SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
ACT of 1934
For the quarterly period ended September 30, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT of 1934
For the transition period from ___________ to ___________
COMMISSION FILE NUMBER: 0-452
TECUMSEH PRODUCTS COMPANY
(Exact name of registrant as specified in its charter)
MICHIGAN 38-1093240
(State of Incorporation) (IRS Employer Identification Number)
100 EAST PATTERSON STREET
TECUMSEH, MICHIGAN 49286
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code:
(517) 423-8411
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [X] No [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act).
Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class of Stock Outstanding at September 30, 2005
-------------- ---------------------------------
Class B Common Stock, $1.00 par value 5,077,746
Class A Common Stock, $1.00 par value 13,401,938
Page 1
TABLE OF CONTENTS
Page
----
Part I. Financial Information
Item 1. Financial Statements
Consolidated Condensed Balance Sheets.......................... 3
Consolidated Condensed Statements of Income.................... 5
Consolidated Condensed Statements of Cash Flows................ 6
Notes to Consolidated Condensed Financial Statements........... 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 17
Item 3. Quantitative and Qualitative Disclosures About Market
Risk...................................................... 31
Item 4. Controls and Procedures................................... 32
Part II. Other Information........................................... 34
Signatures 35
Certification of CEO Pursuant to Section 302......................... Exh 31.1
Certification of CFO Pursuant to Section 302......................... Exh 31.2
Certification of CEO Pursuant to Section 906......................... Exh 32.1
Certification of CFO Pursuant to Section 906......................... Exh 32.2
Page 2
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION - ITEM 1
CONSOLIDATED CONDENSED BALANCE SHEETS
(Unaudited)
SEPTEMBER 30, December 31,
2005 2004
------------- ------------
(Dollars in millions, except share data)
ASSETS
Current Assets:
Cash and cash equivalents $ 83.9 $ 227.9
Accounts receivable, less allowance for doubtful accounts of $9.5
in 2005 and $11.0 in 2004 266.9 220.4
Inventories 370.2 394.2
Deferred and recoverable income taxes 31.1 36.9
Other current assets 109.4 47.8
-------- --------
Total current assets 861.5 927.2
Property, plant, and equipment, at cost, net of accumulated
depreciation of $964.8 in 2005 and $933.1 in 2004 601.1 554.8
Goodwill 133.8 243.5
Other intangibles 58.7 62.4
Deferred income taxes -- 29.6
Prepaid pension expense 181.8 171.9
Other assets 87.0 73.4
-------- --------
Total assets $1,923.9 $2,062.8
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable, trade 170.6 $ 178.1
Income taxes payable 5.4 5.4
Short-term borrowings 88.1 68.8
Accrued liabilities 131.5 169.2
-------- --------
Total current liabilities 395.6 421.5
Long-term debt 293.1 317.3
Deferred income taxes 18.3 8.0
Other postretirement benefit liabilities 210.1 210.7
Product warranty and self-insured risks 16.4 21.2
Accrual for environmental matters 40.8 41.3
Pension liabilities 21.4 24.5
Other non-current liabilities 32.1 --
-------- --------
Total liabilities 1,027.8 1,044.5
-------- --------
Commitments and contingencies
Stockholders' Equity
Class A common stock, $1 par value; authorized 75,000,000
shares; issued and outstanding 13,401,938 shares in 2005 and
2004 13.4 13.4
Class B common stock, $1 par value; authorized 25,000,000
shares; issued and outstanding 5,077,746 shares in 2005 and
2004 5.1 5.1
Retained earnings 862.5 1,041.9
Accumulated other comprehensive income (loss) 15.1 (42.1)
-------- --------
Total stockholders' equity 896.1 1,018.3
-------- --------
Total liabilities and stockholders' equity $1,923.9 $2,062.8
======== ========
Page 3
The accompanying notes are an integral part of these
Consolidated Condensed Financial Statements.
Page 4
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION - ITEM 1
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -------------------
2005 2004 2005 2004
------- ------- -------- --------
(Dollars in millions, except per share data)
Net sales $ 478.5 $ 478.6 $1,404.8 $1,439.8
Cost of sales and operating expenses 431.5 403.4 1,285.0 1,245.3
Selling and administrative expenses 41.4 49.6 135.9 145.4
Impairments, restructuring charges, and other items 1.4 2.0 111.3 5.6
------- ------- -------- --------
Operating income (loss) 4.2 23.6 (127.4) 43.5
Interest expense (8.0) (5.3) (22.4) (16.5)
Interest income and other, net 1.9 2.3 6.9 10.6
------- ------- -------- --------
Income (loss) before taxes (1.9) 20.6 (142.9) 37.6
Tax provision 30.9 8.3 24.8 14.3
------- ------- -------- --------
Net income (loss) ($32.8) $ 12.3 ($167.7) $ 23.3
======= ======= ======== ========
Basic and diluted earnings (loss) per share ($1.77) $ 0.67 ($9.07) $ 1.26
======= ======= ======== ========
Weighted average shares (in thousands) 18,480 18,480 18,480 18,480
======= ======= ======== ========
Cash dividends declared per share $ 0.00 $ 0.32 $ 0.64 $ 0.96
======= ======= ======== ========
The acompanying notes are an integral part of these Consolidated Condensed
Financial Statements.
Page 5
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION - ITEM 1
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------
2005 2004
------ ------
(Dollars in millions)
Cash Flows from Operating Activities:
Cash provided by (used in) operating
activities ($34.6) $ 34.5
Cash Flows from Investing Activities:
Capital expenditures (88.6) (55.6)
------ ------
Cash used in investing activities (88.6) (55.6)
------ ------
Cash Flows from Financing Activities:
Dividends paid (11.8) (17.7)
Proceeds (Repayments) of borrowings, net 38.8 (35.4)
Repayments of long-term debt (50.0) --
------ ------
Cash used in financing activities (23.0) (53.1)
------ ------
Effect of exchange rate changes on cash 2.2 2.5
------ ------
Decrease in cash and cash equivalents (144.0) (71.7)
Cash and Cash Equivalents:
Beginning of period 227.9 344.6
------ ------
End of period $ 83.9 $272.9
====== ======
The accompanying notes are an integral part of these Consolidated Condensed
Financial Statements.
Page 6
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. The consolidated condensed financial statements of Tecumseh Products
Company and Subsidiaries (the "Company") are unaudited and reflect all
adjustments (including normal recurring adjustments) which are, in the
opinion of management, necessary for a fair statement of the financial
position and operating results for the interim periods. The December 31,
2004 condensed balance sheet data was derived from audited financial
statements, but does not include all disclosures required by generally
accepted accounting principles in the United States ("U.S. GAAP"). The
consolidated condensed financial statements should be read in conjunction
with the consolidated financial statements and notes thereto contained in
the Company's Annual Report for the fiscal year ended December 31, 2004.
Due to the seasonal nature of the Company's business, the results of
operations for the interim period are not necessarily indicative of the
results for the entire fiscal year.
2. Comprehensive Income
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- ---------------
2005 2004 2005 2004
------ ----- ------- -----
(Dollars in millions)
Net income (loss) ($32.8) $12.3 ($167.7) $23.3
Other comprehensive income (loss):
Foreign currency translation adjustments 22.8 15.6 38.4 2.4
Gain (Loss) on derivatives (2.0) -- 15.1 (0.3)
Unrealized gain on investment holdings -- -- 3.8 --
------ ----- ------- -----
Total comprehensive income (loss) ($12.0) $27.9 ($110.4) $25.4
====== ===== ======= =====
3. Inventories
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------- ------------
(Dollars in millions)
Raw material $142.2 $169.3
Work in progress 82.5 82.1
Finished goods 141.6 130.0
Supplies 3.9 12.8
------ ------
Total inventories $370.2 $394.2
====== ======
Page 7
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
4. Business Segments
The Company has four reportable segments based on the criteria set forth in
SFAS No. 131 "Disclosures about Segments of an Enterprise and Related
Information": Compressor Products, Electrical Component Products, Engine &
Power Train Products, and Pump Products. Revenues and operating income by
segment for the periods indicated are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -------------------
BUSINESS SEGMENT DATA 2005 2004 2005 2004
- --------------------- ------ ------ -------- --------
(Dollars in millions)
Net sales:
Compressor Products $218.6 $218.9 $ 707.2 $ 664.9
Electrical Component Products 103.3 102.1 305.9 314.3
Engine & Power Train Products 124.2 128.6 297.8 356.9
Pump Products 31.8 28.5 92.4 102.5
Other (a) 0.6 0.5 1.5 1.2
------ ------ -------- --------
Total Net Sales $478.5 $478.6 $1,404.8 $1,439.8
====== ====== ======== ========
Operating income (loss):
Compressor Products $ 7.6 $ 22.5 $ 23.6 $ 53.7
Electrical Component Products 4.8 3.5 4.0 11.2
Engine & Power Train Products (5.2) 2.2 (41.6) (11.2)
Pump Products 3.6 3.1 10.1 11.3
Other (a) (0.6) (0.9) (2.6) (2.7)
Corporate expenses (4.6) (4.8) (9.6) (13.2)
Impairments, restructuring charges, and other
items (1.4) (2.0) (111.3) (5.6)
------ ------ -------- --------
Total operating income (loss) 4.2 23.6 (127.4) 43.5
Interest expense (8.0) (5.3) (22.4) (16.5)
Interest income and other, net 1.9 2.3 6.9 10.6
------ ------ -------- --------
Income (Loss) before taxes ($1.9) $ 20.6 ($142.9) $ 37.6
====== ====== ======== ========
(a) "Other" consists of non-reportable business segments, primarily
Manufacturing Data Systems, Inc.
