ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
BUSINESS DESCRIPTION
Terex is a diversified global manufacturer of capital equipment focused on delivering reliable, customer relevant solutions for the construction, infrastructure, quarrying, mining, shipping, transportation, refining and utility industries. The Company operates in five reportable segments: (i) Terex Aerial Work Platforms; (ii) Terex Construction; (iii) Terex Cranes; (iv) Terex Materials Processing & Mining; and (v) Terex Roadbuilding, Utility Products and Other.
The Terex Aerial Work Platforms segment designs, manufactures and markets aerial work platform equipment, telehandlers, light construction equipment and construction trailers. Products include material lifts, portable aerial work platforms, trailer-mounted articulating booms, self-propelled articulating and telescopic booms, scissor lifts, telehandlers, construction trailers, trailer-mounted light towers, concrete finishing equipment, power buggies, generators, traffic control products, related components and replacement parts, and other products. These products are used primarily by customers in the construction and building maintenance industries to build and/or maintain large physical assets and structures. Terex Aerial Work Platforms products are currently marketed principally under the Terex and Genie brand names and the Terex name in conjunction with these historic brand names: Amida, Bartell, Benford, Load King, Morrison and TerexLift.
The Terex Construction segment designs, manufactures and markets two primary categories of equipment and their related components and replacement parts: heavy construction equipment (including off-highway trucks, scrapers, hydraulic excavators, large wheel loaders, loading machines and truck mounted articulated hydraulic cranes) and compact construction equipment (including loader backhoes, compaction equipment, mini and midi excavators, site dumpers and wheel loaders). These products are primarily used by construction, logging, mining, industrial and government customers in construction and infrastructure projects and supplying coal, minerals, sand and gravel. Terex Construction products are currently marketed principally under the Terex brand name and the Terex name in conjunction with these historic brand names: Atlas, Benford, Fermec, Fuchs, and Schaeff.
The Terex Cranes segment designs, manufactures and markets mobile telescopic cranes, tower cranes, lattice boom crawler cranes, truck mounted cranes (boom trucks) and telescopic container stackers, as well as their related replacement parts and components. These products are used primarily for construction, repair and maintenance of infrastructure, building and manufacturing facilities. Terex Cranes products are currently marketed principally under the Terex brand name and the Terex name in conjunction with these historic brand names: American, Bendini, Comedil, Demag, Franna, P&H, Peiner and PPM. The Company acquired Power Legend International Limited (“Power Legend”) and its affiliates, including a controlling 50% ownership interest in Sichuan Changjiang Engineering Crane Co., Ltd. (“Sichuan Crane”), on April 4, 2006. The results of Power Legend and Sichuan Crane are included in the Terex Cranes segment from their date of acquisition.
The Terex Materials Processing & Mining segment designs, manufactures and markets crushing and screening equipment (including crushers, impactors, washing systems, screens, trommels and feeders), hydraulic mining excavators, high capacity surface mining trucks, drilling equipment, related components and replacement parts, and other products. These products are used primarily by construction, mining, quarrying and government customers in construction and commodity mining. Terex Materials Processing & Mining products are currently marketed principally under the Terex brand name and the Terex name in conjunction with these historic brand names: Canica, Cedarapids, ELJay, Finlay, Halco, Jaques, O&K, Pegson, Powerscreen, Reedrill, Simplicity and Unit Rig. The Company acquired Halco Holdings Limited and its affiliates (“Halco”) on January 24, 2006, and established the Terex NHL Mining Equipment Company Ltd. (“Terex NHL”) joint venture on March 9, 2006. The results of Halco and Terex NHL are included in the Terex Materials Processing & Mining segment from their date of acquisition. There has been no significant activity to date for Terex NHL.
The Terex Roadbuilding, Utility Products and Other segment designs, manufactures and markets asphalt and concrete equipment (including pavers, plants, mixers, reclaimers, stabilizers and profilers), landfill compactors and utility equipment (including digger derricks, aerial devices and cable placers), as well as related components and replacement parts. These products are used primarily by government, utility and construction customers to build roads, construct and maintain utility lines, trim trees and for other commercial operations. Terex Roadbuilding, Utility Products and Other products are currently marketed principally under the Terex brand name and the Terex name in conjunction with these historic brand names: Advance, American Truck Company, ATC, Bid-Well, Cedarapids, CMI, Hi-Ranger, Johnson-Ross and Telelect. Terex also owns the majority of the North American distribution channel for the utility products group through its Terex Utilities distribution network, located primarily in the Southern and Western United States. Terex also owns 40% of Intercontinental Equipment Company, another distributor of utility products. These operations distribute and install the Company’s utility aerial devices as well as other products that service the utility industry.
28
The Company also operates a fleet of rental utility products under the name Terex Utilities Rental. The Company also leases and rents a variety of heavy equipment to third parties under the Terex Asset Services name. The Company, through Terex Financial Services, Inc., facilitates loans and leases between customers and various financial institutions. In Europe, Terex Financial Services Holding B.V. (“TFSH”), a joint venture of the Company and a European financial institution, assists customers in the acquisition of all of the Company’s products.
Included in Eliminations/Corporate are the eliminations among the five segments, as well as certain allocated general and corporate items.
Overview
The Company continues to be encouraged by current trends and its performance for the nine months ended September 30, 2006. Specifically, the Company experienced strong sales over the same period in 2005, as previously implemented pricing actions, operational improvements and continued strong end-markets are reflected in the results for 2006. With regard to sales, a major factor in the Company’s performance was the significantly improving economic condition of many of its end-markets and customers, including the rental market, the mining industry, the global crane market and the market for mobile crushing and screening products. The end-markets for the North American crane business, in particular, have improved and favorably impacted the Company’s financial performance. Global crane demand continues to significantly outpace the current ability to produce and supply product, leading to a large current order backlog. Certain of the Company’s construction products, mainly scrap handling equipment, have shown signs of market contraction relative to the prior year period, and production difficulties in certain construction product lines have negatively impacted the Company’s performance.
The Company anticipates continued strong end-market conditions for the balance of 2006, with most products continuing to participate in the strong global marketplace. For example, the Company expects opportunities for continued strength in the aerial work platforms and materials processing & mining businesses. Additionally, the crane businesses have been experiencing strong end-market demand globally due to numerous infrastructure initiatives and continue to improve their operating performance. The roadbuilding and utility businesses, and other products manufactured by the Company related to infrastructure improvement, have begun to experience increases in demand for their products, except for the concrete mixer truck business, and the Company expects this to continue. The Company believes the roadbuilding and utility end-markets are in the earlier phases of recovery and will offset the slowdown in the concrete mixer truck business going forward. However, the construction businesses continue to lag behind many of the Company’s other businesses. The Company is addressing these issues in a manner that will take several years to fully implement, although the Company does expect meaningful short-term improvements from these businesses, as new products should contribute to profitability and growth. Longer term, the Company plans to build a more cohesive and expansive distribution network to source production in more efficient and cost effective markets.
Since the start of the second quarter of 2006, the Company made several important decisions that are expected to positively contribute to the future financial performance of the Company. In April 2006, Terex completed the acquisition of a 50% controlling interest in Sichuan Crane, a Chinese crane manufacturer. This is the Company’s first manufacturing location in China specifically focused on the crane market and is an important step towards developing better customer relations and capabilities in that important end-market. On June 30, 2006, the Company repaid $100 million principal amount of its outstanding 10-3/8% Senior Subordinated Notes, and on August 14, 2006 repaid the remaining $200 million principal amount of these Notes. Additionally, on July 14, 2006, the Company entered into a new senior credit facility that provides the Company with increased revolving borrowing abilities and additional operational flexibility. These actions represent major steps in the continued improvement of the Company’s capital structure, reducing the overall interest cost and more effectively managing the cash balances of the Company. Recent upgrades from the major debt rating agencies of the Company and its senior debt reflect the improvement in the Company’s capital structure.
In 2005, the Company introduced the Terex Business System (“TBS”), an operating initiative aimed at improving the Company’s internal processes and benefiting the Company’s customers, team members and stakeholders. The TBS initiative is a long-term investment built around lean thinking, and the Company is at an early stage of cultural change based on the TBS principles. The core applications of lean thinking involve the Company’s promotion of a culture of continuous improvement and the removal of waste (anything that does not add value) at every organizational level of the Company. The Company remains committed to delivering strong incremental margin improvements for the balance of 2006 by realizing the benefits of pricing actions, volume leverage and an increasingly effective management of supply costs. Specifically, the Company is focusing on steel, steel fabrications and hydraulics as areas where the Company can leverage its size to reduce costs. For the remainder of 2006, the Company will maintain a focus on cash generation and debt reduction. The Company will concentrate on the implementation of best practices across its locations, and the Company will continue to strive for a target of 15% working capital investment as a percentage of annualized sales, driven mainly by inventory improvement.
29
Working capital is calculated using the Condensed Consolidated Balance Sheet amounts for Trade receivables (net of allowance) plus Inventories less Trade accounts payable. For the nine months ended September 30, 2006, working capital as a percentage of the current quarter’s annualized sales stood at 19.2%. The Company believes that this calculation is a valuable measurement of efficiency in its use of resources.
RESULTS OF OPERATIONS
On January 1, 2006, Terex realigned certain operations in an effort to strengthen its ability to service customers and to recognize certain organizational efficiencies. The mobile crushing and screening group, formerly part of the Terex Construction Segment, is now consolidated within the Terex Materials Processing & Mining Segment. The European telehandlers business, formerly part of the Terex Construction Segment, is now part of the Terex Aerial Work Platforms Segment. Amounts reported for prior periods have been reclassified to conform with this segment realignment.
On September 29, 2006, the Company completed the sale of its ownership interest in Terex Czech s.r.o. and Tatra a.s. (collectively, “Tatra”) to a group of private equity investors. Results of Tatra through the date of its disposition are included as Income from discontinued operations - net of tax in the Condensed Consolidated Statements of Operations for all periods presented.
Three Months Ended September 30, 2006 Compared with Three Months Ended September 30, 2005
Terex Consolidated
| | Three Months Ended September 30, | | |
| | 2006 | | 2005 | | |
| | | % of Sales | | | % of Sales | | % Change In Reported Amounts |
| | ($ amounts in millions) | | |
Net sales | $ | 1,903.7 | - | $ | 1,494.8 | - | | 27.4% |
Gross profit | $ | 367.4 | 19.3% | $ | 240.0 | 16.1% | | 53.1% |
SG&A | $ | 176.3 | 9.3% | $ | 137.4 | 9.2% | | 28.3% |
Income from operations | $ | 191.1 | 10.0% | $ | 102.6 | 6.9% | | 86.3% |
Net sales for the three months ended September 30, 2006 totaled $1,903.7 million, an increase of $408.9 million when compared to the same period in 2005. Net sales relative to the same period in 2005 increased in the Terex Aerial Work Platforms segment due to continued improvement in the rental equipment market globally. Net sales in the Terex Construction segment increased relative to the results from the same period in 2005, reflecting improvement in both compact and heavy construction equipment demand, offset by a slow-down in sales activity for scrap handling equipment. Net sales in the Terex Cranes segment increased from the same period in 2005 levels, resulting from broad-based improvement across most product categories and expansion in China. Net sales in the Terex Materials Processing & Mining segment benefited relative to the same period in 2005, due to continued strong demand from the mining and infrastructure markets. Net sales in the Terex Roadbuilding, Utility Products and Other segment increased relative to the same period in 2005 in many of the roadbuilding and utility product lines.
