SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
(AMENDMENT NO. 1)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
ACT of 1934
For the quarterly period ended March 31, 2006
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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of accelerated
filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange 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 March 31, 2006
-------------- -----------------------------
Class B Common Stock, $1.00 par value 5,077,746
Class A Common Stock, $1.00 par value 13,401,938
Page 1
Explanatory Note
This Form 10-Q/A (this "Amendment No. 1") amends the Quarterly Report on Form
10-Q for the period ended March 31, 2006 that we filed on May 10, 2006 to
correct our accounting for interim period income taxes, which is more fully
discussed in Note 2 of the consolidated financial statements included in Part I
- - Financial Information. Accordingly, we have restated our Consolidated
Financial Statements including our Consolidated Balance Sheet at March 31, 2006,
the Consolidated Statements of Operations for the three months ended March 31,
2006 and 2005, and the related footnotes thereto. This Amendment No. 1 amends
and restates Items 1, 2, and 4 of Part I of the original Form 10-Q. We have also
expanded disclosures related to goodwill in response to comment letters received
from the staff of the Securities and Exchange Commission on July 26, 2006 and
October 19, 2006. No other items in the original Form 10-Q have been amended,
and this Amendment No. 1 does not reflect events occurring after the filing of
the original Form 10-Q, or modify or update the disclosures therein in any other
way.
Pursuant to the rules of the SEC, Item 6 of Part II of the original Form 10-Q
has been amended to contain currently-dated certifications from the Company's
President and Chief Executive Officer and Chief Financial Officer as required by
Section 302 and 906 of the Sarbanes-Oxley Act of 2002. The certifications of the
Company's President and Chief Executive Officer and Chief Financial Officer are
attached to the Amendment No. 1 as Exhibits 31.1, 31.2, 32.1 and 32.2. Items not
being amended and restated are presented for the convenience of the reader only.
Page 2
TABLE OF CONTENTS
Page
--------
Part I. Financial Information
Item 1. Financial Statements
Consolidated Condensed Balance Sheets............................. 4
Consolidated Condensed Statements of Operations................... 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.......................... 20
Item 3. Quantitative and Qualitative Disclosures About Market
Risk.......................................................... 32
Item 4. Controls and Procedures....................................... 34
Part II. Other Information............................................... 37
Signatures............................................................... 39
Amendment No. 1 to First Lien Credit Agreement........................... Exh 4.1
Amendment No. 1 to Second Lien Credit Agreement.......................... Exh 4.2
Management Incentive Plan as amended and restated on March 29, 2006...... Exh 10.1
Executive Deferred Compensation Plan adopted on March 29, 2006........... Exh 10.2
Director Retention Phantom Share Plan as amended and restated on
March 29................................................................. Exh 10.3
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 3
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION - ITEM 1
CONSOLIDATED CONDENSED BALANCE SHEETS
(Unaudited)
MARCH 31,
2006 December 31,
(Dollars in millions, except share data) (RESTATED) 2005
---------- ------------
ASSETS
Current Assets:
Cash and cash equivalents $ 82.8 $ 116.6
Accounts receivable, less allowance for doubtful accounts of
$10.9 in 2006 and $11.3 in 2005 232.6 211.1
Inventories 348.4 346.8
Deferred and recoverable income taxes 40.0 43.4
Other current assets 91.6 89.2
Assets held for sale 48.3 --
-------- --------
Total current assets 843.7 807.1
Property, plant, and equipment, net 590.1 578.6
Goodwill 126.1 130.9
Other intangibles 56.0 54.8
Deferred income taxes 0.5 --
Prepaid pension expense 188.7 185.3
Other assets 50.8 43.8
Assets held for sale 14.7 --
-------- --------
Total assets $1,870.6 $1,800.5
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable, trade $ 201.7 $ 187.3
Income taxes payable 5.3 --
Short-term borrowings 121.2 82.5
Accrued liabilities 133.7 135.3
Liabilities held for sale 15.0 --
-------- --------
Total current liabilities 476.9 405.1
Long-term debt 281.8 283.0
Deferred income taxes 16.8 25.0
Other postretirement benefit liabilities 210.6 210.9
Product warranty and self-insured risks 12.6 14.5
Pension liabilities 15.4 15.2
Other non-current liabilities 36.3 32.4
-------- --------
Total liabilities 1,050.4 986.1
-------- --------
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 794.1 806.6
Accumulated other comprehensive income (loss) 7.6 (10.7)
-------- --------
Total stockholders' equity 820.2 814.4
-------- --------
Total liabilities and stockholders' equity $1,870.6 $1,800.5
======== ========
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 OPERATIONS
(Unaudited)
THREE MONTHS ENDED
MARCH 31,
-----------------------
2006 2005
(Dollars in millions, except per share data) (RESTATED) (restated)
---------- ----------
Net sales $ 446.1 $ 440.2
Cost of sales and operating expenses 411.6 412.7
Selling and administrative expenses 45.2 43.4
Impairments, restructuring charges, and other items 0.6 0.1
------- -------
Operating loss (11.3) (16.0)
Interest expense (8.4) (6.3)
Interest income and other, net 5.0 3.3
------- -------
Loss from continuing operations before taxes (14.7) (19.0)
Tax benefit (2.6) (2.9)
------- -------
Loss from continuing operations (12.1) (16.1)
Income (Loss) from discontinued operations, net of tax (0.5) 0.1
------- -------
Net loss ($12.6) ($16.0)
======= =======
Basic and diluted earnings (loss) per share
Loss from continuing operations ($0.65) ($0.88)
Income (Loss) from discontinued operations, net of tax ($0.03) $ 0.01
------- -------
Net loss ($0.68) ($0.87)
======= =======
Weighted average shares (in thousands) 18,480 18,480
------- -------
Cash dividends declared per share $ 0.00 $ 0.32
------- -------
The accompanying 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)
THREE MONTHS
ENDED
MARCH 31,
-----------------
(Dollars in millions) 2006 2005
------- -------
Cash Flows from Operating Activities:
Cash used by operating activities ($44.5) ($67.4)
Cash Flows from Investing Activities:
Proceeds from sale of assets 9.0 --
Capital expenditures (20.0) (28.7)
Business acquisition (2.0) --
------- -------
Cash used in investing activities (13.0) (28.7)
------- -------
Cash Flows from Financing Activities:
Dividends paid -- (5.9)
Repayment of Senior Guaranteed Notes (250.0) (50.0)
Repayment of Industrial Development Revenue Bonds (10.5) --
Proceeds from First Lien Credit Agreement 168.3 --
Proceeds from Second Lien Credit Agreement 100.0 --
Other proceeds (repayments), net 16.2 8.5
------- -------
Cash provided by (used in) financing activities 24.0 (47.4)
------- -------
Effect of exchange rate changes on cash (0.3) 1.1
------- -------
Decrease in cash and cash equivalents (33.8) (142.4)
Cash and Cash Equivalents:
Beginning of period 116.6 227.9
------- -------
End of period $ 82.8 $ 85.5
======= =======
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,
2005 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, 2005.