The Electrical Component Products segment had inter-segment sales of $12.4
million and $17.3 million in the third quarter of 2005 and 2004, respectively,
and $42.7 million and $50.8 million for the first nine months of 2005 and 2004,
respectively.
Page 8
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
5. Goodwill and Other Intangible Assets
At September 30, 2005, goodwill by segment consisted of the following:
ELECTRICAL ENGINE &
COMPRESSOR COMPONENTS POWER TRAIN PUMPS TOTAL
---------- ---------- ----------- ----- ------
Balance at 1/1/2005 18.6 216.9 2.9 5.1 243.5
Impairment -- (108.0) -- -- (108.0)
Foreign Currency Translation (1.4) -- (0.3) -- (1.7)
---- ------ ---- --- ------
Balance at 9/30/2005 17.2 108.9 2.6 5.1 133.8
Second quarter 2005 results include an impairment charge of $108.0 million
related to the goodwill associated with the 2002 acquisition of FASCO
(which is included in the Electrical Components segment). As previously
disclosed, the failure to achieve the business plan, coupled with expected
future market conditions, has caused the Company to revisit the assumptions
utilized to determine FASCO's estimated fair value in the impairment
assessment performed at December 31, 2004. The deterioration of volumes and
the Company's inability to recover higher commodity and transportation
costs through price increases has resulted in revised expected cash flows
for FASCO.
SFAS 142 requires that the Company estimate the fair value of the reporting
unit as compared to its recorded book value. If the estimated fair value is
less than the book value, then an impairment is deemed to have occurred. In
estimating the fair value of the reporting units, management used
forecasted discounted cash flows. As required by SFAS 142, the Company
measured the amount of goodwill impairment by allocating the estimated fair
value to the tangible and intangible assets within this reporting unit.
Based on this allocation, it was concluded that $108.0 million of the
recorded goodwill in the FASCO reporting unit was impaired and needed to be
expensed as a non-cash charge to continuing operations. Prior to performing
the SFAS 142 analysis, management assessed long lived assets for impairment
in accordance with SFAS 144. No SFAS 144 impairment was identified.
Other intangible assets consisted of the following:
GROSS
CARRYING ACCUMULATED AMORTIZABLE
AMOUNT AMORTIZATION NET LIFE
-------- ------------ ----- -----------
Intangible assets subject to amortization:
Customer relationships and contracts 39.3 7.4 31.9 6-15 years
Technology 15.4 5.9 9.5 3-10 years
Trade-name and trademarks 0.9 0.5 0.4 3-8 years
----- ----- -----
Total 55.6 13.8 41.8
Intangible assets not subject to amortization:
Trade name 16.9 -- 16.9
----- ----- -----
Total intangible assets $72.5 $13.8 $58.7
The estimated amortization expense over the next five years is $5.0 million
for 2005 and approximately $4.2 million annually for 2006 through 2009.
Amortization expense for the three
Page 9
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
months ended September 30 was $1.3 million and $3.2 million for 2005 and
2004, respectively. Amortization expense for year to date ended September
30 was $3.9 million and $9.4 million for 2005 and 2004, respectively.
6. Pension and Other Postretirement Benefit Plans
Components of net periodic benefit (income) cost are as follows:
PENSION BENEFITS OTHER BENEFITS
------------------ -----------------
THREE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
2005 2004 2005 2004
------ ------ ----- -----
Service Cost $ 2.3 $ 2.2 $ 1.3 $ 0.9
Interest Cost 5.4 5.4 2.8 2.4
Expected return on plan assets (10.5) (10.5) -- --
Amortization of prior service costs 0.1 0.3 (0.3) (0.3)
Amortization of net gain (0.6) (1.1) (0.8) (1.6)
------ ------ ----- -----
Net periodic benefit (income) cost ($3.3) ($3.7) $ 3.0 $ 1.4
PENSION BENEFITS OTHER BENEFITS
----------------- -----------------
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------- -----------------
2005 2004 2005 2004
------ ------- ----- -----
Service Cost $ 6.9 $ 6.6 $ 3.9 $ 3.0
Interest Cost 16.2 16.2 8.4 7.5
Expected return on plan assets (31.5) (31.5) -- --
Amortization of prior service costs 0.3 0.9 (0.9) (0.9)
Amortization of net gain (1.8) (3.3) (2.4) (4.2)
------ ------- ----- -----
Net periodic benefit (income) cost ($9.9) ($11.1) $ 9.0 $ 5.4
During the second quarter of 2005, the Company announced some changes to
certain of its retiree medical benefits. Included among these changes were
plans to phase in retiree contributions and raise plan deductibles (both as
of January 1, 2006). The Company also implemented plans to eliminate
Post-65 prescription drug benefits starting January 1, 2008 and discontinue
all retiree medical benefits for anyone hired after January 1, 2006.
As a result of these actions, the Company performed a re-measurement of its
liability at June 30, 2005 factoring in applicable plan changes, as well as
a reduction in the discount rate used in the calculation from 5.85% to
5.5%. The amortization of the benefit related to these changes will be $1.4
million for 2005 and will be recognized in the fourth quarter.
Page 10
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
The Company previously disclosed in its financial statements for the year
ended December 2004, that it expected to contribute $0.1 million to one of
its pension plans in 2005. As of September 30, 2005, no contributions have
been made. The Company presently anticipates contributing a total of $0.1
million to fund this pension plan in 2005.
7. Impairments, Restructuring Charges, and Other Items
During the third quarter, the Company recognized $1.4 million in
restructuring and asset impairment charges. The European Engine & Power
Train and Compressor businesses recorded $0.4 million and $0.5 million,
respectively, under ongoing programs. The remaining $0.5 million related to
the Electrical Components segment represents asset impairment charges for
idled equipment.
The Company also recognized restructuring costs of $1.9 million in the
first half of 2005. These costs included $0.3 million of facility
consolidation costs in the North American Compressor business and a $0.5
million additional impairment charge related to the St. Clair, Missouri
Electrical Components facility. The remaining $1.1 million of restructuring
costs related to the first step in the Company's efforts to reduce its
excess capacity in the European Engine & Power Train operations. Included
in the Company's plans for this operation is a workforce reduction of 100
personnel.
Year to date 2005 results also included an impairment charge of $108.0
million related to the goodwill associated with the 2002 acquisition of
FASCO (which is included in the Electrical Components segment). As
previously disclosed, the failure to achieve the business plan, coupled
with expected future market conditions, has caused the Company to revisit
the assumptions utilized to determine FASCO's estimated fair value in the
impairment assessment performed at December 31, 2004. The deterioration of
volumes and the Company's inability to recover higher commodity and
transportation costs through price increases has resulted in revised
expected cash flows for FASCO. Based on the revised estimates of cash flow,
FASCO's fair value has deteriorated from the previous assessment and, as a
result, a goodwill impairment of $108.0 million was recognized representing
approximately half of the goodwill associated with this segment.
Third quarter 2004 results included a reduction in workforce at one of the
Company's Indian compressor facilities. The action affected approximately
100 employees at the cost of $1.0 million. Year-to-date 2004 results also
included restructuring and impairment charges totaling $4.6 million related
to several of the Company's facilities in its North American Compressor and
Electrical Components businesses.
8. Guarantees and Warranties
A portion of accounts receivable at the Company's Brazilian subsidiary are
sold with recourse. Brazilian receivables sold at September 30, 2005 and
December 31, 2004 were $30.3 million and $101.0 million, respectively. The
Company estimates the fair value of the contingent liability related to
these receivables to be $0.5 million, which is included in operating income
and allowance for doubtful accounts.
Page 11
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
A provision for estimated future warranty costs and estimated returns for
credit relating to warranty are recorded when products are sold and revenue
recognized. A reconciliation of the changes in the Company's product
warranty liability follows:
Nine Months Ended
September 30, 2005
------------------
(Dollars in millions)
Balance at January 1, 2005 $ 38.1
Accruals for warranties 12.5
Settlements made (in cash or in kind) (18.9)
Effect of foreign currency translation (0.3)
------
Balance at September 30, 2005 $ 31.4
9. Debt
Subsequent to the end of the second quarter, the Company renegotiated the
terms of its lending agreements with the holders of the Senior Guaranteed
Notes. The amendment to this agreement added additional restrictive
covenants and relaxed certain others. The capital expenditure covenant
required further amendment in order for the Company to remain in compliance
as of September 30, 2005 and the leverage ratio covenant was eliminated
through December 31, 2006. The amendment also required the Company to
provide collateral including all North American personal property and
select real property. Under the agreement, the Company was permitted to pay
dividends up to current levels beginning with the third quarter 2005. After
the third quarter, however, dividend payments are only permitted to the
extent the Company meets certain financial targets and remains in
compliance with all other terms. This restriction will end if the Company
remains in compliance with this requirement through first quarter 2007. As
of August 8, 2005 the interest rate applicable to this borrowing increased
from 4.6% to 6.60%, payable on the same schedule as the existing notes.