Gross profit for the three months ended September 30, 2006 totaled $367.4 million, an increase of $127.4 million when compared to the same period in 2005. Improvements relative to the same period in 2005 were realized in most of the segments of the Company due to pricing actions and volume leverage, despite some component cost pressures and production start-up issues on new products in the Terex Construction segment that dampened operating results.
Total Selling, general and administrative costs (“SG&A”) increased for the three months ended September 30, 2006 by $38.9 million when compared to the same period in 2005. SG&A increased as a result of higher selling and related costs arising from increased sales levels during the third quarter of 2006, continued investment in certain corporate initiatives such as TBS and marketing and finance organization development, as well as the increase in costs attributable to certain equity and long term compensation programs.
Income from operations increased by $88.5 million for the three months ended September 30, 2006 when compared to the same period in 2005. The Terex Aerial Work Platforms segment experienced improvement in income from operations relative to the same period in 2005, due to unit volume increases and improved realization of pricing actions, resulting from an improving economy primarily in the United States, Europe and Australia. Income from operations in the Terex Construction segment decreased versus the third quarter of 2005, due to the reduced demand for the Company’s scrap handler product, start up delays in the launch of certain new product lines and SG&A cost increases related to certain
30
customers. Income from operations in the Terex Cranes segment increased as compared to the third quarter of 2005, as this segment experienced higher demand that was broad-based across most product categories. Income from operations improved in the Terex Materials Processing & Mining segment as a result of increased demand driven by improved commodity price levels and the continued strength of global infrastructure investment. Income from operations in the Terex Roadbuilding, Utility Products and Other segment improved due to the positive impact resulting from prior cost saving initiatives and pricing actions.
Terex Aerial Work Platforms
| | Three Months Ended September 30, | | |
| | 2006 | | 2005 | | |
| | | % of Sales | | | % of Sales | | % Change In Reported Amounts |
| | ($ amounts in millions) | | |
Net sales | $ | 538.2 | - | $ | 383.4 | - | | 40.4% |
Gross profit | $ | 136.5 | 25.4% | $ | 78.8 | 20.6% | | 73.2% |
SG&A | $ | 37.4 | 6.9% | $ | 27.5 | 7.2% | | 36.0% |
Income from operations | $ | 99.1 | 18.4% | $ | 51.3 | 13.4% | | 93.2% |
Net sales for the Terex Aerial Work Platforms segment for the three months ended September 30, 2006 were $538.2 million, an increase of $154.8 million, or 40%, when compared to the same period in 2005. Net sales increased when compared to the third quarter of 2005 due to continued strong order activity from the rental channel in the United States, improving demand for the Company’s products internationally, and, to a lesser extent, improved parts sales. Rental market demand increased relative to the same period in 2005 as rental channel customers continued to buy new equipment, primarily to expand their fleets and address increased utilization of their existing equipment. Sales of telehandlers increased approximately 13% when compared to the same period in 2005. The growth rate for telehandlers has slowed from the second quarter of 2006 due to the normal seasonal slowdown. This product line continues to see the benefits of integrating with the Genie sales and marketing strategy and selling through the same rental distribution channels as the aerial work platforms products.
Gross profit for the three months ended September 30, 2006 was $136.5 million, an increase of $57.7 million when compared to the same period in 2005. While gross profit benefited from increased unit volume, it was also favorably impacted by the realization of pricing actions that were implemented to offset the increased cost of components over the prior few years. In addition, gross profit was positively impacted by improved margin on sales in the European markets, partially due to the weaker U.S. dollar.
SG&A for the three months ended September 30, 2006 were $37.4 million, an increase of $9.9 million when compared to the same period in 2005. Increased costs were driven by continuing investments in sales personnel, particularly arising from expansion in new markets internationally and increased market penetration.
Income from operations for the three months ended September 30, 2006 was $99.1 million, an increase of $47.8, million or 93%, when compared to the same period in 2005. The increase was due to the favorable impact of pricing and volume, partially offset by the impact of increased component costs and the costs associated with the significant increase in production.
Terex Construction
| | Three Months Ended September 30, | | |
| | 2006 | | 2005 | | |
| | | % of Sales | | | % of Sales | | % Change In Reported Amounts |
| | ($ amounts in millions) | | |
Net sales | $ | 387.7 | - | $ | 358.2 | - | | 8.2% |
Gross profit | $ | 43.1 | 11.1% | $ | 43.5 | 12.1% | | (0.9)% |
SG&A | $ | 38.0 | 9.8% | $ | 34.1 | 9.5% | | 11.4% |
Income from operations | $ | 5.1 | 1.3% | $ | 9.4 | 2.6% | | (45.7)% |
Net sales in the Terex Construction segment increased by $29.5 million for the three months ended September 30, 2006 when compared to the same period in 2005, and totaled $387.7 million. The increase was mainly due to increased revenue from the
31
off highway truck, tractor loader backhoe and mini excavator product lines, offset somewhat by continued weak performance in the scrap handler product line.
Gross profit decreased slightly to $43.1 million for the three months ended September 30, 2006, a decrease of $0.4 million when compared to 2005 results for the same period. Gross profit was primarily impacted by production variances and inventory charges associated with the excavator line, where the introduction of new generation products continues to lag behind schedule, as well as the impact of lower scrap handler net sales in the period.
SG&A for the three months ended September 30, 2006 totaled $38.0 million, an increase of $3.9 million when compared to the same period in 2005. The increase was primarily due to increased bad debt expense related to the bankruptcy of a customer in the U.K., costs associated with development in the Chinese market and the negative translation impact of currency, primarily the British Pound.
Income from operations for the three months ended September 30, 2006 totaled $5.1 million, a decrease of $4.3 million when compared to $9.4 million for the same period in 2005, resulting primarily from the reduced gross profit and increase in SG&A.
Terex Cranes
| | Three Months Ended September 30, | | |
| | 2006 | | 2005 | | |
| | | % of Sales | | | % of Sales | | % Change In Reported Amounts |
| | ($ amounts in millions) | | |
Net sales | $ | 429.0 | - | $ | 289.0 | - | | 48.4% |
Gross profit | $ | 71.9 | 16.8% | $ | 36.7 | 12.7% | | 95.9% |
SG&A | $ | 33.0 | 7.7% | $ | 24.2 | 8.4% | | 36.4% |
Income from operations | $ | 38.9 | 9.1% | $ | 12.5 | 4.3% | | 211.2% |
Net sales for the Terex Cranes segment for the three months ended September 30, 2006 increased by $140.0 million and totaled $429.0 million when compared to $289.0 million for the same period in 2005. The 48% increase in net sales from the third quarter of 2005 was due to improvement in all businesses and product categories. In addition, approximately 7% of the increase was due to the acquisition in April 2006 of a controlling interest in Sichuan Crane.
Gross profit for the three months ended September 30, 2006 increased by $35.2 million relative to the same period in 2005 and totaled $71.9 million. Gross profit in the three months ended September 30, 2006 benefited from increased sales volume, the inclusion of Sichuan Crane, the positive impact of pricing actions, strong recovery in the North American cranes business and the positive effect of a change in product mix towards tower and crawler cranes, offset partially by a retrofit program on two models of the Company’s all-terrain crane product line. These factors all assisted in improving manufacturing throughput, which more than offset the negative impact of component cost increases.
SG&A for the three months ended September 30, 2006 totaled $33.0 million, an increase of $8.8 million over the same period in 2005. The increase was due to the addition of Sichuan Crane and continuous investment in the customer after sales and service departments. However, as a percentage of net sales, SG&A spending decreased to 7.7% as compared to 8.4% in the third quarter of 2005, reflecting the higher pace of increased sales volume relative to increased costs.
Income from operations for the three months ended September 30, 2006 totaled $38.9 million, an increase of $26.4 million when compared to $12.5 million for the same period in 2005. Income from operations in 2006 was positively impacted by pricing increases in excess of cost pressures from suppliers, the benefit of higher sales volume and increased manufacturing throughput, as well as the impact of the acquisition of a controlling interest in Sichuan Crane.
32
Terex Materials Processing & Mining
| | Three Months Ended September 30, | | |
| | 2006 | | 2005 | | |
| | | % of Sales | | | % of Sales | | % Change In Reported Amounts |
| | ($ amounts in millions) | | |
Net sales | $ | 404.1 | - | $ | 337.5 | - | | 19.7% |
Gross profit | $ | 87.1 | 21.6% | $ | 61.6 | 18.3% | | 41.4% |
SG&A | $ | 38.5 | 9.5% | $ | 28.6 | 8.5% | | 34.6% |
Income from operations | $ | 48.6 | 12.0% | $ | 33.0 | 9.8% | | 47.3% |
Net sales in the Terex Materials Processing & Mining segment increased by $66.6 million to $404.1 million in the third quarter of 2006 compared to $337.5 million in the comparable period in 2005. The increase in net sales was attributable to the overall strong demand from the mining and infrastructure markets, mainly the hydraulic mining excavators manufactured in Dortmund, Germany, and related spare parts sales, which benefited from a broader distribution network, and the continued growth of the crushing and screening product lines,as a direct result of a high level of activity by the Company’s quarrying customers.
Gross profit increased by $25.5 million in the three months ended September 30, 2006 when compared to the comparable period in 2005 and totaled $87.1 million. Gross profit improved as a result of the increased sales volume and increased pricing from existing operations, both in terms of new machines and parts and service.
SG&A increased by $9.9 million to $38.5 million in the third quarter of 2006 relative to the comparable period in 2005. The increase in SG&A expense was mainly due to additional staffing to address sales growth, period costs associated with the relocation of the U.S. mining truck business personnel, and the acquisition of the Halco business in the first quarter of 2006.
Income from operations for the Terex Materials Processing & Mining segment was $48.6 million in the third quarter of 2006, an increase of $15.6 million from $33.0 million in the comparable period in 2005. The increase was a result of higher demand for the segment’s products, resulting primarily from continued strong commodity pricing, demand for mobile commercial grade crushing and screening equipment and the increase in global distribution for hydraulic mining excavators, partially offset by increased component costs.
Terex Roadbuilding, Utility Products and Other
| | Three Months Ended September 30, | | |
| | 2006 | | 2005 | | |
| | | % of Sales | | | % of Sales | | % Change In Reported Amounts |
| | ($ amounts in millions) | | |
Net sales | $ | 178.2 | - | $ | 153.6 | - | | 16.0% |
Gross profit | $ | 24.8 | 13.9% | $ | 18.4 | 12.0% | | 34.8% |
SG&A | $ | 19.5 | 10.9% | $ | 17.2 | 11.2% | | 13.4% |
Income from operations | $ | 5.3 | 3.0% | $ | 1.2 | 0.8% | | 341.7% |
| | | | | | | | | |
Net sales for the Terex Roadbuilding, Utility Products and Other segment for the three months ended September 30, 2006 were $178.2 million, an increase of $24.6 million when compared to the same period in 2005. Net sales increased in most business units and product categories, especially in the businesses of roadbuilding and utility products. Except for concrete mixer trucks, general market conditions continued to be positive. Orders received for the three months ended September 30, 2006 for roadbuilding and utility products, excluding concrete mixer trucks, were approximately 35% higher than during the same period in 2005. In addition, firm orders that are expected to be filled within one year remained strong, as customers placed orders prior to the January 2007 effectiveness of new Tier III emissions standards. End markets in the United States continue to show improvement linked to the passage of the federal highway and energy spending bills. The industry, however, is showing signs of slowing demand for concrete mixer trucks due to a decline in residential construction spending. Orders received for the concrete mixer truck product line have declined significantly year over year.