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. Restatement
The Company has restated the quarterly financial data for errors in the
interim period tax provisions. Generally accepted accounting principles
require interim period income taxes to be recorded based on an estimated
annual effective rate. The Company in error combined the income from
foreign jurisdictions with losses from foreign jurisdictions for which tax
benefits are not expected to be realizable, which resulted in an
overstatement in the tax benefit of $3.0 million for the three month period
ended March 31, 2006 and $3.6 million for the three month period ended
March 31, 2005. The footnotes contained herein have been adjusted for
matters discussed in this footnote.
Adjustments made to the period ended March 31, 2006 are as follows:
THREE MONTHS ENDED
MARCH 31, 2006
------------------------------------
(Dollars in millions, except per share data) AS REPORTED ADJUSTMENTS ADJUSTED
----------- ----------- --------
Loss from continuing operations before taxes (14.7) (14.7)
Tax benefit (5.6) 3.0 (2.6)
------ --------
Loss from continuing operations (9.1) (3.0) (12.1)
Loss from discontinued operations, net of tax (0.5) (0.5)
------ --------
Net loss ($9.6) ($3.0) ($12.6)
====== ========
Basic and diluted earnings (loss) per share
Loss from continuing operations ($0.49) ($0.16) ($0.65)
Loss from discontinued operations, net of tax ($0.03) ($0.03)
------ --------
Net loss ($0.52) ($0.16) ($0.68)
====== ========
Page 7
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
Adjustments made to the period ended March 31, 2005 are as follows:
THREE MONTHS ENDED
MARCH 31, 2005
------------------------------------
(Dollars in millions, except per share data) AS REPORTED ADJUSTMENTS ADJUSTED
----------- ----------- --------
Loss from continuing operations before taxes (19.0) (19.0)
Tax benefit (6.5) (3.6) (2.9)
------ ------
Loss from continuing operations (12.5) 3.6 (16.1)
Income from discontinued operations, net of tax 0.1 0.1
------ ------
Net loss ($12.4) $ 3.6 ($16.0)
====== ======
Basic and diluted earnings (loss) per share
Loss from continuing operations ($0.68) ($0.20) ($0.88)
Income from discontinued operations, net of tax $ 0.01 $ 0.01
------- -------
Net loss ($0.67) ($0.20) ($0.87)
======= =======
Adjustments made to selected Consolidated Balance Sheet data are as follows:
March 31, 2006 March 31, 2006
(Dollars in millions) As reported Adjustments restated
-------------- ----------- --------------
Selected Balance Sheet Data:
Income Taxes Payable 2.3 3.0 5.3
Retained Earnings 797.1 (3.0) 794.1
----- -----
3. Comprehensive Income
THREE MONTHS ENDED
MARCH 31,
-----------------------
2006 2005
(Dollars in millions) (RESTATED) (restated)
---------- ----------
Net loss ($12.6) ($16.0)
Other comprehensive income (loss):
Foreign currency translation adjustments $ 23.2 (6.5)
Gain (Loss) on derivatives (0.9) 3.9
Unrealized gain (loss) on investment holdings (3.9) 3.8
------- ------
Total comprehensive income (loss) $ 5.8 ($14.8)
======= ======
Page 8
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
4. Inventories
MARCH 31, DECEMBER 31,
(Dollars in millions) 2006 2005
--------- ------------
Raw material $123.2 $128.5
Work in progress 84.5 73.3
Finished goods 132.4 136.7
Supplies 8.3 8.3
------ ------
Total inventories $348.4 $346.8
====== ======
Page 9
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
5. Business Segments
The Company has three 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, and
Engine & Power Train Products. Previously, the Company also reported a Pump
Products business segment; however, as a result of the decision, during the
first quarter of 2006, to sell 100% of its ownership in Little Giant Pump
Company, such operations are no longer reported in loss from continuing
operations before tax. Little Giant operations represented approximately
90% of that previously reported segment. Since the Company's remaining pump
business does not meet the definition of a reporting segment as defined by
SFAS No. 131, "Segment Reporting," the Company will no longer report a Pump
Products segment, and operating results of the remaining pump business are
included in Other for segment reporting purposes. Revenues and operating
income by segment for the periods indicated are as follows:
THREE MONTHS ENDED
MARCH 31,
BUSINESS SEGMENT DATA ------------------
(Dollars in millions) 2006 2005
------- -------
Net sales:
Compressor Products $ 251.5 $ 241.0
Electrical Component Products 109.1 100.2
Engine & Power Train Products 80.9 94.9
Other (a) 4.6 4.1
------- -------
Total Net Sales $ 446.1 $ 440.2
======= =======
Operating income (loss):
Compressor Products $ 6.6 $ 8.6
Electrical Component Products 4.9 (1.1)
Engine & Power Train Products (18.5) (20.9)
Other (a) 0.3 (0.2)
Corporate expenses (4.0) (2.3)
Impairments, restructuring charges, and other items (0.6) (0.1)
------- -------
Total operating loss from continuing operations (11.3) (16.0)
Interest expense (8.4) (6.3)
Interest income and other, net 5.0 3.3
------- -------
Loss from continuing operations before taxes ($14.7) ($19.0)
======= =======
(a) "Other" consists of non-reportable business segments.
The Electrical Component Products segment had inter-segment sales of $11.9
million and $16.7 million in the first quarter of 2006 and 2005, respectively.
