used to purchase shares of reorganized Federal-Mogul at a predetermined exercise price.
Unsecured creditors, including trade creditors, of the U.S. Debtors are projected to receive cash distributions under the Plan equal to 35% of their allowed claims, payable in three annual installments, provided that the aggregate of all allowed unsecured claims against the U.S. Debtors does not exceed $258 million. Any excess above this amount could result in a reduction in the percentage distribution that the unsecured creditors of the U.S. Debtors ultimately receive. Unsecured creditors, including trade creditors, of the U.K. Debtors will receive distributions that vary according to terms specified within the Plan and Disclosure Statement.
There are two possible types of U.K. schemes of arrangements. The first is under Section 425 of the Companies Act of 1985, which may involve a scheme for the reconstruction of the Company. If a majority in number representing
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three-fourths in value of the creditors or members or any class of them agree to the compromise or arrangement, it is binding if sanctioned by the High Court. Section 425 may be invoked where there is an Administration order in force in relation to the Company. The other possible type of scheme arises under Section 1 of the Insolvency Act of 1986 in relation to Company Voluntary Arrangements (“CVA”). If a majority in value representing more than three-fourths of the creditors agrees to the compromise or arrangement set out in the CVA proposal, it will be approved.
Piston Rings is unable to predict with a high degree of certainty at this time what treatment will be accorded under any such plan of reorganization to claims arising from intercompany indebtedness, licenses, executory contracts, transfers of goods and services, and other intercompany arrangements, transactions and relationships that were entered into prior to the Petition Date. Various parties in the Chapter 11 Cases may challenge these arrangements, transactions, and relationships, and the outcome of those challenges, if any, may have an impact on the treatment of various claims under such plan of reorganization.
The Bankruptcy Court may confirm a plan of reorganization only upon making certain findings required by the Bankruptcy Code, and a plan may be confirmed over the dissent of non-accepting creditors and equity security holders if certain requirements of the Bankruptcy Code are met. The payment rights and other entitlements of pre-petition creditors and equity security holders may be substantially altered by any plan of reorganization confirmed in the Chapter 11 Cases. There is no assurance that there will be sufficient assets to satisfy the Debtors’ pre-petition liabilities in whole or in part, and the pre-petition creditors of some Debtors may be treated differently than those of other Debtors.
Chapter 11 Financing
In connection with the Restructuring Proceedings, Federal-Mogul entered into a DIP credit facility to supplement liquidity and fund operations during the restructuring proceedings. In December 2004, Federal-Mogul renegotiated its DIP credit facility. Prior to December 2004, Federal-Mogul’s DIP credit facility had an interest rate of either the alternate base rate (“ABR”) plus 2 percentage points or a formula based on the London Inter-Bank Offered Rate (“LIBOR”) plus 3 percentage points. The ABR is the greater of either the bank’s prime rate or the base CD rate plus 1 percentage point or the federal funds rate plus ½ percentage point.
The December 2004 DIP credit facility expires in December 2005, and the interest rate is either the alternate base rate (“ABR”) plus 1¼ percentage points or a formula based on the London Inter-Bank Offered Rate (“LIBOR”) plus 2¼ percentage points. The ABR is the greater of either the bank’s base rate or the federal funds rate plus ½ percentage point. In addition, the commitment available under the DIP credit facility is mandatorily reduced by a portion of proceeds received from future asset or business divestitures.