Gross profit for the three months ended September 30, 2006 totaled $24.8 million, an increase of $6.4 million when compared to the same period in 2005. The gross profit margin during this period improved to 13.9% compared to 12.0% during the same period in 2005. Gross profit margin in this largely United States based business segment, was favorably impacted by pricing actions, the positive effects of certain reorganization activities that have been implemented over the prior
33
few years and management’s continued focus on improving operational processes through on-going continuous improvement initiatives, partially offset by cost increases.
SG&A for the three months ended September 30, 2006 totaled $19.5 million, an increase of $2.3 million when compared to the same period in 2005. The net increase was mainly due to increased sales commission costs in the roadbuilding businesses primarily in support of expansion of the Brazilian roadbuilding operation as well as sales growth in other asphalt products. General and administration costs increased primarily due to increased personnel related costs to support management’s on-going initiative to improve talent throughout this segment and the current consolidation of an existing distribution joint venture.
Income from operations for the Terex Roadbuilding, Utility Products and Other segment for the three months ended September 30, 2006 was $5.3 million, an increase of $4.1 million when compared to the same period in 2005. The increase reflects the sales growth and gross profit improvement in the roadbuilding and utility product businesses from prior cost saving initiatives and pricing actions.
Terex Corporate / Eliminations
| | Three Months Ended September 30, | | |
| | 2006 | | 2005 | | |
| | | % of Sales | | | % of Sales | | % Change In Reported Amounts |
| | ($ amounts in millions) | | |
Net sales | $ | (33.5) | - | $ | (26.9) | - | | 24.5% |
Income (loss) from operations | $ | (5.9) | 17.6% | $ | (4.8) | 17.8% | | 22.9% |
The Company’s consolidated results include the elimination of intercompany sales activity between segments. Additionally, certain expenses at the corporate level were not allocated to the business segments, which in 2006 were primarily attributable to the increased cost of certain equity and long term compensation programs, as well as certain unallocated expenses related to the Company’s global enterprise system implementation.
Net Interest Expense
During the three months ended September 30, 2006, the Company’s net interest expense was $16.3 million, or $5.8 million lower than the same period in the prior year. This reduction was primarily related to higher interest income combined with lower debt balances.
Loss on Early Extinguishment of Debt
The Company recorded a charge on early extinguishment of debt of $16.6 million, which included a $10.4 million expense associated with the call premium for the repayment of $200 million of outstanding debt on August 14, 2006 and $6.2 million of amortization of debt acquisition costs accelerated because of this debt repayment and the termination of the Company’s previous credit facility.
Other Income (Expense) – Net
Other income (expense) – net for the three months ended September 30, 2006 was income of $0.6 million, a decrease of $1.3 million when compared to the same period in the prior year, primarily due to increased foreign exchange and minority interest charges.
Income Taxes
During the three months ended September 30, 2006, the Company recognized income tax expense of $53.2 million on income from continuing operations before income taxes of $158.8 million, an effective rate of 33.5%, as compared to income tax expense of $30.8 million on income from continuing operations before income taxes of $82.4 million, an effective rate of 37.4%, for the three months ended September 30, 2005. The effective tax rate for the three months ended September 30, 2006 was lower than in the prior year period, primarily due to changes in the geographical distribution of earnings and a change in estimate of export tax incentives. An income tax benefit of $0.8 million was recorded within Income from discontinued operations for the three months ended September 30, 2006. Income tax expense of $1.2 million was recorded on the disposition of discontinued operations. For tax purposes, the cash received on the disposition was greater than the Company’s basis and, therefore, income tax expense was recorded.
34
Nine Months Ended September 30, 2006 Compared with Nine Months Ended September 30, 2005
Terex Consolidated
| | Nine Months Ended September 30, | | |
| | 2006 | | 2005 | | |
| | | % of Sales | | | % of Sales | | % Change In Reported Amounts |
| | ($ amounts in millions) | | |
Net sales | $ | 5,618.1 | - | $ | 4,588.2 | - | | 22.4% |
Gross profit | $ | 1,067.6 | 19.0% | $ | 707.2 | 15.4% | | 51.0% |
SG&A | $ | 527.5 | 9.4% | $ | 405.9 | 8.8% | | 30.0% |
Income from operations | $ | 540.1 | 9.6% | $ | 301.3 | 6.6% | | 79.3% |
Net sales for the nine months ended September 30, 2006 totaled $5,618.1 million, an increase of $1,029.9 million when compared to the same period in 2005. During this period, the Company continued to realize the benefits of end-market recoveries and pricing actions. Net sales relative to 2005 significantly increased in the Terex Aerial Work Platforms segment as a result of improved economic conditions in the rental equipment market, with an increasing proportion of sales from international growth. Net sales in the Terex Construction segment were higher, due to increased demand for compact construction equipment and heavy truck products, offset by weaker sales in the scrap handling product line and production delays regarding certain product lines. Net sales in the Terex Cranes segment increased from 2005 levels, with the recovery broad-based across most product categories and aided by expansion in China. Net sales in the Terex Materials Processing & Mining segment benefited relative to 2005 from improvements in commodity prices, mainly for coal and iron ore and increasing overall demand for its products, particularly hydraulic excavators. Net sales in the Terex Roadbuilding, Utility Products and Other segment increased relative to 2005 in most product categories.
Gross profit for the nine months ended September 30, 2006 totaled $1,067.6 million, an increase of $360.4 million when compared to the same period in 2005. Improvements relative to 2005 were realized in most segments of the Company due to the impact of pricing actions and volume leverage, despite continued component cost pressures negatively impacting operating results.
Total SG&A increased for the nine months ended September 30, 2006 by $121.6 million when compared to the same period in 2005. SG&A increased as a result of higher selling and related costs arising from increased sales levels during 2006, increased costs attributable to certain equity and long term compensation programs, as well as expense related to the Company’s global enterprise system implementation.
Income from operations increased by $238.8 million for the nine months ended September 30, 2006 when compared to the same period in 2005. The Terex Aerial Work Platforms segment experienced significant improvement in income from operations relative to the same period in 2005, due to unit volume and improved realization of pricing actions, resulting from an improving economy primarily in the United States, Europe and Australia. Income from operations in the Terex Construction segment decreased versus 2005, due to the reduced demand for the Company’s scrap handler product, start up delays in the launch of certain new product lines and the unfavorable impact of foreign currency on imports to the United States. Income from operations in the Terex Cranes segment increased as compared to 2005, as this segment experienced higher demand that was broad-based across most product categories and also due to the expansion in Asian markets. Income from operations improved in the Terex Materials Processing & Mining segment because of increased demand from the mining and infrastructure markets. Income from operations in the Terex Roadbuilding, Utility Products and Other segment improved due to the positive impact resulting from prior cost saving initiatives and pricing actions.
35
Terex Aerial Work Platforms
| | Nine months Ended September 30, | | |
| | 2006 | | 2005 | | |
| | | % of Sales | | | % of Sales | | % Change In Reported Amounts |
| | ($ amounts in millions) | | |
Net sales | $ | 1,576.3 | - | $ | 1,083.9 | - | | 45.4% |
Gross profit | $ | 401.4 | 25.5% | $ | 207.3 | 19.1% | | 93.6% |
SG&A | $ | 112.3 | 7.1% | $ | 74.9 | 6.9% | | 49.9% |
Income from operations | $ | 289.1 | 18.3% | $ | 132.4 | 12.2% | | 118.4% |
| | | | | | | | | |
Net sales for the Terex Aerial Work Platforms segment for the nine months ended September 30, 2006 were $1,576.3 million, an increase of $492.4 million when compared to the same period in 2005. Net sales increased when compared to the same period in 2005 as a result of stronger demand from the rental channel in the United States, improving demand for the Company’s products internationally, increasing market penetration of the telehandler product line, and, to a lesser extent, improved parts sales. Rental market demand increased relative to the same period in 2005 as rental channel customers continued to buy new equipment, primarily to address increased utilization of their existing equipment. Sales of telehandler products increased significantly when compared to the same period in 2005, as this product line continued to see the benefits of integrating the Genie sales and marketing strategy and selling through the same rental distribution channels as the aerial work platforms products. Light construction products also contributed to the segment’s sales growth over the prior year period.
Gross profit for the nine months ended September 30, 2006 was $401.4 million, an increase of $194.1 million when compared to the same period in 2005. While gross profit benefited from the unit volume increase, it was also favorably affected by pricing actions that were implemented to offset increases in the cost of components over the prior few years.
SG&A for the nine months ended September 30, 2006 were $112.3 million, an increase of $37.4 million when compared to the same period in 2005. Resources added to address the increasing sales levels and to expand the international sales and service infrastructure were the primary reasons for the additional costs, as well as increased bad debt expense when compared to the prior year period.
Income from operations for the nine months ended September 30, 2006 was $289.1 million, an increase of $156.7 million when compared to the same period in 2005. The increase was due to the favorable impact of pricing and unit volume, partially offset by the impact of increased component costs.
Terex Construction
| | Nine months Ended September 30, | | |
| | 2006 | | 2005 | | |
| | | % of Sales | | | % of Sales | | % Change In Reported Amounts |
| | ($ amounts in millions) | | |
Net sales | $ | 1,150.1 | - | $ | 1,140.3 | - | | 0.9% |
Gross profit | $ | 139.1 | 12.1% | $ | 143.3 | 12.6% | | (2.9)% |
SG&A | $ | 114.4 | 9.9% | $ | 98.0 | 8.6% | | 16.7% |
Income from operations | $ | 24.7 | 2.1% | $ | 45.3 | 4.0% | | (45.5)% |
Net sales in the Terex Construction segment increased by $9.8 million for the nine months ended September 30, 2006 when compared to the same period in 2005. The slight increase in net sales reflected a variety of items, with positive year over year performance by the off-highway truck and loader backhoe product lines partially offset by softening in certain other businesses, mainly the scrap handler product line.
Gross profit decreased to $139.1 million for the nine months ended September 30, 2006, a decrease of $4.2 million when compared to 2005 results for the same period. Gross profit was negatively impacted by the reduced sales volume of the scrap handling business and costs associated with the launch of new products, partially offset by price increases.
SG&A for the nine months ended September 30, 2006 totaled $114.4 million, an increase of $16.4 million when compared to the same period in 2005. Costs related to product development efforts, engineering costs ahead of a new product launch,
36
costs associated with development in China and increased resources to manage the sales growth in certain businesses were the primary drivers for the increase in SG&A.
Income from operations for the nine months ended September 30, 2006 totaled $24.7 million, a decrease of $20.6 million when compared to $45.3 million for the same period in 2005, primarily resulting from reduced scrap handler sales volume, increased cost associated with new product launches and increased personnel expenses.