There is no change to the maturity schedule.
In conjunction with the amendment to the Senior Guaranteed Notes indicated
above, the Company also renegotiated the terms of its $100 million
five-year revolving credit facility. Similar to the arrangement applicable
to the Senior Guaranteed Notes, certain covenants have been relaxed and
others added. The Company's debt under the amended credit agreement will
participate in the collateral established under the Senior Guaranteed
Notes. The amended credit facility has an applicable Eurodollar rate
margin, letter of credit fee rate and facility fee rate based on a sliding
scale related to the Company's debt to EBITDA ratio. The Eurodollar rate
margin and letter of credit fee rate was set at 210 basis points and the
facility fee rate was set at 40.0 basis points on August 8, 2005. As of
September 30, 2005, the Company had borrowed $10 million under the
revolving credit facility at an average interest rate of 4.35%.
The holders of the Company's industrial revenue bonds will share in the
collateral established through these amendments.
Due to further deterioration of future expected results related to the
exchange rate between the Brazilian Real and the U.S. Dollar and the global
demand for refrigeration and freezer compressors, the Company elected to
not pay a dividend in the third quarter and does not currently expect to be
able to pay dividends through first quarter 2007 under the terms of its
current borrowing agreements.
Page 12
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
The Company continues to monitor its future expected results in
relationship to the financial covenants specified under the terms of the
respective borrowing arrangements, and should the Company fail to comply
with such covenants, further amendments would be required. If the Company
were to fail to obtain such amendment, the lenders could exercise their
rights under the terms of the agreement. Alternatively, the Company may
seek new financing arrangements which provide greater flexibility than
currently afforded under the existing Senior Guaranteed Notes, in
combination with potential sales of assets as part of its overall business
strategies.
10. Environmental Matters
The Company has been named by the U.S. Environmental Protection Agency
("EPA") as a potentially responsible party ("PRP") in connection with the
Sheboygan River and Harbor Superfund Site in Wisconsin. In May 2000, the
EPA issued a Record of Decision ("ROD") selecting the remedy for the Site.
The Company is one of several named PRP's in the proposed cleanup action.
The EPA has estimated the cost of cleanup at $40.9 million. Additionally,
the Wisconsin Department of Natural Resources ("WDNR"), as a Natural
Resource Trustee, is investigating what additional requirements, if any,
the state may have beyond those specified under the ROD.
The EPA has indicated its intent to address the site in two phases, with
the Company's Sheboygan Falls plant site and the upper river constituting
the first phase ("Phase I") and the middle and lower river and harbor being
the second phase ("Phase II"). In March 2003, the Company entered into a
Consent Decree with the EPA concerning the performance of remedial design
and remedial action for Phase I. The Consent Decree has also been approved
by the U.S. Department of Justice, but it has yet to become a final
judgment pending approval by the pertinent federal district court.
Negotiation of a Consent Decree regarding Phase II has yet to commence.
On March 25, 2003, with the cooperation of the EPA, the Company and
Pollution Risk Services, LLC ("PRS") entered into a Liability Transfer and
Assumption Agreement (the "Liability Transfer Agreement"). Under the terms
of the Liability Transfer Agreement, PRS assumed all of the Company's
responsibilities, obligations and liabilities for remediation of the entire
Site and the associated costs, except for certain specifically enumerated
liabilities. Also, as required by the Liability Transfer Agreement, the
Company purchased Remediation Cost Cap insurance, with a 30 year term, in
the amount of $100.0 million and Environmental Site Liability insurance in
the amount of $20.0 million. The Company believes such insurance coverage
will provide sufficient assurance for completion of the responsibilities,
obligations and liabilities assumed by PRS under the Liability Transfer
Agreement. On October 10, 2003, in conjunction with the Liability Transfer
Agreement, the Company completed the transfer of title to the Sheboygan
Falls, Wisconsin property to PRS.
The total cost of the Liability Transfer Agreement to the Company,
including the cost of the insurance policies, was $39.2 million. The
Company recognized a charge of $13.6 million ($8.7 million net of tax) in
the first quarter of 2003. The charge consisted of the difference between
the cost of the Liability Transfer Agreement and amounts previously accrued
for the cleanup. The Company continues to maintain an additional reserve of
$0.5 million to reflect its potential environmental liability arising from
operations at the Site, including potential residual liabilities not
assumed by PRS pursuant to the Liability Transfer Agreement.
It is the intent of the Company, PRS and the EPA to negotiate provisions
that would add PRS as a PRP by amendment to the Consent Decree, which
requires the approval of the U.S. Department of Justice. Until such
approval is received, U.S. GAAP requires that the Company continue to
record
Page 13
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
the full amount of the estimated remediation liability of $39.7 million and
a corresponding asset of $39.2 million included in Other Assets in the
balance sheet. While the Company believes the arrangements with PRS are
sufficient to satisfy substantially all of the Company's environmental
responsibilities with respect to the Site, these arrangements do not
constitute a legal discharge or release of the Company's liabilities with
respect to the Site. The actual cost of this obligation will be governed by
numerous factors, including, without limitation, the requirements of the
WDNR, and may be greater or lower than the amount accrued.
The Company, in cooperation with the WDNR, also conducted an investigation
of soil and groundwater contamination at the Company's Grafton, Wisconsin
plant. It was determined that contamination from petroleum and degreasing
products used at the plant were contributing to an off-site groundwater
plume. The Company began remediation of soils in 2001 on the east side of
the facility. Additional remediation of soils began in the fall of 2002 in
two other areas on the plant site. At September 30, 2005, the Company had
accrued $2.3 million for the total estimated cost associated with the
investigation and remediation of the on-site contamination. Investigation
efforts related to the potential off-site groundwater contamination have to
date been limited in their nature and scope. The extent, timing and cost of
off-site remediation requirements, if any, are not presently determinable.
The Company and TRC Companies and TRC Environmental Corporation
(collectively, "TRC") entered into a Consent Order with the Wisconsin
Department of Natural Resources (the "WDNR") on December 29, 2004 relating
to the Hayton Area Remediation Project ("HARP") downstream from the
Company's New Holstein, Wisconsin facility. The Consent Order provides a
framework for the completion of the remediation and regulatory closure at
HARP.
Concurrent to entering into the Consent Order, the Company and two of its
subsidiaries and TRC entered into an Exit Strategy Agreement (the
"Agreement"), whereby the Company transferred to TRC substantially all of
its obligations to complete the HARP remediation pursuant to the Consent
Order and in accordance with applicable environmental laws and regulations.
As required by the Agreement, the Company purchased a Pollution Legal
Liability Select Cleanup Cost Cap Policy (the "Policy"). The Company
believes that the Policy provides additional assurance that the
responsibilities, obligations, and liabilities transferred and assigned by
the Company and assumed by TRC under the Agreement will be completed.
Although the arrangements with TRC and the WDNR do not constitute a legal
discharge or release of the Company's liabilities, the Company believes
that the specific work substitution provisions of the Consent Order and the
broad coverage terms of the Policy, collectively, are sufficient to satisfy
substantially all of the Company's environmental obligations with respect
to the HARP remediation.
In addition to the above-mentioned environmental matters, the Company is
also currently participating with the EPA and various state agencies at
certain other sites to determine the nature and extent of any remedial
action that may be necessary with regard to such other sites. At September
30, 2005 and December 31, 2004, the Company had accrued $42.8 million and
$43.3 million, respectively, for environmental remediation, including $39.7
million relating to the Sheboygan River and Harbor Superfund Site.
Additionally, as of September 30, 2005 and December 31, 2004, the Company
had recorded a corresponding asset of $39.2 million relating to the
Sheboygan River and Harbor Superfund Site in connection with its agreement
with PRS. As these matters continue toward final resolution, amounts in
excess of those already provided may be necessary to discharge the Company
from its obligations for these sites. Such amounts, depending on their
amount and timing, could be material to reported net income in the
particular
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
quarter or period that they are recorded. In addition, the ultimate
resolution of these matters, either individually or in the aggregate, could
be material to the consolidated financial statements.