Financial Statement Presentation
The accompanying consolidated financial statements have been prepared in accordance with AICPA Statement of Position 90-7 (“SOP 90-7”), “Financial Reporting by Entities in Reorganization under the Bankruptcy Code” and on a going concern basis, which contemplates continuity of operations and realization of assets and liquidation of liabilities in the ordinary course of business. However, as a result of the Restructuring Proceedings, such realization of assets and liquidation of liabilities, without substantial adjustments and/or changes of ownership, is highly uncertain. Given this uncertainty, there is substantial doubt about the ability of Piston Rings to continue as a going concern. While operating as debtors-in-possession under the protection of Chapter 11 of the Bankruptcy Code and Administration under the Act, and subject to approval of the Bankruptcy Court, Administrators or the High Court or otherwise as permitted in the ordinary course of business, Piston Rings may sell or otherwise dispose of assets and liquidate or settle liabilities for some amounts other than those reflected in the consolidated financial statements. Further, a plan of reorganization or scheme of arrangement could materially change the amounts and classifications in the historical consolidated financial statements.
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As reflected in the consolidated financial statements, “Liabilities subject to compromise” refers to liabilities of entities of Piston Rings included in the Restructuring Proceedings incurred prior to the Petition Date. The amounts of the various liabilities that are subject to compromise are set forth below. These amounts represent Piston Rings’ estimate of known or potential pre-petition claims to be resolved in connection with the Restructuring Proceedings. Such claims remain subject to future adjustments. Future adjustments may result from (i) negotiations; (ii) actions of the Bankruptcy Court, High Court or Administrators; (iii) further developments with respect to disputed claims; (iv) rejection of executory contracts and unexpired leases; (v) the determination as to the value of any collateral securing claims; (vi) proofs of claim; or (vii) other events. Payment terms for these claims will be established in connection with the Restructuring Proceedings.
| December 31 | ||||||
| 2004 | 2003 | |||||
| (Millions of Dollars) | ||||||
Accounts payable and accrued liabilities | $ | 5.9 | $ | 4.4 | ||
Accounts payable to affiliated companies | 146.6 | 146.5 | ||||
Environmental liabilities | 1.3 | 1.3 | ||||
Total | $ | 153.8 | $ | 152.2 | ||
The Debtors, including Piston Rings, have received approval from the Bankruptcy Court to pay or otherwise honor certain of their pre-petition obligations, including employee wages, salaries, benefits and other employee obligations and from limited available funds, pre-petition claims of certain critical vendors, certain customer programs and warranty claims and certain other pre-petition claims.
Pursuant to the Bankruptcy Code, Federal-Mogul has filed schedules with the Bankruptcy Court setting forth the assets and liabilities of the Debtors as of the Petition Date. On October 4, 2002, the Debtors issued approximately 100,000 proof of claim forms to its current and prior employees, known creditors, vendors and other parties with whom the Debtors have previously conducted business. To the extent that recipients disagree with the claims as quantified on these forms, the recipient may file discrepancies with the Bankruptcy Court. Differences between amounts recorded by the Debtors and claims filed by creditors will be investigated and resolved as part of the Restructuring Proceedings. The Bankruptcy Court ultimately will determine liability amounts that will be allowed for these claims in the Chapter 11 Cases. A March 3, 2003 bar date was set for the filing of proofs of claim against the Debtors. Because the Debtors have not completed evaluation of the claims received in connection with this process, the ultimate number and allowed amount of such claims are not presently known. The resolution of such claims could result in a material adjustment to the Company’s financial statements.
The Debtors, including Piston Rings, continue to review and analyze the proofs of claim filed to date. In addition, the Debtors continue to file objections and seek stipulations to certain claims. Additional claims may be filed after the general bar date, which could be allowed by the Bankruptcy Court. Accordingly, the ultimate number and allowed amount of such claims are not presently known and cannot be reasonably estimated at this time. The resolution of such claims could result in a material adjustment to the Company’s financial statements.
The appropriateness of using the going concern basis for the Piston Rings’ financial statements is dependent upon, among other things: (i) Federal-Mogul’s ability to comply with the terms of the DIP credit facility and any cash management order entered by the Bankruptcy Court in connection with the Chapter 11 Cases; (ii) the ability of Federal-Mogul to maintain adequate cash on hand; (iii) the ability of Federal-Mogul to generate cash from operations; (iv) confirmation of a plan(s) of reorganization under the Bankruptcy Code; (v) confirmation of a scheme(s) of arrangement in the U.K. under Administration; and (vi) Federal-Mogul’s ability to achieve profitability following such confirmations.