Terex Cranes
| | Nine months Ended September 30, | | |
| | 2006 | | 2005 | | |
| | | % of Sales | | | % of Sales | | % Change In Reported Amounts |
| | ($ amounts in millions) | | |
Net sales | $ | 1,238.3 | - | $ | 924.0 | - | | 34.0% |
Gross profit | $ | 197.8 | 16.0% | $ | 113.2 | 12.3% | | 74.7% |
SG&A | $ | 96.0 | 7.8% | $ | 79.1 | 8.6% | | 21.4% |
Income from operations | $ | 101.8 | 8.2% | $ | 34.1 | 3.7% | | 198.5% |
Net sales for the Terex Cranes segment for the nine months ended September 30, 2006 were $1,238.3 million, an increase of $314.3 million when compared to the same period in 2005. The strong increase in net sales was due to a general improvement in all businesses and product categories, with particular strength in North American cranes and tower cranes in general, when compared to the same period in 2005. Net sales also increased approximately 6% due to the revenue generated by the April 2006 acquisition of a controlling interest in Sichuan Crane.
Gross profit for the nine months ended September 30, 2006 increased by $84.6 million relative to the same period in 2005 and totaled $197.8 million. Gross profit in the nine months ended September 30, 2006 benefited from increased sales volume, the inclusion of Sichuan Crane, the positive impact of pricing actions taken during 2005 and the strong recovery in the North American cranes market, more than offsetting the negative impact of component cost pressures.
SG&A for the nine months ended September 30, 2006 totaled $96.0 million, an increase of $16.9 million over the same period in 2005. The increase was due to higher spending levels in all cranes businesses, mainly driven by higher sales volume and the impact of the acquisition of Sichuan Crane. However, as a percentage of net sales, SG&A spending decreased to 7.8% as compared to 8.6% in 2005, reflecting the benefit of higher sales volume.
Income from operations for the nine months ended September 30, 2006 totaled $101.8 million, a significant increase of $67.7 million when compared to $34.1 million for the same period in 2005. Income from operations in 2006 was positively impacted by pricing actions in excess of cost pressures from suppliers.
Terex Materials Processing & Mining
| | Nine months Ended September 30, | | |
| | 2006 | | 2005 | | |
| | | % of Sales | | | % of Sales | | % Change In Reported Amounts |
| | ($ amounts in millions) | | |
Net sales | $ | 1,191.1 | - | $ | 1,011.5 | - | | 17.8% |
Gross profit | $ | 249.2 | 20.9% | $ | 175.6 | 17.4% | | 41.9% |
SG&A | $ | 110.5 | 9.3% | $ | 87.8 | 8.7% | | 25.9% |
Income from operations | $ | 138.7 | 11.6% | $ | 87.8 | 8.7% | | 58.0% |
| | | | | | | | | |
Net sales in the Terex Materials Processing & Mining segment increased by $179.6 million to $1,191.1 million in the first nine months of 2006, compared to $1,011.5 million in the same period in 2005. The increase in net sales was attributable to the overall strong demand for mining products, mainly the hydraulic mining excavators manufactured in Dortmund, Germany and related spare parts sales, which benefited from a broader distribution network, and the continued growth of the crushing and screening product lines.
Gross profit increased by $73.6 million in the nine months ended September 30, 2006 when compared to the same period in 2005 and totaled $249.2 million. Gross profit improved as a result of the increased sales volume, net sales mix and pricing actions from existing operations across all product categories, both in terms of new machines and parts and service.
37
SG&A increased by $22.7 million to $110.5 million in the first nine months of 2006 relative to the comparable period in 2005. The increase in SG&A was mainly due to additional staffing to meet sales growth, period costs associated with the relocation of the U.S. mining truck business personnel, and the acquisition of the Halco business in January 2006.
Income from operations for the Terex Materials Processing & Mining segment was $138.7 million for the first nine months of 2006, a significant increase of $50.9 million from $87.8 million in the comparable period in 2005. The increase was a result of higher demand for the segment’s products, due primarily to continued strong commodity pricing, the increase in global distribution for the hydraulic mining excavators and the benefits of prior pricing actions, partially offset by increased component costs.
Terex Roadbuilding, Utility Products and Other
| | Nine months Ended September 30, | | |
| | 2006 | | 2005 | | |
| | | % of Sales | | | % of Sales | | % Change In Reported Amounts |
| | ($ amounts in millions) | | |
Net sales | $ | 552.3 | - | $ | 506.9 | - | | 9.0% |
Gross profit | $ | 79.0 | 14.3% | $ | 64.8 | 12.8% | | 21.9% |
SG&A | $ | 54.7 | 9.9% | $ | 52.9 | 10.4% | | 3.4% |
Income from operations | $ | 24.3 | 4.4% | $ | 11.9 | 2.3% | | 104.2% |
| | | | | | | | | |
Net sales for the Terex Roadbuilding, Utility Products and Other segment for the nine months ended September 30, 2006 were $552.3 million, an increase of $45.4 million when compared to the same period in 2005. Growth was achieved in most business units and product categories, but especially in the businesses of roadbuilding and utility products.
Gross profit for the nine months ended September 30, 2006 totaled $79.0 million, an increase of $14.2 million when compared to the same period in 2005. Gross profit margin improved in the utilities business, with the other businesses showing a slight decline. Gross profit margin in this largely United States based business segment was favorably impacted by pricing actions, as well as the positive effects of certain reorganization activities that were implemented over the prior few years, partially offset by increases in component costs.
SG&A for the segment for the nine months ended September 30, 2006 totaled $54.7 million, an increase of $1.8 million when compared to the same period in 2005, although costs were lower as a percentage of net sales.
Income from operations for the Terex Roadbuilding, Utility Products and Other segment for the nine months ended September 30, 2006 was $24.3 million, an increase of $12.4 million when compared to the same period in 2005. The increase was due primarily to the favorable impact of pricing actions and the positive effect of recent cost reduction activities.
Terex Corporate / Eliminations
| | Nine months Ended September 30, | | |
| | 2006 | | 2005 | | |
| | | % of Sales | | | % of Sales | | % Change In Reported Amounts |
| | ($ amounts in millions) | | |
Net sales | $ | (90.0) | - | $ | (78.4) | - | | 14.8% |
Income (loss) from operations | $ | (38.5) | 42.8% | $ | (10.2) | 13.0% | | 277.5% |
| | | | | | | | | |
The Company’s consolidated results include the elimination of intercompany sales activity between segments. Additionally, certain expenses at the corporate level were not allocated to the business segments, which in 2006 were primarily attributable to the increased cost of certain equity and long term compensation programs as well as certain unallocated expenses related to the Company’s global enterprise system implementation.
38
Net Interest Expense
During the nine months ended September 30, 2006, the Company’s net interest expense was $59.7 million, which was $4.8 million lower than during the same period in the prior year. This reduction was primarily related to higher interest income combined with lower debt balances.
Loss on Early Extinguishment of Debt
The Company recorded a charge on early extinguishment of debt of $23.3 million, including a $15.6 million expense associated with the call premiums for the repayment of $300 million of outstanding debt in June and August 2006, in addition to $7.7 million of amortization of debt acquisition costs accelerated because of this debt repayment and the termination of the Company’s previous credit facility.
Other Income (Expense) – Net
Other income (expense) – net for the nine months ended September 30, 2006 was income of $0.6 million compared to income of $1.8 million in the comparable period for 2005. This decrease was primarily due to increased foreign exchange and minority interest charges.
Income Taxes
During the nine months ended September 30, 2006, the Company recognized income tax expense of $162.1 million on income from continuing operations before income taxes of $457.7 million, an effective rate of 35.4%, as compared to income tax expense of $88.3 million on income from continuing operations before income taxes of $238.6 million, an effective rate of 37.0%, in the prior year period. The effective tax rate for the nine months ended September 30, 2006 was lower than in the prior year period, primarily due to changes in the geographical distribution of earnings and a change in estimate of export tax incentives. An income tax benefit of $0.8 million was recorded within Income from discontinued operations for the three months ended September 30, 2006. This benefit offsets the Provision for income taxes recorded in the six months ended June 30, 2006 for discontinued operations. Utilization of net operating loss carry forwards results in no Provision for income taxes for the nine months ended September 30, 2006 for discontinued operations. Income tax expense of $1.2 million was recorded on the disposition of discontinued operations. For tax purposes, the cash received on the disposition was greater than the Company’s basis and, therefore, income tax expense was recorded.
LIQUIDITY AND CAPITAL RESOURCES
The Company’s main sources of funding are cash generated from operations, loans from the Company’s bank credit facilities and funds raised in capital markets. Management believes that cash generated from operations, together with the Company’s bank credit facilities and cash on hand, provides the Company with adequate liquidity to meet the Company’s operating and debt service requirements. The Company had cash and cash equivalents of $428.3 million at September 30, 2006. In addition, the Company had $554.0 million available for borrowing under its revolving credit facilities at September 30, 2006.
Generating cash from operations depends primarily on the Company’s ability to earn net income through the sales of the Company’s products and to manage its investment in working capital. The Company continues to focus on collection of receivables in a timely manner. Consistent with past practice, each quarter the Company sells receivables to various third party financial institutions through several pre-arranged facilities. The discontinuance of these facilities could negatively affect the Company’s liquidity. During the third quarter of 2006 and 2005, the Company sold, without recourse, accounts receivable approximating 11% and 15% of its third quarter revenue in 2006 and 2005, respectively, to provide additional liquidity.
The Company is focused on reducing inventory levels in relation to its sales volume by sharing, throughout the Company, many of the best practices and lean manufacturing processes that several of its business units have successfully utilized. These initiatives are expected to reduce the levels of raw materials and work in process needed to support the business and enable the Company to reduce its manufacturing lead times, thereby reducing the Company’s working capital requirements.
The Company’s ability to generate cash from operations is subject to the following factors:
• | A substantial number of the Company’s customers fund their purchases through third party finance companies. Finance companies extend credit to customers based on the credit worthiness of the customers and the expected residual value of the Company’s equipment. Changes either in the customers’ credit rating or in used equipment values may affect the ability of customers to purchase equipment. |
39
• | As the Company’s sales increase, the absolute amount of working capital needed to support the business may increase with a corresponding reduction in cash generated by operations. The initiatives described above are intended to reduce the relative increase in working capital. |
• | As described above, the Company insures and sells a portion of its accounts receivable to third party finance companies. These third party finance companies are not obligated to purchase accounts receivable from the Company, and may choose to limit or discontinue further purchases from the Company at any time. Changes in customers’ credit worthiness, in the market for credit insurance or in the willingness of third party finance companies to purchase accounts receivable from the Company may affect the Company’s cash flow from operations. |
• | The Company purchases material and services from its suppliers on terms extended based on the Company’s overall credit rating. Changes in the Company’s credit rating may affect suppliers’ willingness to extend terms and increase the cash requirements of the business. |
• | Sales of the Company’s products are subject to general economic conditions, weather, competition and foreign currency fluctuations, and other such factors that in many cases are outside the Company’s direct control. For example, during periods of economic uncertainty, many of the Company’s customers have tended to delay purchasing decisions, which has had a negative impact on cash generated from operations. |
Traditionally, the Company’s customers’ peak buying periods are in the first half of a calendar year as a result of their need to have new equipment available for the spring, summer and fall construction season in Northern Hemisphere end-markets. Therefore, historically, the Company’s sales have tended to be seasonal, with slightly more than half of the Company’s sales typically generated in the first two quarters of a calendar year.