11. Income Taxes
The Company recognized tax expense of $30.9 million on a loss before taxes
of $1.9 million for the quarter and $24.8 million on a loss before taxes of
$142.9 million for the nine months ended September 30, 2005 as compared
with an effective tax rate of 40% and 38% for the respective periods in
2004. The current quarter expense was primarily related to the recognition
of deferred tax asset valuation allowances against amounts previously
recorded by the Brazilian Engine operations ($7.1 million) and U.S. ($18.1
million) as the preponderance of negative evidence indicates that these
deferred taxes will not be recoverable. The continued strength of the
Brazilian Real against the U.S. Dollar and other factors has diminished the
prospects of tax planning strategies utilizing these carry-forwards in a
timely manner. The comparison of our year to date effective rate to prior
year was also affected by the non-deductibility of the goodwill impairment
recognized in the second quarter of 2005. Excluding these charges, the
effective rate varies from rates used in prior periods as the result of not
providing benefits on losses in jurisdictions where the preponderance of
negative evidence suggests that these deferred tax assets would not be
recoverable.
12. Commitments and Contingencies
A lawsuit filed against the Company and other defendants alleges that the
horsepower labels on the products the plaintiffs purchased were inaccurate.
The plaintiffs seek certification of a class of all persons in the United
States who, beginning January 1, 1995 through the present, purchased a
lawnmower containing a two stroke or four stroke gas combustible engine up
to 20 horsepower that was manufactured by defendants. The complaint seeks
an injunction, compensatory and punitive damages, and attorneys' fees. No
orders have been entered in the case, and there has been limited discovery.
While the Company believes it has meritorious defenses and intends to
assert them vigorously, there can be no assurance that the Company will
prevail. The Company also may pursue settlement discussions. It is not
possible to reasonably estimate the amount of the Company's ultimate
liability, if any, or the amount of any future settlement, but the amount
could be material to the Company's financial position, consolidated results
of operations and cash flows.
The Company is also the subject of, or a party to, a number of other
pending or threatened legal actions involving a variety of matters,
including class actions, incidental to its business. Although their
ultimate outcome cannot be predicted with certainty, and some may be
disposed of unfavorably to the Company, management does not believe that
the disposition of these other matters will have a material adverse effect
on the consolidated financial position or results of operations of the
Company.
13. New Accounting Standards
On November 24, 2004, the FASB issued Statement No. 151, Inventory Costs,
an amendment of ARB No. 43, Chapter 4 (FAS 151). The standard adopts the
IASB view related to inventories that abnormal amounts of idle capacity and
spoilage costs should be excluded from the cost of inventory and expensed
when incurred. Additionally, the Board made the decision to clarify the
meaning of the term 'normal capacity'. The provisions of FAS 151 are
applicable to inventory costs
Page 15
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
incurred during fiscal years beginning after June 15, 2005. The Company
does have operations with idle capacity; however, while the Company has not
yet calculated the effects of this pronouncement, it does not believe the
effects will be material.
14. Subsequent Event
On October 28, 2005, the Company announced it would cease engine assembly
operations in Corinth, Mississippi and consolidate such activities at its
U.S. assembly facility in Dunlap, Tennessee. This move affects
approximately 280 people with layoffs to begin on or after December 31,
2005. The Company estimates the costs to be $1.5 million, consisting
primarily of severance and asset relocation costs.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Executive Summary
We are one of the largest independent producers of hermetically sealed
compressors in the world, one of the world's leading manufacturers of small
gasoline engines and power train products used in lawn and garden applications,
and one of the leading manufacturers of fractional horsepower motors for the
United States market. We also produce a variety of pump products with a wide
range of applications. Our net sales have grown from $1.4 billion for the year
ended December 31, 2001 to $1.9 billion for the year ended December 31, 2004.
The primary source of sales growth was our 2002 acquisition of FASCO Motors, now
the key component of our presence in the U.S. fractional horsepower motor
market. Our products are sold in countries all over the world.
In evaluating our financial condition and operating performance, we focus
primarily on profitable sales growth and cash flows, as well as return on
invested capital on a consolidated basis. In addition to maintaining and
expanding our business with our existing customers in our more established
markets, we rely on developing new products and improving our ability to
penetrate new markets through enhancements to the functionality, performance and
quality of our existing products. For instance, in 2005 our Compressor Group
expects to introduce a scroll-style compressor to serve commercial and air
conditioning markets throughout the globe, and it will begin producing a new
expanded range rotary compressor in India for global applications. Our
Electrical Components Group has expanded its range of Brushless DC ("BLDC")
variable speed motor products and our Pump Group will be selling a range of new
energy saving pump models. To continue to grow sales and improve cash flows, we
must successfully bring these products to market in a timely manner and win
customer acceptance.
International sales are important to our business as a whole with sales to
customers outside the United States representing approximately 44% of total
consolidated net sales in 2004. The Company's dependence on sales in foreign
countries entails certain commercial and political risks, including currency
fluctuations, unstable economic or political conditions in some areas and the
possibility of various government interventions into trade policy. We have
experienced some of these factors and continue to carefully pursue these
markets.
Our operating results are indicative of the environment that manufacturers face
in today's global economy. The addition of new productive capacities in low-cost
locations, like China, has resulted in new capacities and deflationary pricing
in many of the market segments in which we operate. Like many of our customers
and competitors, we have restructured older operations to remain cost
competitive, including the movement of productive capacities to low-cost
locations or nearer to customer facilities. These restructurings involve
significant costs, in both financial and human terms. In addition, many of our
markets are subject to macroeconomics trends, which expand and contract, and
many overall trends which affect demand, such as weather.
The foreign manufacturing operations we have developed are subject to many
risks, including governmental expropriation, governmental regulations that may
be disadvantageous to businesses owned by foreign nationals, and instabilities
in the workforce due to changing political and social conditions. These
considerations are especially significant in the context of our Brazilian
operations. The Brazilian compressor operations provided a significant portion
of total Compressor Products segment production during 2004, and our Curitiba,
Brazil facility is the key future manufacturing site to supply worldwide demand
for lawn and garden engines.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
As a global manufacturer with production in 11 countries and sales in over 110
countries throughout the world, results are sensitive to changes in foreign
currency exchange rates. In total, those movements have not been favorable to us
during 2005. We have developed strategies to mitigate or partially offset the
impact, primarily hedging where the risk of loss is greatest. In particular, we
have entered into foreign currency forward purchases to hedge the Brazilian
export sales denominated in both U.S. Dollars and Euros. Additionally, we have
structured local financing relationships as natural hedges.
Lastly, commodity prices increased very rapidly during 2004 and 2005. Due to
contractual commitments and competitive markets, we were not able to fully
recover these cost increases through price increases and other cost savings.
Increases in certain raw material, energy and commodity costs had a material
adverse impact on our operating results in 2004 and continue to have a
significant affect on our profitability in 2005. We have developed strategies to
mitigate or partially offset the impact, which include aggressive cost reduction
actions, cost optimization engineering strategies, selective in-sourcing of
components where we have available capacity, continued consolidation of our
supply base, and acceleration of low-cost country sourcing. In addition, the
sharing of increased raw material costs has been, and will continue to be, the
subject of negotiations with our customers. While we believe that our mitigation
strategies eventually will offset a substantial portion of the financial impact
of these increased costs, no assurances can be given that the magnitude and
duration of these increased costs will not have a continued material adverse
impact on our operating results. We are very focused on efforts to help us
maintain our ability to compete on cost.
Our success in generating cash flow will depend, in part, on our ability to
efficiently manage working capital. In this regard, changes in inventory
management practices and customer and vendor payment terms are expected to have
a positive impact on our reported cash flows through 2005. In addition, our cash
flow is also dependent on our ability to efficiently manage our capital
spending. We use cash return on invested capital as a measure of the efficiency
with which assets are deployed to increase earnings. Improvements in our return
on invested capital will depend on our ability to maintain an appropriate asset
base for our business and to increase productivity and operating efficiency.
For further information related to other factors that have had, or may in the
future have, a significant impact on our business, financial condition or
results of operations, see Forward-Looking Statements and Item 7, Management's
Discussion and Analysis of Financial Condition and Results of Operations Risk
Factors in our Annual Report on Form 10-K for the year ended December 31, 2004.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations
A summary of our operating results as a percentage of net sales is shown below
(dollar amounts in millions):
THREE MONTHS ENDED SEPTEMBER 30, 2005 % 2004 %
- -------------------------------- ------- ----- ------ -----
(dollars in millions)
Net sales $ 478.5 100.0% $478.6 100.0%
Cost of sales and operating expenses 431.5 90.2% 403.4 84.3%
Selling and administrative expenses 41.4 8.7% 49.6 10.4%
Impairments, restructuring charges, and
other items 1.4 0.3% 2.0 0.4%
------- ------
Operating income 4.2 0.9% 23.6 4.9%
Interest expense (8.0) 1.7% (5.3) 1.1%
Interest income and other, net 1.9 0.4% 2.3 0.5%
------- ------
Income (Loss) before taxes (1.9) 0.4% 20.6 4.3%
Tax provision 30.9 6.5% 8.3 1.7%
------- ------
Net income (loss) ($32.8) 6.9% $ 12.3 2.6%
======= ======
Three Months Ended September 30, 2005 vs. Three Months Ended September 30, 2004
Net sales in the third quarter of 2005 were $478.5 million as compared to $478.6
million in the third quarter of 2004. Excluding an increase in sales of $20.5
million resulting from the effect of changes in foreign currency exchange rates,
sales decreased $20.6 million or 4.3% versus the same quarter in the prior year.