Page 10
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
6. Goodwill and Other Intangible Assets
At March 31, 2006, goodwill by segment consisted of the following:
ELECTRICAL
COMPRESSOR COMPONENTS PUMPS TOTAL
---------- ---------- ----- ------
Balance at 1/1/2006 $16.9 $108.9 $ 5.1 $130.9
Reclassified to held for sale (5.1) (5.1)
Foreign Currency Translation 0.3 0.3
----- ------ ----- ------
Balance at 3/31/2006 $17.2 $108.9 $ 0.0 $126.1
===== ====== ===== ======
At March 31, 2005, goodwill by segment consisted of the following:
ELECTRICAL ENGINE & POWER
COMPRESSOR COMPONENTS TRAIN OTHER TOTAL
---------- ---------- -------------- ----- ------
Balance at 1/1/2005 $18.6 $216.9 $ 2.9 $5.1 $243.5
Foreign Currency Translation (0.6) -- (0.1) -- (0.7)
----- ------ ----- ---- ------
Balance at 3/31/2005 $18.0 $216.9 $ 2.8 $5.1 $242.8
===== ====== ===== ==== ======
As discussed in the Significant Accounting Policies and Critical Accounting
Estimates sections of the Form 10-K for the year ended December 31, 2005,
the Company traditionally conducts its annual assessment of impairment in
the fourth quarter by comparing the carrying value of the Company's
reporting units to their fair value. Fair value of the Company's goodwill
and other intangible assets is estimated based upon a present value
technique using discounted future cash flows, forecasted out over a six
year period, with residual growth rates forecasted at 3.0% thereafter. The
Company uses management business plans and projections as the basis for
expected future cash flows. In evaluating such business plans for
reasonableness in the context of their use for predicting discounted cash
flows in its valuation model, the Company evaluates whether there is a
reasonable basis for differences between actual results of the preceding
year and projected results for the upcoming years. This methodology can
potentially yield significant improvements in growth rates in the first few
years of forecast data, due to multiple factors such as improved
efficiencies or incremental sales volume opportunities that are deemed to
be reasonably likely to be achieved.
Assumptions in estimating future cash flows are subject to a high degree of
judgment and complexity. The Company makes every effort to forecast these
future cash flows as accurately as possible with the information available
at the time the forecast is developed. However, changes in the assumptions
and estimates may affect the carrying value of goodwill, and could result
in additional impairment charges in future periods. Factors that have the
potential to create variances between forecasted cash flows and actual
results include but are not limited to (i) fluctuations in sales volumes,
which can be driven by multiple external factors, including weather
conditions affecting demand; (ii) product costs, particularly commodities
such as copper; (iii) currency exchange fluctuations; (iv) acceptance of
the Company's pricing actions undertaken in response to rapidly changing
commodity prices and other product costs; and (v) interest rate
Page 11
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
fluctuations. Refer to "Cautionary Statements Relating to Forward-Looking
Statements" in Item 2 for other factors that have the potential to impact
estimates of future cash flows.
Discount rates utilized in the goodwill valuation analysis are derived from
published resources such as Ibbotson. The rates utilized were 9.25% at
December 31, 2005 for all business units for which goodwill is currently
recorded.
Operating profit (loss) as a percentage of sales revenue is also a key
assumption in the fair value calculation. The range of assumptions used
incorporates the anticipated results of the Company's ongoing productivity
improvements over the life of the forecast model.
Other intangible assets consisted of the following:
GROSS
CARRYING ACCUMULATED
AMOUNT AMORTIZATION NET AMORTIZABLE LIFE
-------- ------------ ----- ----------------
Intangible assets subject to amortization:
Customer relationships and contracts $39.3 $ 8.6 $30.7 6-15 years
Technology 12.0 3.6 8.4 5-10 years
----- ----- -----
Total 51.3 12.2 39.1
Intangible assets not subject to amortization:
Trade name 16.9 -- 16.9
----- ----- -----
Total intangible assets $68.2 $12.2 $56.0
===== ===== =====
The estimated amortization expense over the next five years is $4.2 million
for 2006 through 2008 and approximately $3.9 million annually for 2009
through 2010. Amortization expense for the three months ended March 31 was
$0.9 million and $1.3 million for 2006 and 2005, respectively.
As a result of the acquisition of In Motion Technologies Pty. Ltd. (IMT),
the Company recorded an additional technology intangible asset of $2.0
million during the quarter.
Page 12
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
7. 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
MARCH 31, MARCH 31,
------------------ ------------------
2006 2005 2006 2005
------ ------ ----- -----
Service Cost $ 2.4 $ 2.1 $ 0.8 $ 1.1
Interest Cost 5.3 5.1 2.4 2.6
Expected return on plan assets (11.1) (10.0) -- --
Amortization of prior service costs 0.1 0.1 (1.2) (0.3)
Amortization of net gain -- (0.6) -- (0.7)
------ ------ ----- -----
Net periodic benefit (income) cost ($3.3) ($3.3) $ 2.0 $ 2.7
====== ====== ===== =====
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.
The Company does not expect to contribute to its pension plans in 2006.
8. Guarantees and Warranties
A portion of accounts receivable at the Company's Brazilian subsidiary are
sold with recourse. Brazilian receivables sold at March 31, 2006 and
December 31, 2005 were $35.2 million and $32.1 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 13
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:
Three Months Ended Three Months Ended
(Dollars in millions) March 31, 2006 March 31, 2005
------------------ ------------------
Balance at January 1, 2006 $29.4 $38.1
Accruals for warranties 4.3 2.6
Settlements made (in cash or in kind) (4.4) (5.5)
Effect of foreign currency translation 0.2 (0.3)
Reclassification to held for sale (2.7) --
----- -----
Balance at March 31, 2006 $26.8 $34.9
===== =====
As of March 31, 2006, $21.3 million was included in accrued liabilities and
$5.5 million was included in product warranty and self-insured risks.
9. Debt
During the first quarter of 2005, the Senior Guaranteed Notes and Revolving
Credit Facility outstanding at December 31, 2005 were replaced by a new
financing package that included a $275 million First Lien Credit Agreement
and a $100 million Second Lien Credit Agreement. The agreements provide for
security interests in substantially all of the Company's assets and
specific financial covenants related to EBITDA, capital expenditures, and
fixed charge coverage. Additionally, under the terms of the agreements, no
dividends can be paid prior to December 31, 2006 and minimum amounts of
credit availability are required before dividends can be paid thereafter.
The new arrangements bore a weighted average annual interest rate of 9.0%
based upon outstanding balances at closing versus the rate of 6.6%
applicable to the $250 million Senior Guaranteed Notes.
At March 31, 2006, the Company had outstanding letters of credit of $4.8
million. At March 31, 2006, the Company had total availability of $32.8
million under its $275 million First Lien Credit Agreement.
As more fully described in Note 15, subsequent to March 31, 2006, the
Company sold Little Giant Pump Company and proceeds from the sale were used
to repay portions of the new debt arrangements. Approximately, 63% of the
proceeds were applied against the First Lien borrowing and 37% against the
Second Lien borrowing. After giving effect to the repayments, the weighted
average annual interest rate of these borrowings was 8.8%.