For 2006, however, the Company anticipates sales in the second half of the year to be substantially similar to sales in the first half of the year. Sales in the first three quarters of 2006 were driven by the Company’s customers’ desire for delivery of new equipment from March through July in order to have such equipment available for the spring, summer and fall construction seasons in the Northern Hemisphere. Sales for the remainder of 2006 are anticipated to reflect high demand for backlog orders in the aerial work platforms, cranes and mining businesses that will be accepted late in the year, an expected increase in roadbuilding orders arising later in the year as that business continues to recover, and anticipated orders for new products introduced by the Terex Construction segment, leading to a ramp-up in sales for that group in the last quarter of the year.
In 2006, the Company used cash to fund its operations in the first quarter of the year and generated cash in the second and third quarters, and expects to generate cash in the fourth quarter of the year, due largely to improved working capital efficiency and increased profitability.
To help fund its traditional seasonal cash pattern, the Company has maintained a significant cash balance and a revolving line of credit in addition to term borrowings from its bank group. During 2005 and the first six months of 2006, the Company maintained a bank credit facility the (the “Old Credit Agreement”) that originally provided for $375 million of term debt maturing in July 2009 and a revolving credit facility of $300 million that was available through July 2007. The facility also included provisions for an additional $250 million of term borrowing by the Company on terms similar to the original term loan debt under the facility, of which the Company had used $210 million of additional term borrowings.
On July 14, 2006, the Company and certain of its subsidiaries entered into a new Credit Agreement (the “New Credit Agreement”) with the lenders party thereto (the “New Lenders”) and Credit Suisse, as administrative agent and collateral agent. The New Credit Agreement provides the Company with a senior revolving line of credit of up to $700 million that is available through July 14, 2012 and senior term debt of up to $200 million that will mature on July 14, 2013. The revolving line of credit consists of $500 million of available domestic revolving loans and $200 million of available multicurrency revolving loans. The New Credit Agreement also provides for incremental loan commitments of up to $300 million, which may be extended at the option of the New Lenders, in the form of revolving credit loans, term loans or a combination of both. The Company believes this larger revolving line of credit should allow it to use a significant amount of its existing cash balance to reduce debt.
The New Credit Agreement requires the Company to comply with a substantial number of covenants. These covenants require the Company to meet certain financial tests, namely (a) a requirement that the Company maintain a consolidated leverage ratio, as defined in the New Credit Agreement, not in excess of 3.75 to 1.00 on the last day of any fiscal quarter, and (b) a requirement that the Company maintain a consolidated fixed charge coverage ratio, as defined in the New Credit Agreement, of not less than 1.25 to 1.00 for any period of four consecutive fiscal quarters. The covenants also limit, in certain circumstances, Terex’s ability to take a variety of actions, including: incur indebtedness; create or maintain liens on its property or assets; make investments, loans and advances; engage in acquisitions, mergers, consolidations and asset sales; and pay dividends and distributions, including share repurchases. The New Credit Agreement also contains customary events of default.
40
The Company is currently in compliance with all of its financial covenants under the New Credit Agreement. The Company’s future compliance with its financial covenants under the New Credit Agreement will depend on its ability to generate earnings and manage its assets effectively. The Company’s bank credit facilities also have various non-financial covenants, both requiring the Company to refrain from taking certain actions (as described above) and requiring the Company to take certain actions, such as keeping in good standing its corporate existence, maintaining insurance, and providing its bank lending group with financial information on a timely basis. The Company’s future ability to provide its bank lending group with financial information on timely basis will depend on its ability to file its periodic reports with the Securities and Exchange Commission (“SEC”) in a timely manner.
Furthermore, the Company and certain of its subsidiaries agreed to take certain actions to secure borrowings under the New Credit Agreement. As a result, on July 14, 2006, the Company and certain of its subsidiaries entered into a Guarantee and Collateral Agreement with Credit Suisse, as collateral agent for the New Lenders, granting security to the New Lenders for amounts borrowed under the New Credit Agreement.
In connection with the New Credit Agreement, the Company terminated the Old Credit Agreement and related agreements and documents. The Company used the proceeds from $200 million of term loans under the New Credit Agreement and cash on hand to pay in full all amounts outstanding under the Old Credit Agreement at the date of termination.
On June 30, 2006, the Company completed the redemption of $100 million principal amount of its $300 million principal amount outstanding 10-3/8% Senior Subordinated Notes due 2011 (the “10-3/8% Notes”). The total cash paid was $107.8 million, and included a call premium of 5.188% as set forth in the indenture for these 10-3/8% Notes plus accrued interest of $25.65 per $1,000 principal amount at the redemption date. The Company recorded charges of $6.7 million in the second quarter of 2006 for the call premium and accelerated amortization of debt acquisition costs as a loss on early extinguishment of debt.
On August 14, 2006, the Company redeemed the remaining $200 million outstanding principal amount of the 10-3/8% Notes. The total cash paid was $218.0 million, and included a call premium of 5.188% as set forth in the indenture for the 10-3/8% Notes plus accrued interest of $38.33 per $1,000 principal amount at the redemption date. The Company recorded charges of $13.2 million in the third quarter of 2006 for the call premium and accelerated amortization of debt acquisition costs as a loss on early extinguishment of debt.
The interest rates charged under the Company’s bank credit facilities are subject to adjustment based on the Company’s consolidated leverage ratio. The weighted average interest rate on the outstanding portion of the revolving credit component under the Company’s New Credit Agreement was 5.88% at September 30, 2006.
During June 2006, Moody’s Investors Service, Inc. (“Moody’s”) improved its issuer rating for the Company from B2 to Ba3 and Standard and Poor’s Ratings Service (“S&P”) improved its issuer rating for the Company from BB- to BB. In September 2006, Moody’s improved its rating on the Company’s senior secured debt from Ba3 to Ba1 and its rating on the Company’s senior subordinated debt from B2 to B1. Under the terms of the New Credit Facility, Terex provided liens on substantially all its assets in the United States as well as pledges of the stock of certain of its domestic and international subsidiaries as security to the New Lenders. If the New Credit Facility is rated Ba2 or better by Moody’s and BB or better by S&P, both with no negative outlook, for a period of 90 days, liens on assets are no longer required as security. As a result of the recent upgrade from Moody’s, the Company currently meets this condition and anticipates that the liens on its assets provided as security for the New Credit Facility will be eligible for release beginning in the fourth quarter of 2006.
The Company manages its interest rate risk by maintaining a balance between fixed and floating rate debt through interest rate derivatives. Over the long term, the Company believes this balance will produce lower interest cost than a purely fixed rate mix without substantially increasing risk.
The Company continues to review its alternatives to reduce its cost of capital and to reduce debt service costs through a combination of debt refinancing, asset sales and the sale of non-strategic businesses. The Company’s ability to access the capital markets to raise funds, through the sale of equity or debt securities, is subject to various factors, some specific to the Company and others related to general economic and/or financial market conditions. These include results of operations, projected operating results for future periods and debt to equity leverage. The Company’s ability to access the capital markets is also subject to its timely filing of its periodic reports with the SEC, and the Company’s failure to file certain of its periodic reports on a timely basis currently limits the ability of the Company to access the capital markets using short-form registration for a period of twelve months from May 31, 2006. In addition, the terms of the Company’s bank credit facility and senior subordinated notes restrict the Company’s ability to make further borrowings or to sell substantial portions of its assets.
41
Cash Flows
Cash provided by operations for the nine months ended September 30, 2006 totaled $216.8 million, compared to cash provided by operations of $70.0 million for the nine months ended September 30, 2005. The increase in cash provided by operations is consistent with the increase in sales volume, and reflects the improvement in the Company’s financial performance.
Cash used in investing activities for the nine months ended September 30, 2006 was $38.5 million, or $5.5 million less than cash used in investing activities for the nine months ended September 30, 2005, primarily due to the impact of cash proceeds received upon the disposition of discontinued operations in September 2006.
The Company used cash for financing activities of $326.2 million for the nine months ended September 30, 2006, compared to cash used for financing activities for the nine months ended September 30, 2005 of $29.3 million. The change in financing cash flows was primarily due to the repayment of $300 million principal amount of the 10-3/8% Notes in the second and third quarters of 2006 and increased net repayments under the Company’s lines of credit, offset in part by the financing inflow resulting from excess tax benefits associated with stock-based compensation.
OFF-BALANCE SHEET ARRANGEMENTS
Guarantees
Customers of the Company from time to time may fund the acquisition of the Company’s equipment through third-party finance companies. In certain instances, the Company may provide a credit guarantee to the finance company, by which the Company agrees to make payments to the finance company should the customer default. The maximum liability of the Company is limited to the remaining payments due to the finance company at the time of default. In the event of customer default, the Company is generally able to dispose of the equipment with the Company realizing the benefits of any net proceeds in excess of the remaining payments due to the finance company.
As of September 30, 2006, the Company’s maximum exposure to such credit guarantees was $210.3 million, including total credit guarantees issued by Terex Demag, part of the Terex Cranes segment, and Genie, part of the Terex Aerial Work Platforms segment, of $155.7 million and $25.8 million, respectively. The terms of these guarantees coincide with the financing arranged by the customer and generally does not exceed five years. Given the Company’s position as the original equipment manufacturer and its knowledge of end markets, the Company, when called upon to fulfill a guarantee, generally has been able to liquidate the financed equipment at a minimal loss, if any, to the Company.
The Company, from time to time, issues residual value guarantees under sales-type leases. A residual value guarantee involves a guarantee that a piece of equipment will have a minimum fair market value at a future date. As described in Note P – “Litigations and Contingencies” in the Notes to the Condensed Consolidated Financial Statements, the Company’s maximum exposure related to residual value guarantees under sales-type leases was $27.4 million at September 30, 2006. Given the Company’s position as the original equipment manufacturer and its knowledge of end markets, the Company is able to mitigate the risk associated with these guarantees because the maturity of the guarantees is staggered, limiting the amount of used equipment entering the marketplace at any one time.
The Company from time to time guarantees that it will buy equipment from its customers in the future at a stated price if certain conditions are met by the customer. Such guarantees are referred to as buyback guarantees. These conditions generally pertain to the functionality and state of repair of the machine. As of September 30, 2006, the Company’s maximum exposure pursuant to buyback guarantees was $20.1 million. The Company is able to mitigate the risk of these guarantees by staggering the timing of the buybacks and through leveraging its access to the used equipment markets provided by the Company’s original equipment manufacturer status.
The Company has recorded an aggregate liability within Other current liabilities and Other non-current liabilities in the Condensed Consolidated Balance Sheet of approximately $17 million for the estimated fair value of all guarantees provided as of September 30, 2006.
Variable Interest Entities
The Company owns a forty percent (40%) interest in the TFSH joint venture. A European financial institution owns the majority sixty percent (60%) interest in TFSH. As defined by FASB Interpretation No. 46R, “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51,” TFSH is a variable interest entity. Based on the legal, financial and operating structure of TFSH, the Company has concluded that it is not the primary beneficiary of TFSH and that it does not control the operations of TFSH. Accordingly, the Company does not consolidate the results of TFSH into its consolidated
42
financial results. The Company applies the equity method of accounting for its investment in TFSH. The scope of TFSH’s operations includes the opportunity to facilitate the financing of all of the Company’s products sold in Europe.