This was primarily due to lower volumes in the Compressor and Engine & Power
Train segments.
Gross profit and gross margin were $47.0 million and 9.8% in the quarter ended
September 30, 2005, as compared to $75.2 million and 15.7% in the quarter ended
September 30, 2004. Gross profit was negatively affected by the impact of
commodity costs, which reduced gross profit by $24.2 million. Pricing increases
have helped to mitigate the impact of this increase. Gross profit was also
negatively affected by unfavorable foreign exchange rates, particularly the
Brazilian Real, which had an impact of $10.6 million.
Selling, general and administrative expenses were $41.4 million in the three
months ended September 30, 2005, as compared to $49.6 million in the three
months ended September 30, 2004. As a percentage of net sales, selling, general
and administrative expenses were 8.7% and 10.4% in the third quarters of 2005
and 2004, respectively. The decrease is primarily related to improvement in
variable selling costs and global headcount reduction. The completion of the
amortization of non-compete agreements associated with our 2002 acquisition of
FASCO contributed $1.9 million to the decrease.
We incurred $1.4 million in asset impairment and restructuring charges during
the third quarter. The North American Compressor operations recorded $0.5
million of additional moving costs related to previously announced actions and
the European Engine & Power Train operations recorded $0.4 million of additional
termination costs related to previously announced intent to reduce its
workforce.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Engine & Power Train costs relate to the termination of an additional 15
employees and ongoing costs related to previous terminations. The remaining $0.5
million relates to asset impairment for manufacturing equipment idled through a
facility consolidation within the Electrical Components segment.
Interest expense amounted to $8.0 million in the third quarter of 2005 compared
to $5.3 million in the third quarter of 2004. The increase was primarily related
to higher average interest rates applicable to our borrowings both in the United
States and in a number of our foreign locations, in addition to reflecting the
impact of the loss of benefit previously provided by interest rate swaps
exchanging fixed rates for variable.
Interest income and other, net amounted to $1.9 million in the third quarter of
2005 compared to $2.3 million in the third quarter of 2004. This decrease
resulted primarily from lower average deposits in Brazil and the United States.
We recognized tax expense of $30.9 million on a loss before taxes of $1.9
million for the third quarter, as compared with an effective tax rate of 40.3%
on income before taxes of $20.6 million for the corresponding period in 2004.
The current period expense was primarily related to the recognition of deferred
tax asset valuation allowances against amounts previously recorded by the
Brazilian Engine operations ($7.1 million) and U.S. ($18.2 million) as the
preponderance of negative evidence indicates that these deferred tax assets will
not be recoverable. The continued strength of the Brazilian Real against the
U.S. Dollar and other factors has diminished the prospects of tax planning
strategies utilizing these carry-forwards in a timely manner. Excluding these
charges, the unusual result was the product of not providing benefits on losses
in jurisdictions where the preponderance of negative evidence would indicate
that these deferred tax assets would not be recoverable. The effective tax rate
in future periods may vary from standard U.S. tax rates based upon changes in
the mix of profitability between the jurisdictions where benefits on losses are
not provided versus other jurisdictions where provisions and benefits were
recognized. In addition, circumstances could change such that additional
valuation allowances may become necessary on deferred tax assets in various
jurisdictions.
Net loss in the third quarter of 2005 was $32.8 million, or $1.77 per share, as
compared to net income of $12.3 million, or $0.67 per share, in the third
quarter of 2004. The decline was primarily the result of the factors described
above. Excluding charges, this quarter's results reflect the continuation of a
trend of declining quarter over comparable quarter results which began with the
fourth quarter of 2003.
Reportable Operating Segments
The financial information presented below is for our four reportable operating
segments for the periods presented: Compressor, Engine & Power Train, Electrical
Components and Pump. Financial measures regarding each segment's income before
interest, other expense and income taxes ("operating income") and income before
interest, other expense and income taxes divided by net sales ("operating
margin") are not measures of performance under accounting principles generally
accepted in the United States (GAAP). Such measures are presented because we
evaluate the performance of our reportable operating segments, in part, based on
income before interest, other expense and income taxes. These measures should
not be considered in isolation or as a substitute for net income, net cash
provided by operating activities or other income statement or cash flow
statement data prepared in
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
accordance with GAAP or as measures of profitability or liquidity. In addition,
these measures, as we determine them, may not be comparable to related or
similarly titled measures reported by other companies. For a reconciliation of
consolidated income before interest, other expense and income taxes to income
before provision for income taxes, see Note 4, Segment Reporting.
Compressor Products
Third quarter 2005 sales in our compressor business were flat at $218.6 million
from $218.9 million in the third quarter of 2004. Declines in sales of
compressors utilized in room air conditioners and commercial applications offset
the increase in sales due to the effect of foreign currency translation of $19.5
million.
Compressor business operating income and the related margin on net sales for the
third quarter of 2005 amounted to $7.6 million and 3.5% compared to $22.5
million and 10.3% in the third quarter of 2004. The effects of a weaker U.S.
Dollar caused an operating income decline of $11.0 million compared to last
year's third quarter. During the third quarter of 2005 when compared to the
third quarter of 2004, the U.S. Dollar was on average 20.3% weaker versus the
Brazilian Real. Compressor segment operating margin also deteriorated due to an
unfavorable mix of sales and increases in commodity costs in excess of pricing
adjustments. Results in the third quarter indicate lower total market demand in
Europe and South America.
Electrical Component Products
Electrical Components business sales were $103.3 million in the third quarter of
2005, a slight increase when compared to $102.1 million from the third quarter
of 2004. The segment offset volume declines with pricing increases. Volume
declines totaled $4.3 million and were particularly significant in the
automotive seat actuator, blower, and motor businesses.
Electrical Components operating income and margin for the third quarter of 2005
amounted to $4.8 million and 4.6% compared to $3.5 million and 3.4% in the third
quarter of 2004. The improvement in operating income in the quarter largely
resulted from lower sales volumes and poorer mix of sales ($1.8 million) and
higher commodity costs ($2.7 million), being offset by lower amortization of
intangible assets of $1.9 million as well as productivity improvements and
pricing recoveries.
Engine & Power Train Products
Engine & Power Train business sales were slightly down at $124.2 million in the
third quarter of 2005 compared to $128.6 million in the third quarter of 2004.
Loss of business on walk behind rotary lawn applications and other engine lines
used on certain utility products led the decline in sales totaling $8.7 million
and $6.5 million, respectively. This was somewhat offset through increased
volume of engines used in generators.
Engine & Power Train business operating loss in the third quarter of 2005
amounted to $5.2 million compared to income of $2.2 million in the third quarter
of 2004. The decline in quarter results reflects losses in volume and increases
in commodity ($3.8) and other costs ($9.6) somewhat offset by a better mix of
sales of $7.0 million.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Pump Products
Pump business sales in the third quarter of 2005 amounted to $31.8 million
compared to $28.5 million in same period in 2004. The 11.6% increase in sales
was the result of volume growth across almost all of the segment's lines of
business.
Operating income and margin amounted to $3.6 million and 11.3% in the third
quarter of 2005 compared to $3.1 million and 10.9% in the same period in 2004.
The increase in operating income was primarily attributable to the increases in
sales volumes. The margin decline was a result of sales mix.
Nine Months Ended September 30, 2005 vs. Nine Months Ended September 30, 2004
NINE MONTHS ENDED SEPTEMBER 30, 2005 % 2004 %
- ------------------------------- -------- ----- -------- -----
(dollars in millions)
Net sales $1,404.8 100.0% $1,439.8 100.0%
Cost of sales and operating expenses 1,285.0 91.5% 1,245.3 86.5%
Selling and administrative expenses 135.9 9.7% 145.4 10.1%
Impairments, restructuring charges, and
other items 111.3 7.9% 5.6 0.4%
-------- ----- -------- -----
Operating income (loss) (127.4) 9.1% 43.5 3.0%
Interest expense (22.4) 1.6% (16.5) 1.1%
Interest income and other, net 6.9 0.5% 10.6 0.7%
-------- ----- -------- -----
Income (Loss) before taxes (142.9) 10.2% 37.6 2.6%
Tax provision 24.8 1.8% 14.3 1.0%
-------- ----- -------- -----
Net income (loss) ($167.7) 11.9% $ 23.3 1.6%
======== ===== ======== =====
Net sales in the nine months ended September 30, 2005 were $1,404.8 million as
compared to $1,439.8 million in the same period of 2004. Excluding an increase
in sales of $66.0 million resulting from the effect of changes in foreign
currency exchange rates, sales decreased $101.0 million or 7.0% versus the same
quarter in the prior year. This was primarily due to lower volumes in the
Compressor and Engine & Power Train segments. Year to date sales declines were
also experienced in our Electrical Components and Pump segments.