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. 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 May
Page 14
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
2003, the Company concluded a Consent Decree with the EPA concerning the
performance of remedial design and remedial action for Phase I, deferring
for an unspecified period any action regarding Phase II.
In March 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 has 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.
As the Liability Transfer Agreement was executed prior to the signing of
the original Consent Decree for the Phase I work, the original Consent
Decree was amended in the fourth quarter of 2005 to include PRS as a
signing party. This assigns PRS full responsibility for complying with the
terms of the Consent Decree and allows the EPA to enforce the Consent
Decree directly with PRS. Prior to the execution of this amendment, U.S.
GAAP required that the Company continue to record 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. With the
subsequent amendment, the Company has removed the asset and $39.2 million
of the liability from 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.
With respect to other environmental matters, the Company has been
voluntarily participating in a cooperative effort to investigate and
cleanup PCB contamination in the watershed of the south branch of the
Manitowoc River, at and downstream from the Company's New Holstein,
Wisconsin facility. On December 29, 2004, 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")
relating to this effort known as the Hayton Area Remediation Project
("HARP"). The Consent Order provides a framework for the completion of the
remediation and regulatory closure at HARP.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
Concurrently, on December 29, 2004, 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. TRC's
obligations under the Agreement include any ongoing monitoring or
maintenance requirements and certain off-site mitigation or remediation, if
required. TRC will also manage any third-party remediation claims that
might arise or otherwise be filed against the Company.
As required by the Agreement, the Company also purchased a Pollution Legal
Liability Select Cleanup Cost Cap Policy (the "Policy") from American
International Specialty Lines Company. The term of the Policy is 20 years
with an aggregate combined policy limit of $41 million. The policy lists
the Company and TRC as named insureds and includes a number of first and
third party coverages for remediation costs and bodily injury and property
damage claims associated with the HARP remediation and contamination. 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. The total cost of the exit strategy insured
remediation arrangement to Tecumseh was $16.4 million. This amount included
$350,000 that was paid to the WDNR pursuant to the Consent Order to settle
any alleged liabilities associated with natural resource damages. The
charge represented the cost of the agreements less what was previously
provided for cleanup costs to which the Company had voluntarily agreed.
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 March 31, 2006, 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.
In addition to the above-mentioned sites, 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 March 31, 2006 and December
31, 2005, the Company had accrued $3.4 million and $3.5 million,
respectively, for environmental remediation. 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 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.
Page 16
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
11. Income Taxes
The first quarter 2006 consolidated statement of operations reflects a $2.6
million income tax benefit, which was recorded pursuant to SFAS No. 109,
"Accounting for Income Taxes." SFAS 109 specifies the allocation method of
income taxes between categories of income defined by that statement as
those that are included in net income (continuing operations and
discontinued operations) and those included in comprehensive income but
excluded from net income.
SFAS 109 is applied by tax jurisdiction, and in periods in which there is a
pre-tax loss from continuing operations and pre-tax income in another
category (such as other comprehensive income), tax expense is first
allocated to other comprehensive income with a related benefit recorded in
continuing operations. The first quarter of 2006 reflects tax benefit in
the statement of operations and tax expense in other comprehensive income.
At March 31, 2006 and December 31, 2005, full valuation allowances are
recorded for net operating loss carryovers for those tax jurisdictions in
which the Company is in a cumulative year loss position.
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 incurred during fiscal years beginning after
June 15, 2005. The Company's adoption of this pronouncement during the
first quarter of 2006 did not have a material effect.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
14. Discontinued Operations
During the first quarter of 2006, the Company approved a plan to proceed
with a transaction to sell 100% of its ownership interest in its Little
Giant Pump Company subsidiary. The net assets of the subsidiary are
classified as held for sale at March 31, 2006 and December 31, 2005, and
its results for the quarters ended March 31, 2006 and 2005 are included in
income (loss) from discontinued operations. Interest expense of $2.3
million and $1.4 million was allocated to discontinued operations for all
the periods presented because the Company's new financing package required
that the proceeds from the sale be utilized to repay portions of the
Company's debt. The Company's remaining pump business does not meet the
definition of an operating segment as defined by SFAS No. 131, "Segment
Reporting." Accordingly, its operating results are included in Other within
the Results by Segment table.
Following is a summary of assets and liabilities of Little Giant Pump
Company at March 31, 2006 and December 31, 2005, which are reflected in the
consolidated balance sheets as held for sale:
March 31, December 31,
(Dollars in millions) 2006 2005
--------- -----------------
Accounts receivable, net $17.2 $13.5
Inventories 30.8 25.7
Other current assets 0.3 0.3
Property, plant and equipment, net 9.6 10.1
Goodwill 5.1 5.1
----- -----
Assets held for sale $63.0 $54.7
===== =====
Accounts payable, trade $ 9.6 $ 7.2
Accrued liabilities 5.4 5.5
----- -----
Liabilities held for sale $15.0 $12.7
===== =====
Following is a summary of income (loss) from discontinued operations for
the quarters ended March 31, 2006 and 2005:
March 31, March 31,
(Dollars in millions) 2006 2005
--------- ---------
Net sales $26.8 $24.2
Costs of sales and operating expenses 19.2 17.9
Selling and administrative expenses 5.6 4.7
----- -----
Operating income 2.0 1.6
Interest expense allocated 2.3 1.4
----- -----
Income (Loss) from discontinued
operations before income taxes (0.3) 0.2
Tax provision 0.2 0.1
----- -----
Income (Loss) from discontinued
operations, net of tax ($0.5) $ 0.1
===== =====
Page 18
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
15. Subsequent Event
During the first quarter of 2006, the Company entered into an agreement to
sell its Little Giant Pump Company subsidiary to Franklin Electric Company,
Inc. for approximately $121 million, subject to post-closing adjustments.
The subsidiary is classified as held for sale at March 31, 2006, and its
results for the periods ended March 31, 2006 and 2005 are included in
income (loss) from discontinued operations. On April 21, 2006, the Company
completed the sale. As required by the Company's new financing package, the
proceeds from the sale were used to repay portions of the Company's debt.
Page 19
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Restatement of Previously Issued Financial Statements
The Company has restated the quarterly financial statements for matters,
principally regarding the interim period tax provisions, discussed in Footnote 2
to the consolidated financial statements included in Item 1 of Part 1 of this
Form 10-Q/A. Generally accepted accounting principles require interim period
income taxes to be recorded based on an estimated annual effective rate. The
Company in error combined the income from foreign jurisdictions with losses from
foreign jurisdictions for which tax benefits are not expected to be realizable.