As of September 30, 2006, TFSH had total assets of $436 million, consisting primarily of financing receivables and lease related equipment, and total liabilities of $394 million, consisting primarily of debt issued by the joint venture partner. Prior to March 31, 2006, the Company provided guarantees related to potential losses arising from shortfalls in the residual values of financed equipment or credit defaults by the joint venture’s customers. As of September 30, 2006, the maximum exposure to loss under these guarantees was $24 million. Additionally, the Company is required to maintain a capital account balance in TFSH, pursuant to the terms of the joint venture, which could result in the reimbursement to TFSH by the Company of losses to the extent of the Company’s ownership percentage. As a result of the capital account balance requirements for TFSH, during the first quarter of 2006, the Company contributed its proportional share of these requirements, which represented an additional $3.4 million in cash to TFSH.
Sale-Leaseback Transactions
The Company’s rental business typically rents equipment to customers for periods of no less than three months. To better match cash outflows in the rental business to cash inflows from customers, the Company finances substantially all of the equipment through a series of sale-leasebacks classified as operating leases. The leaseback period is typically 60 months in duration. At September 30, 2006, the historical cost of equipment being leased back from the financing companies was approximately $80 million and the minimum lease payments for the remainder of 2006 will be approximately $4 million.
CONTINGENCIES AND UNCERTAINTIES
Foreign Currencies and Interest Rate Risk
The Company’s products are sold in over 100 countries around the world and, accordingly, revenues of the Company are generated in foreign currencies, while the costs associated with those revenues may or may not be incurred in the same currencies. The major foreign currencies, among others, in which the Company does business, are the Euro and British Pound. The Company may, from time to time, hedge specifically identified committed and forecasted cash flows in foreign currencies using forward currency sale or purchase contracts. At September 30, 2006, the Company had foreign exchange contracts with a notional value of $476.1 million.
The Company manages exposure to interest rates by incurring a mix of indebtedness bearing interest at both floating and fixed rates at inception and maintaining an on-going balance between floating and fixed rates on this mix of indebtedness through the use of interest rate swaps when necessary.
Certain of the Company’s obligations, including its senior subordinated notes, bear interest at a fixed interest rate. The Company has entered into an interest rate swap agreement to convert the fixed rate to a floating rate with respect to approximately $200 million of the principal amount of its indebtedness under its 7-3/8% Senior Subordinated Notes. The floating rate is based on a spread of 2.45% over the London Interbank Offer Rate (“LIBOR”). At September 30, 2006, the floating rate was 7.68%.
Other
The Company is subject to a number of contingencies and uncertainties including, without limitation, product liability claims, workers’ compensation liability, intellectual property litigation, self-insurance obligations, tax examinations and guarantees. Many of the exposures are unasserted or the proceedings are at a preliminary stage, and it is not presently possible to estimate the amount or timing of any cost to the Company. However, the Company does not believe that these contingencies and uncertainties will, in the aggregate, have a material adverse effect on the Company. When it is probable that a loss has been incurred and possible to make reasonable estimates of the Company’s liability with respect to such matters, a provision is recorded for the amount of such estimate or for the minimum amount of a range of estimates when it is not possible to estimate the amount within the range that is most likely to occur.
The Company generates hazardous and non-hazardous wastes in the normal course of its manufacturing operations. As a result, Terex is subject to a wide range of federal, state, local and foreign environmental laws and regulations. These laws and regulations govern actions that may have adverse environmental effects, such as discharges to air and water, and also require compliance with certain practices when handling and disposing of hazardous and non-hazardous wastes. These laws and regulations also impose liability for the costs of, and damages resulting from, cleaning up sites, past spills, disposals and other releases of hazardous substances, should any of such events occur. No such incidents have occurred which required the Company to pay material amounts to comply with such laws and regulations. Compliance with such laws and regulations has
43
required, and will continue to require, the Company to make expenditures. The Company does not expect that these expenditures will have a material adverse effect on its business or profitability.
On February 1, 2006, the Company received a copy of a written order of a private investigation from the SEC. Terex has been cooperating with the SEC and will continue to cooperate fully to furnish the SEC staff with information needed to complete their investigation.
Terex also received a subpoena from the SEC dated May 9, 2005, in a matter entitled “In the Matter of United Rentals, Inc.” The subpoena principally requested information to assist the SEC in its investigation of four transactions involving Terex and its subsidiaries, on the one hand, and United Rentals, Inc. on the other, in 2000 and 2001. Terex is also cooperating fully with this investigation. The U.S. Attorney’s office has also requested information from the Company about these transactions and the Company intends to fully cooperate with this request.
A class action and derivative complaint entitled Michael Morter, derivatively on behalf of nominal defendant Terex Corporation, v. G. Chris Andersen, Ronald M. DeFeo, Don DeFosset, William H. Fike, Donald P. Jacobs, David A. Sachs, J.C. Watts, Jr., Helge H. Wehmeier and Phillip C. Widman, defendants, and Terex Corporation, nominal defendant, was previously filed. The complaint alleged breach of fiduciary duty and breach of the Company’s by-laws. The court has approved a settlement agreement among the parties with respect to this lawsuit and has required a notice to be sent by plaintiff’s counsel. The agreement requires the Company to make minor modifications to its Governance Guidelines and its Audit Committee Charter and will not have a material impact on the Company’s financial statements.
On November 2, 2006, the Company received a subpoena from the United States Department of Justice, Antitrust Division, with respect to its investigation into pricing practices in the rock crushing and screening equipment industry. Terex intends to cooperate fully with this investigation.
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 151, “Inventory Costs an amendment of ARB No. 43, Chapter 4.” SFAS No. 151 discusses the general principles applicable to the pricing of inventory. Paragraph 5 of Accounting Research Bulletin (“ARB”) No. 43, Chapter 4 provides guidance on allocating certain costs to inventory. SFAS No. 151 amends ARB No. 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current-period charges. In addition, SFAS No. 151 requires allocation of fixed production overheads to the costs of conversion be based on normal capacity of production facilities. As required by SFAS No. 151, the Company adopted this accounting standard on January 1, 2006. Adoption of SFAS No. 151 did not have a material impact on the Company’s financial statements.
In December 2004, the FASB issued SFAS No. 123R “Share-Based Payment.” SFAS No. 123R requires that cost resulting from all share-based payment transactions be recognized in the financial statements. SFAS No. 123R also establishes fair value as the measurement method in accounting for share-based payments to employees. In March 2005, the SEC released Staff Accounting Bulletin No. 107, “Share-Based Payment” (“SAB No. 107”), which provides interpretive guidance on SFAS No. 123R. SAB No. 107 does not change the accounting required by SFAS No. 123R. The Company adopted this accounting standard on January 1, 2006. The Company used the modified prospective method for its transition to this accounting standard. Adoption of SFAS No. 123R did not have a material impact on the Company’s financial statements.
In June 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections.” SFAS No. 154 changes requirements for the accounting for and reporting of a change in accounting principle. This statement requires retrospective applications to prior periods’ financial statements of a voluntary change in accounting principle unless it is impractical. In addition, this statement requires that a change in depreciation, amortization, or depletion for long-lived, non-financial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. The Company adopted this accounting standard on January 1, 2006. Adoption of SFAS No. 154 did not have a material impact on the Company’s financial statements.
In June 2005, the FASB ratified Emerging Issues Task Force (“EITF”) Issue No. 05-5 (“EITF No. 05-5”), “Accounting for Early Retirement or Postemployment Programs with Specific Features (such as Terms Specified in Altersteilzeit Early Retirement Arrangements).” Altersteilzeit (“ATZ”) is an early retirement program in Germany designed to create an incentive for employees, within a certain age group, to retire before the legal retirement age. Although established by law, the actual arrangement is negotiated between the employer and employee. Under an ATZ Early Retirement Program (Type I and Type II) or an arrangement with the same terms, salary payments should be recognized ratably over the portion of the ATZ period when the employee is providing the active services. Accruals for the termination benefit under Type II should be accrued ratably from the date the employee signs the ATZ contract to the end of the active service period. The Company adopted this EITF on January 1, 2006. Adoption of EITF No. 05-5 did not have a material impact on the Company’s financial statements.
44
In June 2006, the FASB ratified EITF Issue No. 06-3 (“EITF No. 06-3”), “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That is, Gross versus Net Presentation).” The classification in the income statement of taxes is considered an accounting policy and any change in presentation would require the application of FASB No. 154, “Accounting Changes and Error Corrections.” In addition, under the scope of EITF No. 06-3, significant taxes would require disclosure of the accounting policy elected and amounts reflected in gross revenue for all periods presented. The provisions of EITF No. 06-3 are effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact on its financial statements of adopting EITF No. 06-3.
In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (“FIN No. 48”), which clarifies the accounting for uncertainty in tax positions. FIN No. 48 requires that the Company recognize in its financial statements the impact of a tax position, if that position is more likely than not to be sustained on audit, based on the technical merits of the position. The provisions of FIN No. 48 are effective for fiscal years beginning after December 15, 2006, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The Company is currently evaluating the impact on its financial statements of adopting FIN No. 48.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB No. 108”), to address diversity in practice in quantifying financial statement misstatements. SAB No. 108 requires the Company to quantify misstatements based on their impact on each of its financial statements and related disclosures. SAB No. 108 is effective as of the end of the Company’s 2006 fiscal year, allowing a one-time transitional cumulative effect adjustment to retained earnings as of January 1, 2006 for errors that were not previously deemed material, but are material under the guidance in SAB No. 108. The Company is currently evaluating the impact of adopting SAB No. 108 on its financial statements.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The provisions of SFAS No. 157 are effective as of the beginning of the Company’s 2008 fiscal year. The Company is currently evaluating the impact of adopting SFAS No. 157 on its financial statements.
In September 2006, the FASB issued SFAS No. 158, “Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106, and 132(R).” SFAS No. 158 requires that the Company recognize the funded status of its defined benefit and other postretirement benefit plans in its December 31, 2006 balance sheet, with changes in the funded status recognized through comprehensive income in the year in which they occur. SFAS No. 158 also requires the measurement of the funded status of the Company’s plans as of its year-end balance sheet date no later than 2008. The Company currently uses its year-end balance sheet date as its measurement date. Based on the Company’s funded status of plan obligations disclosed in Note Q to the Company’s Consolidated Financial Statements in its Annual Report on Form 10-K for the year ended December 31, 2005, the estimated impact of adopting SFAS No. 158 would have been a reduction to December 31, 2005 comprehensive income of approximately $21 million, net of tax, with no impact to the Company’s Consolidated Statements of Income or Cash Flows. This estimate is based on the assumption that deferred tax assets related to pension and other post retirement benefits will be realized. The actual impact of adopting SFAS No. 158 could materially differ from this estimate as a result of changes in assumptions used in the valuation of projected plan obligations and the fair value of plan assets measured as of December 31, 2006.
ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
The Company is exposed to certain market risks which exist as part of its ongoing business operations and the Company uses derivative financial instruments, where appropriate, to manage these risks. The Company, as a matter of policy, does not engage in trading or speculative transactions. For further information on accounting policies related to derivative financial instruments, refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.