Gross profit and gross margin were $119.8 million and 8.5% in the nine months
ended September 30, 2005, as compared to $194.5 million and 13.5% in the nine
months ended September 30, 2004. Gross profit was negatively affected by the
impact of commodity costs which were $78.2 million higher in relative terms.
Pricing increases helped to mitigate the impact of this increase, though neither
the Electrical Components or Engine & Power Train segments were able to achieve
complete recovery. Gross profit was also negatively affected by unfavorable
foreign exchange rates, particularly the Brazilian Real.
Selling, general and administrative expenses were $135.9 million in the nine
months ended September 30, 2005, as compared to $145.4 million in the nine
months ended September 30, 2004. As a percentage of net sales, selling, general
and administrative expenses were 9.7% and 10.1% in the nine months ended
September 30, 2005 and September 30, 2004, respectively. The completion of the
amortization of non-compete agreements associated with our 2002 acquisition of
FASCO contributed
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
$5.7 million to the decrease in selling, general and administrative expenses in
2005. The comparison to sales did not improve due to higher relative first
quarter selling costs, particularly in the Brazilian compressor operations.
We incurred $3.3 million in asset impairment and restructuring charges during
the nine months ended September 30, 2005. The North American Compressor
operations recorded $0.9 million of additional moving costs related to
previously announced actions. The European Engine & Power Train operations
recorded $1.4 million of termination costs related to previously announced
intent to reduce its workforce. The Engine & Power Train costs relate to the
termination of approximately 115 employees. The remaining $1.0 million relates
to asset impairment for manufacturing equipment idled through a facility
consolidation and additional impairment of the carrying value of a closed plant,
both within the Electrical Components segment.
Current year results also include an impairment charge of $108.0 million related
to the goodwill associated with the 2002 acquisition of FASCO (which is included
in the Electrical Components segment). As previously disclosed, the failure to
achieve the business plan, coupled with expected market conditions, has caused
us to revisit the assumptions utilized to determine FASCO's estimated fair value
in the impairment assessment performed at December 31, 2004. The deterioration
of volumes and our inability to recover higher commodity and transportation
costs through price increases has resulted in revised expected cash flows for
FASCO. Based on the revised estimates of cash flow, FASCO's estimated fair value
has deteriorated from the previous assessment and, as a result, a goodwill
impairment of $108.0 million was recognized.
Interest expense amounted to $22.4 million in the nine months ended September
30, 2005 compared to $16.5 million in the comparable period of 2004. The
increase was primarily related to higher average interest rates applicable to
our borrowings both in the United States and in a number of our foreign
locations, in addition to reflecting the impact of the loss of benefit
previously provided by interest rate swaps exchanging fixed rates for variable.
Interest income and other, net amounted to $6.9 million in the nine months ended
September 30, 2005 compared to $10.6 million in the same period of 2004. This
decrease resulted primarily from lower average deposits in Brazil and the United
States.
We recorded income tax expense of $24.8 million on a loss before taxes of $142.9
million for the nine months ended September 30, 2005, as compared with an
effective tax rate of 38.0% for the corresponding period in 2004. The primary
differences in our tax benefit rate for the third quarter and the first nine
months of fiscal 2005 as compared with the corresponding periods of fiscal 2004
was primarily due to non-deductibility of the goodwill impairment recognized in
the second quarter of 2005 and the recognition of deferred tax asset valuation
allowances during the third quarter of 2005 related to the Brazilian Engine
operations ($7.1 million) and U.S. ($18.2 million) as the preponderance of
negative evidence indicates that these deferred tax assets will not be
recoverable. The continued strength of the Brazilian Real against the U.S.
Dollar and other factors has diminished the prospects of tax planning strategies
utilizing these carry-forwards in a timely manner. Excluding the goodwill
impairment and valuation allowances, the unusual result was also the product of
not providing benefits on losses in jurisdictions where the preponderance of
negative evidence would indicate that these deferred tax assets would not be
recoverable. The effective tax rate in future periods may vary from
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
the 35% used in prior years based upon changes in the mix of profitability
between the jurisdictions where benefits on losses are not provided versus other
jurisdictions where provisions and benefits were recognized. In addition,
circumstances could change such that additional valuation allowances may become
necessary on deferred tax assets in various jurisdictions.
Net loss in the nine months ended September 30, 2005 was $167.7 million, or
$9.07 per share, as compared to net income of $23.3 million, or $1.26 per share,
in the nine months ended September 30, 2004. The current period decline was
primarily the result of the impact of the goodwill impairment described above.
Additional factors discussed through the Reportable Operating Segments
discussion that follows contributed to the operating loss experienced which
results even after excluding the impairment, other charges and deferred tax
asset valuation allowances.
REPORTABLE OPERATING SEGMENTS
Please see the previous discussion of our use of segment income before interest,
other expense and income taxes ("operating income") and income before interest,
other expense and income taxes divided by net sales ("operating margin") on page
18.
Compressor Products
Compressor business sales in the first nine months of 2005 increased 6.4% to
$707.2 million from $664.9 million in the first nine months of 2004. The
increase for the period from the prior year was mainly attributable to the
effect of foreign currency translation that increased sales by $62.8 million.
Excluding the effect of foreign currency fluctuation, volume increases of
compressor products that are primarily manufactured by the Company in its
Brazilian and Indian facilities and sold into the original equipment markets for
residential refrigerators and freezers and volume increases in compressor
products for commercial applications were more than offset by declines in sales
of compressors used in room air conditioners.
Compressor business operating income and the related margin on net sales for the
nine months ended September 30, 2005 amounted to $23.6 million and 3.3% compared
to $53.7 million and 8.1% for the first nine months of 2004. The effects of
foreign currency exchange rates caused a decline of $25.5 million. During the
nine month period, the U.S. Dollar was on average 17% weaker versus the
Brazilian Real and 3% weaker versus the Euro. Compressor segment operating
margin also deteriorated due to an unfavorable mix of sales and higher commodity
and transportation costs.
Electrical Component Products
Sales for the first nine months of 2005 amounted to $305.9 million compared to
$314.3 million in the first nine months of 2004. Volume declines totaled $19.7
million and were particularly significant in the automotive seat actuator,
blowers, and residential and commercial aftermarket.
Electrical Components operating income and margin for the first nine months of
2005 amounted to $4.0 million and 1.3% compared to $11.2 million and 3.6% in the
first nine months of 2004. The decline in operating income in the period largely
resulted from lower sales volumes ($7.9 million), higher commodity costs ($15.0
million), and unanticipated operational inefficiencies primarily related to the
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
closure of the St. Clair facility ($1.2 million), partially offset by lower
amortization of intangible assets of $5.7 million.
Engine & Power Train Products
Engine & Power Train business sales declined 16.6% to $297.8 million in the nine
months ended September 30, 2005 compared to $356.9 million in the corresponding
period of 2004. Loss of business totaling $32.7 million on walk behind rotary
lawn applications led the decline in sales. Volumes were also lower in the
transaxle business and in other engine lines utilized on certain utility
products. These volume declines were somewhat offset by increased sales of
engines used in generators.
Engine & Power Train business operating loss in the nine months ended September
30, 2005 amounted to $41.6 million compared to a loss of $11.2 million in the
corresponding period of 2004. The decline in year to date results reflects
increases in commodity costs of $10.6 million and other costs of $13.7 million.
The significant costs associated with excess capacities in the U.S. and Europe
contributed substantially to the Engine & Power Train losses. The excess
capacity situation was exacerbated by the current shift of production to our
Brazilian manufacturing facility resulting in duplicate capacities. We intend to
complete substantial cost reductions and volume improvements throughout 2005 and
into 2006 to achieve sustained improvement.
Pump Products
Pump business sales in the nine months ended 2005 amounted to $92.4 million
compared to $102.5 million in comparable period in 2004. The 9.9% reduction in
sales was primarily attributable to the loss of water gardening business at one
mass market retailer.
Operating income and margin amounted to $10.1 million and 10.9% in the nine
months ended September 30, 2005 compared to $11.3 million and 11.0% in the
comparable period in 2004. The decrease in operating income and margin was
primarily attributable to the reductions in sales volumes.
OTHER MATTERS
Environmental Matters
We are subject to various federal, state and local laws relating to the
protection of the environment and are actively involved in various stages of
investigation or remediation for sites where contamination has been alleged.
(See Note 10 to the financial statements.) Liabilities relating to probable
remediation activities are recorded when the costs of such activities can be
reasonably estimated based on the facts and circumstances currently known.
Difficulties exist estimating the future timing and ultimate costs to be
incurred due to uncertainties regarding the status of laws, regulations, levels
of required remediation, changes in remediation technology and information
available.
At September 30, 2005 and December 31, 2004, we had accrued $42.8 million and
$43.3 million, respectively, for environmental remediation. As these matters
continue toward final resolution, amounts in excess of those already provided
may be necessary to discharge our obligations for these sites.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Such amounts, depending on their amount and timing, could be material to
reported net income in the particular quarter or period in which they are
recorded. In addition, the ultimate resolution of these matters, either
individually or in the aggregate, could be material to the consolidated
financial statements.