3. Commitments and Contingencies
Environmental Liabilities
Piston Rings has identified certain present and former properties at which it may be responsible for cleaning up environmental contamination, in some cases as a result of contractual commitments. Piston Rings is actively seeking
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to resolve these matters. Although difficult to quantify based on the complexity of the issues, Piston Rings has accrued amounts corresponding to its best estimate of the costs associated with such matters based upon current available information from site investigations and consultants.
Environmental reserves were $3.6 million and $3.7 million at December 31, 2004 and 2003, respectively and are included in the consolidated balance sheets as follows:
| December 31 | ||||||
| 2004 | 2003 | |||||
| (Millions of Dollars) | ||||||
Current liabilities | $ | 0.9 | $ | 1.2 | ||
Long-term accrued liabilities | 1.4 | 1.2 | ||||
Liabilities subject to compromise | 1.3 | 1.3 | ||||
| $ | 3.6 | $ | 3.7 | |||
The decrease in the reserve during 2004 resulted primarily from a downward adjustment of certain reserves based on new and more accurate estimates of expected costs. Management believes that such accruals will be adequate to cover Piston Rings’ estimated liability for its exposure in respect to such matters. In the event that such liabilities were to significantly exceed the amounts recorded by Piston Rings, Piston Rings’ results of operations and financial condition could be materially affected. At December 31, 2004, management estimates that reasonably possible material additional losses above and beyond management’s best estimate of required remediation costs as recorded approximates $4 million.
Environmental reserves subject to compromise include those that may be reduced in Federal Mogul’s bankruptcy proceeding because they may be determined to be “dischargeable debts” incurred prior to Federal Mogul’s filing for bankruptcy. Such liabilities generally arise at either (1) commercial waste disposal sites to which Piston Rings and other companies sent wastes for disposal, or (2) sites in relation to which Piston Rings has a contractual obligation to indemnify the current owner of a site for the costs of cleanup of contamination that was released into the environment before Piston Rings sold the site.
Environmental reserves determined not to be subject to compromise include those which arise from a legal obligation of Piston Rings, under an administrative or judicial order, to perform cleanup at a site. Such obligations are normally associated with sites, which a bankrupt entity such as Piston Rings owns and either operates or formerly operated.
The best estimate of environmental liability at a site may change from time to time during a bankruptcy proceeding even though the liability relating to that site is subject to compromise and Piston Rings’ responsibility to make payments is stayed. Notwithstanding the stay of proceedings regarding such a site, activities such as further site investigation and/or actual cleanup work usually continue to be performed by other parties. Such activities may produce new and better information that requires Piston Rings to revise its best estimate of total site cleanup costs and its own share of such costs.
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4. Inventories
Inventories consisted of the following:
| December 31 | ||||||||
| 2004 | 2003 | |||||||
| (Millions of Dollars) | ||||||||
Raw materials. | $ | 0.9 | $ | 0.5 | ||||
Work-in-process | 3.8 | 3.1 | ||||||
Finished goods | 2.6 | 2.7 | ||||||
| 7.3 | 6.3 | |||||||
Valuation reserves | (0.1 | ) | (0.2 | ) | ||||
| $ | 7.2 | $ | 6.1 | |||||
5. Property, Plant and Equipment
Property, plant and equipment consisted of the following:
Estimated Useful Life | December 31 | |||||||||
| 2004 | 2003 | |||||||||
| (Millions of Dollars) | ||||||||||
Land | — | $ | 0.4 | $ | 0.4 | |||||
Buildings and building improvements | 24-40 years | 14.8 | 13.7 | |||||||
Machinery and equipment | 3-12 years | 91.6 | 89.2 | |||||||
| 106.8 | 103.3 | |||||||||
Accumulated depreciation | (48.3 | ) | (40.4 | ) | ||||||
| $ | 58.5 | $ | 62.9 | |||||||
Future minimum payments under noncancelable operating leases with initial or remaining terms of more than one year are as follows, in millions:
2005 | $ | 0.2 | |
2006 | 0.1 | ||
2007 | 0.1 | ||
2008 | 0.1 | ||
2009 | 0.1 | ||
Thereafter | — |
Total rental expense under operating leases for the years ended December 31, 2004, 2003 and 2002 was $0.2 million, $0.2 million and $0.3 million, respectively, exclusive of property taxes, insurance and other occupancy costs generally payable by Federal-Mogul.