Foreign Exchange Risk
The Company is exposed to fluctuations in foreign currency cash flows related to third party purchases and sales, intercompany product shipments and intercompany loans. The Company is also exposed to fluctuations in the value of foreign currency investments in subsidiaries and cash flows related to repatriation of these investments. Additionally, the Company is exposed to volatility in the translation of foreign currency earnings to U.S. Dollars. Primary exposures include the U.S. Dollar versus functional currencies of the Company’s major markets, which include the Euro, British Pound and Australian Dollar. The Company assesses foreign currency risk based on transactional cash flows and identifies naturally offsetting positions and purchases hedging instruments to protect anticipated exposures. At September 30, 2006, the Company had foreign currency contracts with a notional value of $476.1 million. The fair market value of these arrangements, which represents the cost to settle these contracts, was a net gain of $2.7 million at September 30, 2006.
45
Interest Rate Risk
The Company is exposed to interest rate volatility with regard to future issuances of fixed rate debt and existing issuances of variable rate debt. The Company manages its exposure to interest rates by incurring a mix of indebtedness bearing interest at both floating and fixed rates at inception and maintains an on-going balance between floating and fixed rates on this mix of indebtedness through the use of interest rate swaps when necessary. At September 30, 2006, approximately 58.1% of the Company’s debt was floating rate debt and the weighted average interest rate for all debt was approximately 7.69%.
At September 30, 2006, the Company had a $200.0 million interest rate swap that converted a fixed rate to a floating rate. The floating rate was 7.68% at September 30, 2006. The fair market value of this arrangement, which represents the cost to settle this contract, was a net loss of $5.4 million.
At September 30, 2006, the Company performed a sensitivity analysis for the Company’s derivatives and other financial instruments that have interest rate risk. The Company calculated the pretax earnings effect on its interest sensitive instruments. Based on this sensitivity analysis, the Company has determined that an increase of 10% in the Company’s average floating interest rates at September 30, 2006 would have increased interest expense by approximately $2.5 million in the nine months ended September 30, 2006.
Commodities Risk
Principal materials used by the Company in its various manufacturing processes include steel, castings, engines, tires, hydraulic cylinders, drive trains, electric controls and motors, and a variety of other commodities and fabricated or manufactured items. The Company’s performance may be impacted by extreme movements in material costs and from availability of these materials. Specifically, the Company has recently had difficulty in obtaining some of its necessary components, particularly large off-highway tires. In addition, during the past several years, the Company was affected by increases in the cost of steel, although the cost of steel has moderated recently. Steel is a major material component for many of the Company’s products, so as the cost of steel increased, the cost to manufacture these products increased. The cost of steel has increased, and the availability of steel has decreased, in response to higher demand caused by a recovering end-market and higher consumption of steel by emerging economies such as China.
In the absence of labor strikes or other unusual circumstances, substantially all materials are normally available from multiple suppliers. Current and potential suppliers are evaluated on a regular basis on their ability to meet the Company’s requirements and standards. The Company actively manages its material supply sourcing, and may employ various methods to limit risk associated with commodity cost fluctuations and availability. With respect to the increases in the cost of steel, for example, the Company designed and implemented plans to mitigate the impact, including the use of alternate suppliers, leveraging the Company’s overall purchase volumes to obtain favorable costs, and increasing the price of the Company’s products. Tire shortages can impact customer deliveries, and the Company continues to search for acceptable alternative supply sources, as well as utilizing customer provided tires and re-treaded used tires in appropriate circumstances. In reaction to supplier cost increases, starting in 2005, several of the Company’s operations implemented price increases directly intended to offset increases in the prices of steel and other components.
ITEM 4. | CONTROLS AND PROCEDURES |
(a) | Evaluation of Disclosure Controls and Procedures |
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports the Company files under the Securities Exchange Act of 1934 (the “Exchange Act”) 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 (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding required financial disclosure. In connection with the preparation of this Quarterly Report on Form 10-Q, the Company’s management carried out an evaluation, under the supervision and with the participation of the Company’s management, including the CEO and CFO, as of September 30, 2006, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as such term is defined under Rule 13a-15(e) under the Exchange Act. Based upon this evaluation, the Company’s CEO and CFO concluded that the Company’s disclosure controls and procedures were not effective as of September 30, 2006 because of the material weaknesses discussed below. Notwithstanding the material weaknesses discussed below, the Company’s management has concluded that the consolidated financial statements included in this Quarterly Report on Form 10-Q make a fair statement in all material respects of the Company’s financial condition, results of operations and cash flows for the periods presented in conformity with generally accepted accounting principles.
46
(b) Changes in Internal Control Over Financial Reporting
There were changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the Company’s quarter ended September 30, 2006, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. In the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, management identified the following material weaknesses in the Company’s internal control over financial reporting: (a) maintenance of a sufficient complement of personnel with a level of accounting knowledge, experience and training in the application of generally accepted accounting principles commensurate with the Company’s financial reporting requirements and (b) accounting for income taxes. Remediation of these weaknesses had not yet been fully evidenced and therefore these material weaknesses continued to exist as of September 30, 2006.
In response to those material weaknesses identified as of December 31, 2005, the Company has taken a number of substantial actions and will continue to take further significant steps to strengthen its control processes and procedures in order to remediate such material weaknesses. The Company will continue to evaluate the effectiveness of its internal controls and procedures on an ongoing basis and will take further action as appropriate.
The following are among the specific actions taken by the Company in its internal control over financial reporting processes during the quarter ended September 30, 2006 to address the sufficient complement of finance personnel material weakness identified as of December 31, 2005:
• | Continued to recruit and upgrade additional personnel in key areas throughout the Company’s financial organization to both keep pace with the growth of the Company and to enhance the capabilities of the Company’s financial organization. Third quarter 2006 appointments included a Vice President of Finance and a Director of Finance for Terex China, a U.S. based Manager of Internal Control Compliance, a site Controller at a Materials Processing & Mining segment location and a site Controller at a Roadbuilding, Utility Products and Other segment location. |
• | Prepared initial development assessments for a specific set of core competencies for business unit finance leaders, representing a key element of the Company’s human resource planning for evaluating and developing finance personnel. |
• | Implemented an internet-based educational training program for approximately 1,200 key domestic and international employees relating to legal and ethical compliance matters. |
The following are among the specific actions taken by the Company in its internal control over financial reporting processes during the quarter ended September 30, 2006 to address the material weakness in accounting for income taxes identified as of December 31, 2005:
• | Recruited and upgraded additional tax personnel, including third quarter 2006 appointments of two additional U.S. Tax Managers. |
• | Provided enhanced and ongoing tax training for financial and tax personnel, including five European training sessions that were attended by over 50 finance team members addressing the Company’s policies and procedures for determining and documenting income tax liabilities and deferred income tax assets and liabilities, as well as preparing income tax provision calculations. |
• | Developed a detailed tax remediation plan with identification of key milestones, including the completion of domestic and foreign accrual to return analyses, confirmation of deferred assets and liabilities related to certain leasing activities, confirmation of tax depreciation related to certain assets, and additional levels of management review to be completed during the 2006 year end reporting cycle. |
• | Continued to engage an outside provider to assist the Company in the more complex and labor intensive areas of its income tax accounting and reconciliation processes. |
The Company intends to take further actions to remediate the material weaknesses identified above as existing as of December 31, 2005, including:
• | Increasing internal audit scope and capabilities to address the needs of an evolving internal control environment. |
47
• | Simplifying the Company’s legal and reporting entity structure to facilitate the processing of intercompany transactions and reduce complexity in the tax reporting processes. |
• | Implementing a common information technology platform/business management system for use throughout the Company to facilitate the accounting for and reconciliation of transactions as well as to provide operational benefits. A robust network infrastructure will be established linking the business units through communication and collaboration software as well as interacting with the business management system and improving the control over system updates, access and backup capabilities. |
• | Continuation of mandatory business practices meetings conducted globally by the Company’s Chairman and Chief Executive Officer, Chief Financial Officer, General Counsel and Senior Vice President of Human Resources as well as several others and covering the Company’s Code of Ethics and Conduct, U.S. GAAP, compliance issues, full disclosure and other business practice matters. |
• | Continuing to develop and implement educational programs providing training to employees to promote an open and transparent global business culture, where the Company’s employees use responsible business practices. |
• | Execution of the tax remediation plan discussed above, as well as completion of the testing of annual tax provisioning processes for the year ending December 31, 2006, validating the changes previously made by the Company. |
The effectiveness of any system of controls and procedures is subject to certain limitations, and, as a result, there can be no assurance that the Company’s controls and procedures will detect all errors or fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system will be attained.
The Company will continue to develop new policies and procedures as well as educate and train its employees on its existing policies and procedures in a continual effort to improve its internal control over financial reporting, and will be taking further actions as appropriate. The Company views this as an ongoing effort to which it will be devoting significant resources and which will need to be maintained and updated over time.
The Company believes that the foregoing actions have improved and will continue to improve its internal control over financial reporting, as well as its disclosure controls and procedures.
PART II. | OTHER INFORMATION |
The Company is involved in certain claims and litigation arising in the ordinary course of business, which are not considered material to the financial operations or cash flow of the Company. For information concerning litigation and other contingencies see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Contingencies and Uncertainties.”
There have been no material changes in the quarterly period ended September 30, 2006 in the Company’s risk factors from those disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, as updated in the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2006.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
Not applicable.
Item 3. | Defaults Upon Senior Securities |
Not applicable.
Item 4. | Submission of Matters to a Vote of Security Holders |
Not applicable.
48
Not applicable.
Forward-Looking Information
Certain information in this Quarterly Report includes forward-looking statements (within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Exchange Act) regarding future events or the future financial performance of the Company that involve certain contingencies and uncertainties, including those discussed above in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Contingencies and Uncertainties.” In addition, when included in this Quarterly Report or in documents incorporated herein by reference, the words “may,” “expects,” “intends,” “anticipates,” “plans,” “projects,” “estimates” and the negatives thereof and analogous or similar expressions are intended to identify forward-looking statements. However, the absence of these words does not mean that the statement is not forward-looking. The Company has based these forward-looking statements on current expectations and projections about future events. These statements are not guarantees of future performance. Such statements are inherently subject to a variety of risks and uncertainties that could cause actual results to differ materially from those reflected in such forward-looking statements. Such risks and uncertainties, many of which are beyond the Company’s control, include, among others:
| • | the Company’s businesses are highly cyclical and weak general economic conditions may affect the sales of their products and their financial results; |
| • | the Company’s business is sensitive to fluctuations in interest rates and government spending; |
| • | the ability to successfully integrate acquired businesses; |
| • | the retention of key management personnel; |
| • | the Company’s businesses are very competitive and may be affected by pricing, product initiatives and other actions taken by competitors; |
| • | the effects of changes in laws and regulations; |
| • | the Company’s business is international in nature and is subject to changes in exchange rates between currencies, as well as international politics; |
| • | the Company’s continued access to capital and ability to obtain parts and components from suppliers on a timely basis at competitive prices; |
| • | the financial condition of suppliers and customers, and their continued access to capital; |
| • | the Company’s ability to timely manufacture and deliver products to customers; |
| • | possible work stoppages and other labor matters; |
| • | the Company’s debt outstanding and the need to comply with restrictive covenants contained in the Company’s debt agreements; |
| • | the Company’s ability to maintain adequate disclosure controls and procedures, maintain adequate internal controls over financial reporting and file its periodic reports with the SEC on a timely basis; |
| • | the Company’s implementation of a global enterprise system and its performance; |
| • | the investigation of the Company by the SEC; |
| • | limitations on the Company’s ability to access the capital markets using short form SEC documents; |
| • | compliance with applicable environmental laws and regulations; |
| • | product liability claims and other liabilities arising out of the Company’s business; and |
Actual events or the actual future results of the Company may differ materially from any forward looking statement due to these and other risks, uncertainties and significant factors. The forward-looking statements contained herein speak only as of the date of this Quarterly Report and the forward-looking statements contained in documents incorporated herein by reference speak only as of the date of the respective documents. The Company expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statement contained or incorporated by reference in this Quarterly Report to reflect any change in the Company’s expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.