AlixPartners Engagement
We engaged AlixPartners during the third quarter of 2005 to assist in the
restructuring plans of the Engine & Power Train business. These plans include
focusing on improving profitability and customer service. The participation by
AlixPartners allows the Company to affect this change in a shorter time frame
than it otherwise could have achieved. The plan includes eliminating the
significant duplicate capacity, among other cost reduction efforts.
LIQUIDITY AND CAPITAL RESOURCES
Our primary liquidity needs are to fund capital expenditures, service
indebtedness, and support working capital requirements. Our principal sources of
liquidity are cash flows from operating activities and borrowings under
available credit facilities. A substantial portion of our operating income is
generated by foreign operations. As a result, we are dependent on the earnings
and cash flows of and the combination of dividends, distributions and advances
from our foreign operations to provide the funds necessary to meet our
obligations in each of our legal jurisdictions. There are no significant
restrictions on the ability of our subsidiaries to pay dividends or make other
distributions.
Cash Flow
Cash used in operating activities was $34.6 million in the first nine months of
2005 as compared to cash provided by operations of $34.5 million in the first
nine months of 2004. The decrease was primarily the result of the declining net
income; however, it represents an improvement of $20.9 million from the first
six months as the Company successfully reduced its investment in working capital
during the third quarter by $4.9 million. The cash generated from operations
during the third quarter was used to fund capital expenditures and losses. Year
to date, the Company used existing cash balances to prepay $50 million of the
Company's Guaranteed Senior Guaranteed Notes, pay dividends, and fund capital
expenditures.
Cash flows used in investing activities were $88.6 million in the first nine
months of 2005 as compared to $55.6 million in the first nine months of 2004,
reflecting a $33.0 million increase in capital expenditures in 2005, primarily
related to new product expansions in Brazil and India.
Cash flows used in financing activities were $23.0 million in the first nine
months of 2005 as compared to $53.1 million in the first nine months of 2004,
primarily reflecting the repayment of $50 million of our Senior Guaranteed Notes
in the first quarter net of additional foreign borrowings during 2005 versus
repayments in 2004. The Company also paid dividends in the first and second
quarters amounting to $11.8 million. The Company has currently suspended its
dividend, did not pay a dividend during the third quarter, and does not expect
to accumulate sufficient earnings under the terms of its current borrowing
agreements to pay a dividend through first quarter 2007.
Page 26
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Capitalization
In addition to cash provided by operating activities, we use a combination of
our credit facility and long-term debt to fund our capital expenditures and
working capital requirements. For the nine months ended September 30, 2005 and
September 30, 2004, our average outstanding debt balance was $370.9 million and
$399.2 million, respectively. The weighted average long-term interest rate,
including the effect of hedging activities, was 4.64% and 3.47% for the
respective periods. Among other factors, the change in the weighted average,
long-term interest rate for the respective periods reflects the increase in the
borrowing rate applicable to the $250 million Senior Guaranteed Notes which
changed from 4.6% to 6.6% on August 8, 2005.
We use our $100 million revolving credit facility as needed for our short-term
working capital fluctuations and general corporate purposes. For the nine months
ended September 30, 2005, our average outstanding unsecured short-term debt
balance was $11.2 million at a weighted average interest rate of 4.3%. This
facility was not utilized during 2004. At September 30, 2005, $17.9 million was
utilized for letters of credit.
The Company may also utilize long-term financing arrangements in connection with
state investment incentive programs.
Accounts Receivable Sales
Certain of our Brazilian and Asian subsidiaries periodically sell their accounts
receivable with financial institutions. Such receivables are factored with
recourse to us and, in most cases, are excluded from accounts receivable in our
consolidated balance sheets. The amount of sold receivables excluded from our
balance sheet was $30.3 million and $101.0 million as of September 30, 2005 and
December 31, 2004, respectively. We cannot provide any assurances that these
facilities will be available or utilized in the future.
Adequacy of Liquidity Sources
Historically, cash flows from operations and borrowing capacity under available
credit facilities were sufficient to meet our long-term debt maturities,
projected capital expenditures and anticipated working capital requirements;
however, the negative results experienced over the last quarter of 2004 and the
first six months of 2005 and the recognition of the goodwill impairment charge
required the Company to amend its debt covenants in both the Note Purchase
Agreement with the holders of its Senior Guaranteed Notes and the credit
agreement for its Revolving Credit Facility, under which JPMorgan Chase Bank,
N.A. acts as agent for a group of lenders. The amendments were signed on August
5, 2005. New terms of the agreements provide for security interests in certain
of the Company's assets and specific covenants related to EBITDA and capital
expenditures through December 2006. The capital expenditure covenant required
further amendment in order for the Company to remain in compliance as of
September 30, 2005 and the leverage ratio covenant was eliminated through
December 31, 2006. While the terms of the agreement also permit resumption of
dividends, presuming continued compliance with these covenants and subject to
minimum levels of EBITDA, beginning with the fourth quarter of 2005 through the
first quarter of 2007, the Company does not currently expect to pay dividends
through this compliance period and elected not to pay a dividend in the third
quarter.
The Company continues to monitor its future expected results in relationship to
the financial covenants specified under the terms of the respective borrowing
arrangements, and should the Company fail to comply with such covenants,
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
further amendments would be required. If the Company fails to obtain such
amendment, the lenders could exercise their rights under the terms of the
agreement. Alternatively, the Company may seek new financing arrangements which
provide greater flexibility than currently afforded under the existing Senior
Guaranteed Notes, in combination with potential sales of assets as part of its
overall business strategies. See Item 7, "Management's Discussion and Analysis
of Financial Condition and Results of Operations," in our Annual Report on Form
10-K for additional discussion related to the year ended December 31, 2004.
SIGNIFICANT ACCOUNTING POLICIES AND CRITICAL ACCOUNTING ESTIMATES
Some of our accounting policies require management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. These estimates and
assumptions are subject to an inherent degree of uncertainty. They are based on
our historical experience, the terms of existing contracts, our evaluation of
trends in the industry, information provided by our customers and suppliers, and
information available from other outside sources, as appropriate. Actual results
in these areas could differ from our estimates. For a discussion of our
significant accounting policies and critical accounting estimates, see Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Significant Accounting Policies and Critical Accounting
Estimates," and Note 1, "Accounting Policies," to the consolidated financial
statements included in our Annual Report on Form 10-K for the year ended
December 31, 2004. There have been no significant changes to our significant
accounting policies or critical accounting estimates during the first nine
months of 2005.
Recently Issued Accounting Pronouncements
Inventory Costs
The Financial Accounting Standards Board ("FASB") issued SFAS No. 151,
"Inventory Costs - an amendment of ARB No. 43, Chapter 4." This statement
clarifies the requirement that abnormal inventory-related costs be recognized as
current-period charges and requires that the allocation of fixed production
overheads to inventory conversion costs be based on the normal capacity of the
production facilities. The provisions of this statement are to be applied
prospectively to inventory costs incurred during fiscal years beginning after
June 15, 2005. While we have idle production capacity in several of our
facilities and we are still evaluating the impact of this pronouncement, we do
not believe the effects will be material.
OUTLOOK
Information in this "Outlook" section should be read in conjunction with the
cautionary language and discussion of risks included below.
The outlook for the remainder of the year is subject to the same variables that
have negatively impacted the Company's year to date results. Commodity costs and
key currency rates, particularly the Brazilian Real, will remain key factors to
any rebound in the final quarter of the year. Recent indicators provide only
slight encouragement as the Company expects the Brazilian Real to continue to
Page 28
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
negatively affect its business. The Company has been acting on variables within
its control, such as aggressively executing cost cutting actions. Global
headcounts have been reduced by 2,300 since March 31, 2005, and the Company has
changed retiree and healthcare benefits in the U.S. with an expected annual
benefit of $4.0 million. The Company has engaged AlixPartners to assist in the
completion of the Engine & Power Train Group restructuring, where substantial
cost reductions associated with the elimination of duplicate capacities, are
expected to benefit future periods. Despite these efforts, the Company expects
fourth quarter results to lag comparable 2004 results, particularly due to the
Compressor segment. Higher costs, an unfavorable Brazilian Real, weaker global
markets for refrigeration and freezer compressors, and continued shifts to
Asian-based rotary compressor for air conditioning are all factors. In addition,
these factors can be reasonably expected to continue into 2006.
The Company will continue to focus its efforts on improving the profitability
and competitiveness of its worldwide operations. It is likely that additional
production relocation and consolidation initiatives will take place during 2005
and 2006 that could have an effect on the consolidated financial position and
future results of operations of the Company.
CAUTIONARY STATEMENTS RELATING TO FORWARD-LOOKING STATEMENTS
This discussion contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act that are subject to the safe harbor
provisions created by that Act. In addition, forward-looking statements may be
made orally in the future by or on behalf of us. Forward-looking statements can
be identified by the use of terms such as "expects," "should," "may,"
"believes," "anticipates," "will," and other future tense and forward-looking
terminology, or by the fact that they appear under the caption "Outlook."