6. Goodwill and Other Intangible Assets
Effective January 1, 2002, Piston Rings adopted SFAS No. 142, resulting in the discontinuance of amortization of goodwill and indefinite-lived intangible assets. The adoption of this standard also required the reclassification of various intangible asset classes according to the measurability of their useful lives. Upon the adoption of SFAS No. 142, Piston Rings recorded a non-cash charge of $47.3 million to reduce the carrying value of its goodwill and indefinite-lived intangible assets to their estimated fair value as required by SFAS No. 142. The charge is presented as a cumulative effect of change in accounting principle in the consolidated statement of operations for the year ended December 31, 2002.
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7. Redeemable Stock
Piston Rings issued 862 shares of Class B common stock, redeemable at the option of the holder, to a minority investor in 1994. The shares of Class B stock were redeemable for $23,201.85 per share plus accrued dividends.
In July 2004, Federal-Mogul Piston Rings Inc. reached an agreement with the minority investor whereby the investor exchanged its shares of class B stock for a general unsecured claim of $1.5 million. The settlement agreement was approved by the Bankruptcy Court on July 30, 2004. As a result of this agreement, Piston Rings recorded a gain of $18.5 million.
8. Long-Term Debt and Other Financing Arrangements
Piston Rings’ cash and indebtedness is managed on a worldwide basis by Federal-Mogul. The majority of the cash provided by or used by a particular division, including Piston Rings, is provided through a consolidated cash and debt management system. As a result, the amount of domestic cash or debt historically related to Piston Rings is not determinable.
Federal-Mogul allocated to Piston Rings $110.8 million of the debt incurred to purchase T&N plc and calculated interest at a rate of 6% through the Petition date. In accordance with SOP 90-7, Piston Rings stopped recording interest expense on its outstanding notes, effective October 1, 2001. For the years ended December 31, 2004, 2003 and 2002 Piston Rings’ contractual interest not accrued or paid for this note was $6.6 million. Since the petition date, Piston Rings has been relieved a total of $21.5 million of interest payable under this note.
Federal-Mogul has pledged 100% of Piston Rings’ capital stock and also provided collateral in the form of a pledge of inventories, property, plant and equipment, real property and intellectual properties to secure certain outstanding debt of Federal-Mogul. In addition, Piston Rings has guaranteed fully and unconditionally, on a joint and several basis, the obligation to pay principal and interest under Federal-Mogul’s Senior Credit Agreement and its publicly registered debt. Such pledges and guarantees have also been made by other subsidiaries of Federal-Mogul. Federal-Mogul is in default of the terms of such debt agreements. Borrowings outstanding on such agreements aggregated $4,026.9 million and $4,020.7 million as of December 31, 2004 and 2003, respectively.