Accordingly, the Company has restated its Consolidated Financial Statements as
of and for the three months ended March 31, 2006 and 2005.
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. Our net sales have grown by approximately $400 million
from the year ended December 31, 2001 to the year ended December 31, 2005. 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, our Compressor Group will
introduce a scroll-style compressor to serve commercial refrigeration and air
conditioning markets throughout the globe, and it will begin producing a new
expanded range rotary compressor in India for global applications, while our
Electrical Components Group has expanded its range of Brushless DC ("BLDC")
variable speed motor products. 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 50% of total
consolidated net sales in 2005. 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.
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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
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 2005, and our Curitiba,
Brazil facility is the key future manufacturing site to supply worldwide demand
for lawn and garden engines.
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 and the first three months of 2006. 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, 2005 and into 2006.
Due to 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 have had a material adverse impact on
our operating results during these periods. 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 had a positive impact
on our reported cash flows when comparing the first quarter of 2006 to 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 "Cautionary Statements Relating To Forward-Looking
Statements" below.
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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 MARCH 31,
(dollars in millions) 2006 % 2005 %
------- ----- ------- -----
Net sales $ 446.1 100.0% $ 440.2 100.0%
Cost of sales and operating expenses 411.6 92.3% 412.7 93.8%
Selling and administrative expenses 45.2 10.1% 43.4 9.9%
Impairments, restructuring charges,
and other items 0.6 0.1% 0.1 0.0%
------- -------
Operating loss (11.3) (2.5%) (16.0) (3.6%)
Interest expense (8.4) 1.9% (6.3) 1.4%
Interest income and other, net 5.0 1.1% 3.3 0.7%
------- -------
Loss from continuing operations
before taxes (14.7) (3.3%) (19.0) (4.3%)
Tax benefit (2.6) (0.6%) (2.9) (0.6%)
------- -------
Loss from continuing operations ($12.1) (2.7%) ($16.1) (3.7%)
======= =======
Three Months Ended March 31, 2006 vs. Three Months Ended March 31, 2005
Consolidated net sales from continuing operations in the first quarter of 2006
increased to $446.1 million from $440.2 million in 2005. Excluding the increase
in sales due to the effects of currency fluctuation of $9.1 million, 2006 first
quarter sales declined by $3.2 million. While sales improved in the Compressor
and Electrical Components segments, declines in sales in the Engine & Power
Train segment more than offset the increases.
Cost of sales and operating expenses was $411.6 million in the three months
ended March 31, 2006, as compared to $412.7 million in the three months ended
March 31, 2005. As a percentage of net sales, cost of sales and operating
expenses were 92.3% and 93.8% in the first quarters of 2006 and 2005,
respectively. The improvement was primarily due to improved operational
efficiencies and lower fixed costs associated with plant closures. Also included
in cost of sales and operating expenses was the $3.5 million gain from the sale
of the Douglas, Georgia engine facility.
Selling, general and administrative expenses were $45.2 million in the three
months ended March 31, 2006, as compared to $43.4 million in the three months
ended March 31, 2005. As a percentage of net sales, selling, general and
administrative expenses were 10.1% and 9.9% in the first quarters of 2006 and
2005, respectively. The increase was primarily related to AlixPartners' fees of
$9.0 million offset by improved variable selling costs and global headcount
reductions.
Interest expense amounted to $8.4 million in the first quarter of 2006 compared
to $6.3 million in the first quarter of 2005. The increase was primarily related
to the higher average interest rates associated with the Company's current
borrowing arrangements.
Page 22
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Interest income and other, net was $5.0 million in the first quarter of 2006
compared to $3.3 million in the first quarter of 2005. The impact of lower
interest income due to lower cash balances was more than offset by a gain of
$3.6 million on the sale of the Company's interest in Kulthorn Kirby Public
Company Limited, a manufacturer of compressors based in Thailand. The sale of
the stock was completed in conjunction with the end of a licensing agreement
between the Company's Compressor operations and Kulthorn Kirby.
The first quarter 2006 consolidated statement of operations reflects a $2.6
million income tax benefit, which was recorded pursuant to SFAS No. 109,
"Accounting for Income Taxes." SFAS 109 specifies the allocation method of
income taxes between categories of income defined by that statement as those
that are included in net income (continuing operations and discontinued
operations) and those included in comprehensive income but excluded from net
income.
SFAS 109 is applied by tax jurisdiction, and in periods in which there is a
pre-tax loss from continuing operations and pre-tax income in another category
(such as other comprehensive income), tax expense is first allocated to other
comprehensive income with a related benefit recorded in continuing operations.
The first quarter of 2006 reflects tax benefit in the statement of operations
and tax expense in other comprehensive income. At March 31, 2006 and December
31, 2005, full valuation allowances are recorded for net operating loss
carryovers for those tax jurisdictions in which the Company is in a cumulative
year loss position.
Net loss from continuing operations in the first quarter of 2006 was $12.1
million, or $0.65 per share, as compared to net loss of $16.1 million, or $0.88
per share, in the first quarter of 2005. The improvement was primarily the
result of the factors described above.
Reportable Operating Segments
The financial information presented below is for our three reportable operating
segments for the periods presented: Compressor, Electrical Components, and
Engine & Power Train. Financial measures regarding each segment's income (loss)
before interest, other expense, income taxes, and impairments, restructuring
charges, and other items ("operating income") and income (loss) before interest,
other expense and income taxes and impairments, restructuring charges, and other
items 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 (loss) before interest, other
expense, income taxes, and impairments, restructuring charges, and other items.
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 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 (loss) before interest,
other expense and income taxes, impairments, restructuring charges, and other
items to income before provision for income taxes, see Note 5, Business
Segments.
Page 23
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Compressor Products
First quarter 2006 sales in the Compressor business increased 4.4% to $251.5
million from $241.0 million in the prior year. The increase for the period was
mostly attributable to effects of foreign currency translation that increased
current quarter sales by $9.2 million. Overall, unit sales volumes were
relatively consistent with the prior year with some change in product mix.
Compressor business operating income and related margin for the first quarter of
2006 were $6.6 million and 2.6%, respectively, compared to $8.6 million and 3.6%
in the first quarter of 2005. The operating income decrease was attributable to
an unfavorable product mix and higher material and other input costs offset by
productivity improvements. The Brazilian Real that was on average 16% stronger
against the U.S. Dollar in the first quarter of 2006 versus 2005, but hedging
activities mitigated the financial impact.