Readers are cautioned that actual results may differ materially from those
projected as a result of certain risks and uncertainties, including, but not
limited to, i) changes in business conditions and the economy in general in both
foreign and domestic markets; ii) the effect of terrorist activity and armed
conflict; iii) weather conditions affecting demand for air conditioners, lawn
and garden products, portable power generators and snow throwers; iv) the
success of our ongoing effort to bring costs in line with projected production
levels and product mix; v) financial market changes, including fluctuations in
interest rates and foreign currency exchange rates; vi) economic trend factors
such as housing starts; vii) emerging governmental regulations; viii)
availability and cost of materials, particularly commodities, including steel,
copper and aluminum, whose cost can be subject to significant variation; ix)
actions of competitors; x) the ultimate cost of resolving environmental and
legal matters; xi) our ability to profitably develop, manufacture and sell both
new and existing products; xii) the extent of any business disruption that may
result from the restructuring and realignment of our manufacturing operations or
system implementations, the ultimate cost of those initiatives and the amount of
savings actually realized; xiii) potential political and economic adversities
that could adversely affect anticipated sales and production in Brazil; xiv)
potential political and economic adversities that could adversely affect
anticipated sales and production in India, including potential military conflict
with neighboring countries; xv) our ability to reduce a substantial amount of
costs in the Engine & Power Train group associated with excess capacity, and
xvi) the ongoing financial health of major customers. These forward-looking
statements are made only as of the date of this report, and we undertake no
obligation
Page 29
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
to update or revise the forward-looking statements, whether as a result of new
information, future events or otherwise.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to risk during the normal course of business from credit
risk associated with accounts receivable and from changes in interest rates,
commodity prices, and foreign currency exchange rates. The exposure to these
risks is managed through a combination of normal operating and financing
activities which include the use of derivative financial instruments in the form
of foreign currency forward exchange contracts and commodity forward purchasing
contracts. Fluctuations in commodity prices and foreign currency exchange rates
can be volatile, and the Company's risk management activities do not totally
eliminate these risks. Consequently, these fluctuations can have a significant
effect on results. A discussion of the Company's policies and procedures
regarding the management of market risk and the use of derivative financial
instruments was provided in its Annual Report on Form 10-K in Item 7A and in
Notes 1 and 12 of the Notes to Consolidated Financial Statements. The Company
does not utilize financial instruments for trading or other speculative
purposes. There have been no changes in these policies or procedures during the
third quarter of 2005.
The Company utilizes foreign currency forward exchange contracts to hedge
foreign currency receivables, payables, and other known transactional exposures
for periods consistent with the expected cash flows of the underlying
transactions. The contracts generally mature within one year and are designed to
limit exposure to exchange rate fluctuations because gains and losses on the
hedged transactions offset gains and losses on the contracts. At September 30,
2005 and December 31, 2004, the Company held foreign currency forward exchange
contracts and foreign currency call options with total notional values in the
amount of $96.7 million and $53.4 million, respectively.
The Company uses commodity forward purchasing contracts to help control the cost
of traded commodities, primarily copper and aluminum, used as raw material in
the production of motors, electrical components and engines. Local management is
allowed to contract commodity forwards for a limited percentage of projected raw
material requirements up to one year in advance. The total values of commodity
forwards outstanding at September 30, 2005 and December 31, 2004 were $36.8
million and $23.7 million, respectively.
The Company is subject to interest rate risk, primarily associated with its
borrowings. The Company's $250 million Senior Guaranteed Notes are fixed-rate
debt. The Company's remaining borrowings, which consist of bank borrowings by
its foreign subsidiaries and Industrial Development Revenue Bonds, are
variable-rate debt. Currently, 67% of the Company's total debt is fixed-rate.
While changes in interest rates do not affect the fair value of the Company's
variable-interest rate debt, they do affect future earnings and cash flows. A 1%
increase in interest rates would increase interest expense for the year by
approximately $1.3 million.
Page 31
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 4
CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in the reports that the Company
files or submits under the Securities Exchange Act of 1934 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 President and Chief Executive Officer
and Vice President, Treasurer and Chief Financial Officer, as appropriate, to
allow timely decisions regarding required disclosure.
As of the end of the fiscal quarter covered by this report, the Company carried
out an evaluation, under the supervision and with the participation of the
Company's Disclosure Committee and management, including the President and Chief
Executive Officer and the Company's Vice President, Treasurer and Chief
Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based
upon such evaluation, the Company's President and Chief Executive Officer along
with the Company's Vice President, Treasurer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures which were
identified as not effective as of December 31, 2004 because of the material
weakness discussed below, have not yet been fully corrected and are, therefore,
not effective as of September 30, 2005. In light of the material weakness, the
Company performed additional analysis and other post-closing procedures to
ensure our consolidated financial statements were prepared in accordance with
generally accepted accounting principles. Accordingly, management believes that
the financial statements included in this report fairly state in all material
respects our financial condition, results of operations and cash flows for the
periods presented.
As outlined in management's annual report as of December 31, 2004, the Company
did not maintain effective controls over the segregation of duties over certain
system access controls as well as security over user access rights to certain
financial application systems which could affect accounts receivable and
revenue, inventory and cost of goods sold, and accounts payable and other
financial statement accounts at a number of its locations. Specifically, the
control deficiencies demonstrated an inadequate design of access security
policies and segregation of duties requirements as well as a lack of independent
monitoring of user access to financial application programs and data.
Individually, these deficiencies were evaluated as representing a more than
remote likelihood that a misstatement that is more than inconsequential, but
less than material, could occur; however, when aggregated, these deficiencies
could result in a misstatement to the financial statement accounts, resulting in
a material misstatement to the consolidated financial statements that would not
be prevented or detected.
The Company has implemented additional controls to remediate this material
weakness. These controls include, but are not limited to, additional levels of
reviews of transactions, additional reviews of changes to financial applications
and data by those with access to both, and reassignment of responsibilities to
provide for better segregation of duties. While specific efforts have been
undertaken to address the segregation of duties and system access issues within
each of the affected locations, the Company has not completed its process to
verify the adequacy of the measures taken and ensure these steps had completely
addressed the previously identified concerns.
The Company has also made progress with respect to its implementation of a
common, global ERP system, which represents the long-term solution to these
deficiencies as well as a significant improvement to the overall internal
control structure of the company. The system implementation includes improved
controls over access to financial application programs and data, independent
Page 32
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 4
CONTROLS AND PROCEDURES
monitoring of users having unrestricted access to financial application programs
and data, and provides for improved segregation of duties. The first business
went live March 1, 2005 and the Company's remaining locations are expected to go
live during 2006 and 2007.
Changes In Internal Control Over Financial Reporting
As noted above, the Company is in the process of implementing a new global ERP
system. Location implementations began in the first quarter of 2005 and the
Company's remaining locations are expected to go live during 2006 and 2007.
During this time period, there will be significant changes in internal controls
over financial reporting at the operations affected. The Company believes it has
designed adequate controls into the new system and will begin testing their
application at each location after their respective go-live dates.
There have been no changes in the Company's internal controls over financial
reporting that occurred during the quarter that have materially affected, or are
reasonably likely to materially affect, the Company's internal control over
financial reporting.
Limitations On The Effectiveness Of Controls And Procedures
Management of the Company, including the chief executive officer and chief
financial officer, does not expect that the Company's disclosure controls and
procedures or internal control over financial reporting will detect or prevent
all error and all fraud. A control system, no matter how well designed and
implemented, can provide only reasonable, not absolute, assurance that the
control system's objective will be met. Because of the inherent limitations in
all control systems, no evaluation of controls can provide absolute assurance
that all control issues within a company are detected.
In addition, projection of any evaluation of the effectiveness of internal
control over financial reporting to future periods is subject to the risk that
controls may become inadequate because of changes in condition, or that the
degree of compliance with policies and procedures included in such controls may
deteriorate.
Page 33
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS
(a) Exhibit
Number Description
------- -----------
31.1 Certification of the President and Chief Executive Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the President and Chief Executive Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
Page 34
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
SIGNATURE
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.
TECUMSEH PRODUCTS COMPANY
(Registrant)
Dated: November 7, 2005 BY: /s/ JAMES S. NICHOLSON
------------------------------------
James S. Nicholson
Vice President, Treasurer and
Chief Financial Officer (on behalf
of the Registrant and as principal
financial officer)
Page 35
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ----------- -----------
4.1 Amendment No. 3 dated November 4, 2005 to Note Purchase Agreement
dated March 5, 2003 by and among Tecumseh Products Company and
certain Purchasers listed therein.
4.2 Second Amendment dated November 4, 2005 to Credit Agreement dated
as of December 21, 2004 among Tecumseh Products Company, the
lenders named therein, and JPMorgan Chase Bank, N.A., as agent.
EX-31.1 Certification of the President and Chief Executive Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
EX-31.2 Certification of the Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
EX-32.1 Certification of the President and Chief Executive Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
EX-32.2 Certification of the Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.