9. Net Parent Investment
Changes in net parent investment were as follows (in millions of dollars):
Balance at January 1, 2002 | $ | (57.8 | ) | |
Net loss | (46.6 | ) | ||
Intercompany transactions, net | 5.2 | |||
Balance at December 31, 2002 | (99.2 | ) | ||
Net income | 1.0 | |||
Intercompany transactions, net | (5.0 | ) | ||
Balance at December 31, 2003 | (103.2 | ) | ||
Net income | 19.1 | |||
Intercompany transactions, net | (2.6 | ) | ||
Balance at December 31, 2004 | $ | (86.7 | ) | |
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10. Income Taxes
Piston Rings files a consolidated return with Federal-Mogul for U.S. federal income tax purposes. Federal income tax expense is calculated on a separate-return basis for financial reporting purposes.
| Year Ended December 31 | |||||||||
| 2004 | 2003 | 2002 | |||||||
| (Millions of Dollars) | |||||||||
Components of income tax expense | |||||||||
Current | $ | 0.2 | $ | 0.1 | $ | 0.1 | |||
Deferred | — | — | 0.6 | ||||||
Income tax expense | $ | 0.2 | $ | 0.1 | $ | 0.7 | |||
A reconciliation between the statutory federal income tax rate and the effective tax rate is as follows:
| Year Ended December 31 | |||||||||
| 2004 | 2003 | 2002 | |||||||
Effective tax rate reconciliation: | |||||||||
U.S. Federal statutory rate | 35 | % | 35 | % | 35 | % | |||
State and local taxes | 1 | 9 | 5 | ||||||
Other non-taxable income | (34 | ) | — | — | |||||
Valuation allowance | (1 | ) | (35 | ) | 10 | ||||
Effective tax rate | 1 | % | 9 | % | 50 | % | |||
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the related amounts used for income tax purposes. Significant components of the Company’s net deferred tax asset are non-deductible accruals and amortization and depreciation timing differences.
| December 31 | ||||||||
| 2004 | 2003 | |||||||
| (Millions of Dollars) | ||||||||
Net current deferred tax assets | $ | 1.3 | $ | 1.5 | ||||
Net long-term deferred tax assets | 44.1 | 60.3 | ||||||
Gross deferred tax assets | 45.4 | 61.8 | ||||||
Valuation allowance | (45.4 | ) | (61.8 | ) | ||||
Net deferred tax assets | $ | — | $ | — | ||||
11. Pension Plans
Piston Rings is included in the Federal-Mogul Corporation Pension Plan. As such, the related pension liability is included in Net Parent Investment at December 31, 2004 and 2003.
The pension charge allocated to Piston Rings was $0.9 million, $0.8 million and $0.8 million for 2004, 2003 and 2002, respectively.
12. Postretirement Benefits Other Than Pensions
As part of T&N plc. and subsequently Federal-Mogul, benefits provided to employees of Piston Rings under various postretirement plans other than pensions, all of which are unfunded, include retiree medical care, dental care, prescriptions and life insurance, with medical care accounting for approximately 95% of the total. The majority of participants under such plans are retirees. The expense related to such plans approximated $2.5 million, $4.8 million and $4.9 million for 2004, 2003 and 2002, respectively.
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13. Concentrations of Credit Risk and Other
Piston Rings grants credit to their customers, which are primarily in the automotive industry. Credit risk with respect to trade receivables is generally diversified due to the large number of entities comprising Piston Rings’ customer base. Piston Rings performs periodic credit evaluations of their customers and generally does not require collateral.
Piston Rings operates in a single business segment. Piston Rings manufactures and distributes piston rings for use in many engine markets including automotive, heavy-duty, diesel, locomotive and compressors. In addition, Piston Rings manufactures and distributes liners to automotive and heavy-duty engine assemblers. Five customers accounted for a combined 62%, 60% and 55% of total revenues in 2004, 2003 and 2002, respectively. All revenues and assets of Piston Rings reside in the United States.
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Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
FEDERAL-MOGUL CORPORATION | ||
By: | /s/ G. Michael Lynch | |
G. Michael Lynch | ||
Executive Vice President and Chief Financial Officer, Principal Financial Officer | ||
By: | /s/ Michael J. Widgren | |
Michael J. Widgren | ||
Chief Accounting Officer | ||
By: | /s/ Lance M. Lis | |
Lance M. Lis | ||
Power of Attorney | ||
Date: February 26, 2005
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