The exhibits set forth on the accompanying Exhibit Index have been filed as part of this Form 10-Q.
49
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: November 3, 2006 | /s/ Phillip C. Widman |
| Senior Vice President and |
| (Principal Financial Officer) |
Date: November 3, 2006 | /s/ Jonathan D. Carter |
| Vice President, Controller and |
| (Principal Accounting Officer) |
50
EXHIBIT INDEX
3.1 | Restated Certificate of Incorporation of Terex Corporation (incorporated by reference to Exhibit 3.1 to the Form S-1 Registration Statement of Terex Corporation, Registration No. 33-52297). |
3.2 | Certificate of Elimination with respect to the Series B Preferred Stock (incorporated by reference to Exhibit 4.3 to the Form 10-K for the year ended December 31, 1998 of Terex Corporation, Commission File No. 1-10702). |
3.3 | Certificate of Amendment to Certificate of Incorporation of Terex Corporation dated September 5, 1998 (incorporated by reference to Exhibit 3.3 to the Form 10-K for the year ended December 31, 1998 of Terex Corporation, Commission File No. 1-10702). |
3.4 | Amended and Restated Bylaws of Terex Corporation (incorporated by reference to Exhibit 3.2 to the Form 10-K for the year ended December 31, 1997 of Terex Corporation, Commission File No. 1-10702). |
4.1 | Indenture, dated as of December 17, 2001, between Terex Corporation, the Guarantors named therein and The Bank of New York, as Trustee (incorporated by reference to Exhibit 4.16 to Form S-4 Registration Statement of Terex Corporation, Registration No. 333-75700). |
4.2 | First Supplemental Indenture, dated as of September 30, 2002, between Terex Corporation and Bank of New York (as successor trustee to United States Trust Company of New York), as Trustee (to Indenture dated as of December 17, 2001) (incorporated by reference to Exhibit 4.20 to the Form 10-K for the year ended December 31, 2002 of Terex Corporation, Commission File No. 1-10702). |
4.3 | Second Supplemental Indenture, dated as of March 31, 2003, between Terex Corporation and Bank of New York (as successor to United States Trust Company of New York), as Trustee (to Indenture dated as of December 17, 2001) (incorporated by reference to Exhibit 4.24 to the Form 10-Q for the quarter ended March 31, 2003 of Terex Corporation, Commission File No. 1-10702). |
4.4 | Third Supplemental Indenture, dated as of November 25, 2003, among Terex Corporation, the Subsidiary Guarantors named therein and The Bank of New York (as successor to United States Trust Company of New York), as Trustee (to Indenture dated as of December 17, 2001) (incorporated by reference to Exhibit 4.9 to the Form 10-K for the year ended December 31, 2003 of Terex Corporation, Commission File No. 1-10702). |
4.5 | Indenture, dated as of November 25, 2003, between Terex Corporation, the Guarantors named therein and HSBC Bank USA, as Trustee (incorporated by reference to Exhibit 4.10 to Form S-4 Registration Statement of Terex Corporation, Registration No. 333-112097). |
10.1 | Terex Corporation Incentive Stock Option Plan, as amended (incorporated by reference to Exhibit 4.1 to the Form S-8 Registration Statement of Terex Corporation, Registration No. 33-21483). |
10.2 | 1994 Terex Corporation Long Term Incentive Plan (incorporated by reference to Exhibit 10.2 to the Form 10-K for the year ended December 31, 1994 of Terex Corporation, Commission File No. 1-10702). |
10.3 | Terex Corporation Employee Stock Purchase Plan, as amended (incorporated by reference to Exhibit 10.3 to the Form 10-Q for the quarter ended June 30, 2004 of Terex Corporation, Commission File No. 1-10702). |
10.4 | 1996 Terex Corporation Long Term Incentive Plan (incorporated by reference to Exhibit 10.1 to Form S-8 Registration Statement of Terex Corporation, Registration No. 333-03983). |
10.5 | Amendment No. 1 to 1996 Terex Corporation Long Term Incentive Plan (incorporated by reference to Exhibit 10.5 to the Form 10-K for the year ended December 31, 1999 of Terex Corporation, Commission File No. 1-10702). |
10.6 | Amendment No. 2 to 1996 Terex Corporation Long Term Incentive Plan (incorporated by reference to Exhibit 10.6 to the Form 10-K for the year ended December 31, 1999 of Terex Corporation, Commission File No. 1-10702). |
10.7 | Terex Corporation 1999 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.7 to the Form 10-Q for the quarter ended March 31, 2000 of Terex Corporation, Commission File No. 1-10702). |
10.8 | Terex Corporation 2000 Incentive Plan, as amended (incorporated by reference to Exhibit 10.8 to the Form 10-Q for the quarter ended June 30, 2004 of Terex Corporation, Commission File No. 1-10702). |
10.9 | Form of Restricted Stock Agreement under the Terex Corporation 2000 Incentive Plan between Terex Corporation and participants of the 2000 Incentive Plan (incorporated by reference to Exhibit 10.4 of the Form 8-K Current Report, Commission File No. 1-10702, dated January 1, 2005 and filed with the Commission on January 5, 2005). |
10.10 | Form of Option Agreement under the Terex Corporation 2000 Incentive Plan between Terex Corporation and participants of the 2000 Incentive Plan (incorporated by reference to Exhibit 10.5 of the Form 8-K Current Report, |
51
Commission File No. 1-10702, dated January 1, 2005 and filed with the Commission on January 5, 2005).
10.11 | Terex Corporation Supplemental Executive Retirement Plan, effective October 1, 2002 (incorporated by reference to Exhibit 10.9 to the Form 10-K for the year ended December 31, 2002 of Terex Corporation, Commission File No. 1-10702). |
10.12 | Terex Corporation 2004 Annual Incentive Compensation Plan (incorporated by reference to Exhibit 10.10 to the Form 10-Q for the quarter ended March 31, 2004 of Terex Corporation, Commission File No. 1-10702). |
10.13 | Summary of material terms of non-CEO 2005 performance targets under the Terex Corporation 2004 Annual Incentive Compensation Plan (incorporated by reference to Exhibit 10.3 of the Form 8-K Current Report, Commission File No. 1-10702, dated January 1, 2005 and filed with the Commission on January 5, 2005). |
10.14 | Summary of material terms of CEO 2005 performance targets under the Terex Corporation 2004 Annual Incentive Compensation Plan (incorporated by reference to Exhibit 10.1 of the Form 8-K Current Report, Commission File No. 1-10702 dated March 31, 2005 and filed with the Commission on April 6, 2005). |
10.15 | Summary of material terms of non-CEO 2006 performance targets under the Terex Corporation 2004 Annual Incentive Compensation Plan (incorporated by reference to Form 8-K Current Report, Commission File No. 1-10702, dated March 7, 2006 and filed with the Commission on March 13, 2006). |
10.16 | Summary of material terms of CEO 2006 performance targets under the Terex Corporation 2004 Annual Incentive Compensation Plan (incorporated by reference to Form 8-K Current Report, Commission File No. 1-10702, dated March 28, 2006 and filed with the Commission on April 3, 2006). |
10.17 | Terex Corporation Amended and Restated Deferred Compensation Plan (incorporated by reference to Exhibit 10.11 to the Form 10-Q for the quarter ended June 30, 2004 of Terex Corporation, Commission File No. 1-10702). |
10.18 | Summary of material terms of Terex Corporation Outside Directors’ Compensation Program (incorporated by reference to Exhibit 10.1 of the Form 8-K Current Report, Commission File No. 1-10702, dated July 18, 2006 and filed with the Commission on July 20, 2006). |
10.19 | Credit Agreement dated as of July 14, 2006, among Terex Corporation, certain of its subsidiaries, the Lenders named therein and Credit Suisse, as Administrative Agent and Collateral Agent (incorporated by reference to Exhibit 10.1 of the Form 8-K Current Report, Commission File No. 1-10702, dated July 14, 2006 and filed with the Commission on July 17, 2006). |
10.20 | Guarantee and Collateral Agreement dated as of July 14, 2006 among Terex Corporation, certain of its subsidiaries and Credit Suisse, as Collateral Agent (incorporated by reference to Exhibit 10.2 of the Form 8-K Current Report, Commission File No. 1-10702, dated July 14, 2006 and filed with the Commission on July 17, 2006). |
10.21 | Employment and Compensation Agreement, dated as of July 1, 2005, between Terex Corporation and Ronald M. DeFeo (incorporated by reference to Exhibit 10.1 of the Form 8-K Current Report, Commission File No. 1-10702, dated July 1, 2005 and filed with the Commission on July 7, 2005). |
10.22 | Life Insurance Agreement, dated as of October 13, 2006, between Terex Corporation and Ronald M. DeFeo (incorporated by reference to Exhibit 10.1 of the Form 8-K Current Report, Commission File No. 1-10702, dated October 13, 2006 and filed with the Commission on October 16, 2006). |
10.23 | Form of Change in Control and Severance Agreement between Terex Corporation and certain executive officers (incorporated by reference to Exhibit 10.1 of the Form 8-K Current Report, Commission File No. 1-10702, dated March 7, 2006 and filed with the Commission on March 13, 2006). |
10.24 | Form of Change in Control and Severance Agreement between Terex Corporation and certain executive officers (incorporated by reference to Exhibit 10.2 of the Form 8-K Current Report, Commission File No. 1-10702, dated March 7, 2006 and filed with the Commission on March 13, 2006). |
10.25 | Offer Letter, dated as of January 5, 2006, between Terex Corporation and Colin Robertson (incorporated by reference to Exhibit 10.1 of the Form 8-K Current Report, Commission File No. 1-10702, dated December 30, 2005 and filed with the Commission on January 6, 2006). |
10.26 | Consulting Agreement dated as of November 13, 2003 between Terex Corporation and Filver S.A. (incorporated by reference to Exhibit 10.30 to Form S-4 Registration Statement of Terex Corporation, Registration No. 333-112097). |
10.27 | Letter Agreement, dated as of October 13, 2006, between Terex Corporation and Robert R. Wilkerson (incorporated by reference to Exhibit 10.2 of the Form 8-K Current Report, Commission File No. 1-10702, dated October 13, 2006 and filed with the Commission on October 16, 2006). |
52
12 | Calculation of Ratio of Earnings to Fixed Charges.* |
31.1 | Chief Executive Officer Certification pursuant to Rule 13a-14(a)/15d-14(a).* |
31.2 | Chief Financial Officer Certification pursuant to Rule 13a-14(a)/15d-14(a).* |
32 | Chief Executive Officer and Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes –Oxley Act of 2002. * |
| * | Exhibit filed with this document. |
53