Electrical Component Products
Electrical Components business sales were $109.1 million for the first quarter
of 2006, an increase of 8.9% over sales of $100.2 million in the same quarter
last year. Volume increases in residential and commercial motor markets of
approximately 16%, where HVAC markets were particularly robust, more than
compensated for a decrease of approximately 11% in the automotive motor market,
as a result of lower build schedules and share losses by the Company's customers
at their respective OEM customers.
Electrical Components operating income and related margin for the first quarter
of 2006 were $4.9 million and 4.5%, respectively, compared to a loss of $1.1
million and (1.1%) in the first quarter of 2005. The improvement was primarily
due to higher sales volumes, improved operational efficiencies, and pricing
actions taken during 2005.
Engine & Power Train Products
Engine & Power Train business sales were $80.9 million in the first quarter of
2006 compared to $94.9 million for the same period a year ago, a decrease of
14.8%. The decline in sales for the first quarter was due to the loss of sales
into the European market from the Company's former Italian subsidiary. As
previously disclosed on December 28, 2005, the Company closed its engine
manufacturing operations of its wholly owned subsidiary, Tecumseh Europa S.p.A.,
located in Turin, Italy. The shutdown was accomplished through an Italian form
of court-supervised liquidation. The effects of the liquidation were reflected
in the Company's 2005 results. The Italian subsidiary was the primary, but not
sole, source of engines for sales in the European market. This decline in unit
volumes sold into Europe was partially offset by an increase in volumes sold
into the United States that were primarily attributable to the placement of the
Company's engines on additional product sku's at existing customers. North
American engine unit deliveries were approximately 11% greater than the prior
year's first quarter.
Engine & Power Train business operating loss and related margin for the first
quarter of 2006 were $18.5 million and (22.9%), respectively, compared to a loss
of $20.9 million and (22.0%) during the same period a year ago. Included in the
2006 loss were AlixPartners' fees of $9.0 million and a $3.5 million gain from
the sale of the Douglas, Georgia engine facility. Exclusive of these two items,
Page 24
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
operating results improved by approximately 38%. The improvement reflected lower
fixed costs associated with plant closures, higher productivity levels in
Brazil, the non-recurrence of costs associated with a transmission recall, and
higher U.S. volumes, partially offset by higher commodity and transportation
costs and a less favorable value of the Brazilian Real.
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 March 31, 2006 and December 31, 2005, we had accrued $3.4 million and $3.5
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. 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. We believe the
participation by AlixPartners will allow the Company to effect 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. During the first quarter of 2006, the Company recognized fees of $9.0
million related to the AlixPartners engagement.
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
For the first quarter 2006, cash used by operations amounted to $44.5 million,
reflecting both an operating loss and net investments in working capital items.
This represented an improvement of $22.9
Page 25
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
million compared to the first quarter 2005, primarily as a result of better
management of working capital over the respective quarters as sales were more in
line with expectations.
Cash used in investing activities was $13.0 million in the first quarter 2006
versus $28.7 million for the same period of 2005. Of the overall decrease, $8.7
million was related to lower capital expenditures due to significant new product
expansions in India and Brazil in the prior years, and $9.0 million related to
proceeds received from the sale of assets during 2006. Included in such sales
were the sale of the Company's 7% interest in Kulthorn Kirby Public Company
Limited stock for $4.7 million and the sale of the Company's former Douglas,
Georgia manufacturing facility for $3.5 million. In addition, during the first
quarter, the Company acquired a small Australian-based company, which owned
patents related to the manufacturing of certain types of electric motors, which
are applicable to both our Electrical Components and Compressor segments. The
entire purchase price was allocated to intangible assets.
Cash flows from financing activities provided cash of $24.0 million in the first
quarter of 2006 as compared to using $47.4 million in the quarter of 2005.
During 2005, we used existing cash balances to prepay $50 million of our then
Senior Guaranteed Notes in order to remain within our debt covenants at March
31, 2005. During the first quarter 2006, the remaining balance of these Senior
Guaranteed Notes, our Revolving Credit Facility and our outstanding Industrial
Revenue Bonds were replaced by a new financing package that included a $275
million First Lien Credit Agreement and a $100 million Second Lien Credit
Agreement.
Capitalization
In addition to cash provided by operating activities, we use a combination of
our revolving credit arrangement under our First Lien Credit Agreement,
long-term debt under our Second Lien Credit Agreement, and foreign bank debt to
fund our capital expenditures and working capital requirements. For the three
months ended March 31, 2006 and March 31, 2005, our average outstanding debt
balance was $372.5 million and $363.6 million, respectively. The weighted
average long-term interest rate, including the effect of hedging activities, was
7.4% and 4.6% 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 our new borrowing arrangements
of 8.8% as compared to the original interest rate of 4.6% under our Senior
Guaranteed Notes.
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 $35.2 million and $32.1 million as of March 31, 2006 and
December 31, 2005, respectively. We cannot provide any assurances that these
facilities will be available or utilized in the future.
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
Adequacy of Liquidity Sources
Historically, cash flows from operations and borrowing capacity under previous
credit facilities were sufficient to meet our long-term debt maturities,
projected capital expenditures and anticipated working capital requirements;
however, the negative results experienced during 2005 deteriorated to the point
where we were not able to remain in compliance with the covenants of the Senior
Guaranteed Notes and the Revolving Credit Facility as amended as of August 5,
2005. Accordingly, on February 6, 2006, we replaced the Senior Guaranteed Notes,
Revolving Credit Agreement and Industrial Revenue Bonds with a new financing
package that included a $275 million first Lien Credit Agreement and a $100
million Second Lien Credit Agreement. The agreements provide for security
interests in substantially all of the Company's assets and specific financial
covenants related to EBITDA, capital expenditures, and fixed charge coverage.
Additionally, under the terms of the agreements, no dividends can be paid prior
to December 31, 2006 and minimum amounts of credit availability are required
before dividends can be paid thereafter.
In addition, subsequent to March 31, 2006, proceeds from the sale of Little
Giant Pump Company were used to repay portions of the new debt arrangements.
Approximately, 63% of the proceeds was applied against the First Lien borrowing
and 37% against the Second Lien borrowing. After giving effect to the
repayments, the weighted average annual interest rate of these borrowings was
8.8%.
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 the amount of availability of funds provided by the computation
of borrowing base. Based upon proceeds provided by the sale of Little Giant and
the total availability of funds, we believe the Company has sufficient liquidity
to complete its turnaround plans; however, should operating performance fall
short of plan, the Company may not remain in compliance with the covenants under
the agreements, or have sufficient availability of funds. In this scenario, the
Company would need to obtain amendments to the borrowing arrangements.
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, 2005.
Although not mentioned at December 31, 2005, we regard the recoverability of our
deferred tax assets as a critical accounting estimate. We are required to
estimate whether recoverability of our deferred tax assets is more likely than
not based on forecasts of taxable earnings in the related tax jurisdiction. We
use historical and projected future operating results, based upon approved
business plans, including a review of the eligible carry-forward period, tax
planning opportunities and other relevant
Page 27
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
considerations. Examples of evidence that we consider when making judgments
about the deferred tax valuation includes tax law changes, a history of
cumulative losses, and variances in future projected profitability. Full
valuation allowances will be maintained against deferred tax assets in the U.S.
and other foreign countries until sufficient positive evidence exists to reduce
or eliminate them. Valuation allowances may be established against remaining
foreign deferred tax assets in Brazil (aggregating approximately $5.1 million)
if negative evidence (such as a continuation of losses recognized during 2006)
results in a determination that it is no longer more likely than not that the
assets will be realized.
As discussed in the Significant Accounting Policies and Critical Accounting
Estimates sections of the Form 10-K for the year ended December 31, 2005, the
Company traditionally conducts its annual assessment of impairment for goodwill
in the fourth quarter by comparing the carrying value of the Company's reporting
units to their fair value. Fair value of the Company's goodwill and other
intangible assets is estimated based upon a present value technique using
discounted future cash flows, forecasted out over a six year period, with
residual growth rates forecasted at 3.0% thereafter. The Company uses management
business plans and projections as the basis for expected future cash flows. In
evaluating such business plans for reasonableness in the context of their use
for predicting discounted cash flows in its valuation model, the Company
evaluates whether there is a reasonable basis for differences between actual
results of the preceding year and projected results for the upcoming years. This
methodology can potentially yield significant improvements in growth rates in
the first few years of forecast data, due to multiple factors such as improved
efficiencies or incremental sales volume opportunities that are deemed to be
reasonably likely to be achieved. In the India reporting unit of the Compressor
Group, the goodwill analysis performed at the end of 2005 projected growth rates
of approximately 35.0% and 29.0% in 2007 and 2008 respectively, before
moderating to a 3.0% residual growth rate. For the reporting unit within the
Electrical Components Group, the rates were approximately 10.0% and 9.0% in 2007
and 2008, thereafter adjusting to 3.0%, and the Europe reporting unit of the
Compressor Group projected growth rates of approximately 5.0% in 2007 and 2008,
adjusted to 3.0% thereafter.
Assumptions in estimating future cash flows are subject to a high degree of
judgment and complexity. The Company makes every effort to forecast these future
cash flows as accurately as possible with the information available at the time
the forecast is developed. However, changes in the assumptions and estimates may
affect the carrying value of goodwill, and could result in additional impairment
charges in future periods. Factors that have the potential to create variances
between forecasted cash flows and actual results include but are not limited to
(i) fluctuations in sales volumes, which can be driven by multiple external
factors, including weather conditions affecting demand; (ii) product costs,
particularly commodities such as copper; (iii) currency exchange fluctuations;
(iv) acceptance of the Company's pricing actions undertaken in response to
rapidly changing commodity prices and other product costs; and (v) interest rate
fluctuations. Refer to "Cautionary Statements Relating to Forward-Looking
Statements" in Item 2 for other factors that have the potential to impact
estimates of future cash flows.
Discount rates utilized in the goodwill valuation analysis are derived from
published resources such as Ibbotson. The rates utilized were 9.25% at December
31, 2005 for all business units for which goodwill is currently recorded.
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
Operating profit (loss) as a percentage of sales revenue is also a key
assumption in the fair value calculation. The range of assumptions used
incorporates the anticipated results of the Company's ongoing productivity
improvements over the life of the forecast model. The Europe reporting unit
forecasted operating profit percentages ranging from 1.3% up to 3.9%. The India
reporting unit forecasted a range of 0.8% to 6.2%, and the reporting unit
within the Electrical Components Group with goodwill forecasted a range of 5.3%
to 7.9%.
Based on the goodwill analysis performed for the year ended December 31, 2005,
changes of 1.0% in the discount rate utilized would increase (decrease) the fair
value calculated for the respective business units as follows:
Change in Change in
valuation valuation
with 1.0% with 1.0%
decrease in increase in
discount rate discount rate
------------- -------------
Compressor Segment - Europe $14.8 ($10.6)
Compressor Segment - India 24.1 (17.3)
Electrical Components Segment 71.8 (52.2)
For the Europe business unit within the Compressor segment, if the discount rate
were to increase by 1.0%, the fair value of the business unit would decrease by
approximately $11 million. Such an increase in the discount rate would result in
the need for management to perform a step 2 analysis on this business unit and
could result in an impairment.
Other than the addition of the disclosure of the policies regarding income taxes
and goodwill noted above, there have been no significant changes to our
significant accounting policies or critical accounting estimates during the
first six months of 2006.
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. The Company's adoption of this pronouncement during the first
quarter of 2006 did not have a material effect.
OUTLOOK
Information in this "Outlook" section should be read in conjunction with the
cautionary language and discussion of risks included below.
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
The outlook for the remainder of 2006 is subject to the same variables that
negatively impacted the Company throughout 2005. Commodity costs, key currency
rates, weather and the overall growth rates of the respective economies around
the world are all important to future performance. Overall, the Company does not
expect these factors to become any more favorable during the year. In fact,
certain key commodities, including copper, aluminum, and steel have risen
precipitously in recent months. From January 1, 2006 through April 28, 2006, the
prices of copper and aluminum have increased approximately 60% and 21%,
respectively.
The Company expects 2006 results to reflect only those actions it has been
taking to reduce costs and, potentially, the benefits of new product
introductions, to the extent they are accepted in the market, and has not
assumed any improvements from currencies or commodity costs. Given the recent
escalation in commodity costs, realization of net improvement in total results,
which is largely expected in the latter half of the year, will greatly depend on
the Company's ability to pass on to its customers the cost of these sizeable
commodity price increases, which are hedged to a lesser extent in the later
months of the year.
With respect to each of the Company's segments, results in the Compressor Group
are expected to lag the results of 2005 throughout the year. The Electrical
Components Group, which has demonstrated monthly year over year improvement
since August of 2005, is expected to continue its improvement through 2006. The
Engine and Power Train business has taken several major steps to eliminate
overcapacity and costs that will benefit 2006, with the most significant
improvements expected in the fourth quarter of the year.
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 2006
that could have an effect on the consolidated financial position and future
results of operations of the Company. In addition, the Company continues to
evaluate potential acquisitions, joint ventures and dispositions that could
improve the overall competitiveness and financial position of the Company and
enhance its product offerings. Such transactions could also have an effect on
future results of operations.
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
Page 30
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 to update or revise the forward-looking statements, whether as a
result of new information, future events or otherwise.
Page 31
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
first quarter of 2006.
The Company is subject to foreign currency exchange exposure for operations
whose assets and liabilities are denominated in currencies other than U.S.
Dollars. On a normal basis, the Company does not attempt to hedge the foreign
currency translation fluctuations in the net investments in its foreign
subsidiaries. The Company does, from time to time, enter into short-term forward
exchange contracts to sell or purchase foreign currencies at specified rates
based on estimated foreign currency cash flows. Company policy allows local
management to hedge known receivables or payables and forecasted cash flows up
to a year in advance. It is the policy of the Company not to purchase financial
and/or derivative instruments for speculative purposes. At March 31, 2006 and
December 31, 2005, the Company held foreign currency forward contracts with a
total notional value of $127.5 million and $173.0 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. Company policy
allows local management to contract commodity forwards for a limited percentage
of projected raw material requirements up to one year in advance. Commodity
contracts at most of the Company's divisions and subsidiaries are essentially
purchase contracts designed to fix the price of the commodities during the
operating cycle. The Company's practice has been to accept delivery of the
commodities and consume them in manufacturing activities. At March 31, 2006 and
December 31, 2005, the Company held a total notional value of $33.8 million and
$61.8 million, respectively, in commodity forward purchasing contracts. The
majority of these contracts were not recorded on the balance sheet as they did
not require an initial cash outlay and do not represent a liability until
delivery of the commodities is accepted; however, commodity contracts at the
Company's French compressor subsidiary are essentially derivative financial
instruments designed to hedge the fluctuation in commodity pricing and, as such,
are subject to the provisions of SFAS No. 133, as amended by SFAS 149.
The Company is subject to interest rate risk, primarily associated with its
borrowings of $403 million at March 2006. The Company's $275 million First Lien
Credit Agreement and $100 million Second Lien Credit agreement are variable-rate
debt. The Company has entered into variable to fixed interest rate swaps with
notional amounts totaling $100 million. The Company's remaining borrowings
consists of variable-rate borrowings by its foreign subsidiaries. This resulted
in 25% of the Company's total debt at March 31, 2006 being fixed-rate. While
changes in interest rates impact the fair value of the fixed rate debt, there is
no impact to earnings and cash flow because the Company intends to hold these
obligations to maturity unless refinancing conditions are favorable.
Alternatively, while changes in
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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
$3.0 million.
Page 33
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 4
CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in the 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 because of the material weaknesses discussed below, which still
exist as of March 31, 2006, the Company's disclosure controls and procedures
were not effective as of March 31, 2006. Notwithstanding the material
weaknesses, 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 amended annual report as of December 31, 2005:
1) The Company did not maintain effective controls 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. These
control deficiencies, when aggregated, could result in misstatements of the
aforementioned financial statement accounts that would result in a material
misstatement of the Company's consolidated financial statements that would not
be prevented or detected. Accordingly, management has determined that this
control deficiency represents a material weakness.
2) The Company did not maintain effective controls over the completeness and
accuracy of interim income taxes. Specifically, the Company did not maintain
effective controls to ensure the completeness and accuracy of (i) state income
tax expense associated with a division accounted for as a discontinued operation
in 2006, (ii) the effective tax rates applied to foreign operations, and (iii)
the allocation of federal income tax expense between continuing and discontinued
operations. This control deficiency resulted in the restatement of the Company's
2005 quarterly consolidated financial statements, the consolidated financial
statements for the first and second quarters of 2006 and adjustments to the
consolidated financial statements for the third quarter of 2006, affecting
accrued liabilities, tax expense (benefit), and income from discontinued
operations, net of tax. Additionally, this control deficiency could result in a
misstatement of the aforementioned accounts that would result in a material
misstatement of the Company's interim and annual consolidated financial
statements that
Page 34
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 4
CONTROLS AND PROCEDURES
would not be prevented or detected. Accordingly, management has determined that
this control deficiency represents a material weakness.
These material weaknesses continued to exist at March 31, 2006.
Management's Remediation Plans
The Company has implemented additional controls to remediate the material
weakness related to user access rights. 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
monitoring of users having unrestricted access to financial application programs
and data, and provides for improved segregation of duties. On April 1, 2006,
five of nine locations, scheduled for implementation during 2006, went live. All
remaining locations are expected to go live before the end of 2007.
With respect to the completeness and accuracy of the calculation of interim
income taxes, the Company has corrected its methodologies to comply with
generally accepted accounting principles. The company has also instituted
additional review procedures relating to these processes that includes
additional management reviews and review by our outside tax advisors prior to
the finalization of the income tax provision for the period. While management
has enhanced internal control processes around the calculation of interim income
taxes, management has not performed an assessment of these controls and cannot
conclude that the material weakness has been remediated.
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
Page 35
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 4
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 36
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Shareholders of Tecumseh Products Company was held on
April 26, 2006. Proxies for the meeting were solicited pursuant to Section 14(a)
of the Securities Exchange Act of 1934, and there was no solicitation in
opposition to management's solicitation.
(a) All of management's nominees for directors as listed in the proxy statement
were elected with the following votes:
Votes Votes
Director For Withheld
- -------- --------- --------
Peter M. Banks 4,303,096 353,124
Jon E. Barfield 4,088,770 567,450
Todd W. Herrick 4,626,030 30,190
Albert A. Koch 4,085,855 570,365
David M. Risley 4,088,825 567,395
(b) The selection of PricewaterhouseCoopers to serve as the independent auditor
of Tecumseh Products Company was approved.
Votes Votes Votes
For Against Abstain
--------- ------- -------
Ratification of PricewaterhouseCoopers
as independent accountants 4,654,519 497 1,204
ITEM 5. OTHER INFORMATION
On May 5, 2006 (effective as of February 6, 2006) we entered into amendments to
our First Lien Credit Agreement and Second Lien Credit Agreement to clarify that
our Brazilian subsidiaries' practice of selling receivables under programs
administered by the Brazilian Central Bank is permitted under each agreement's
covenant limiting the indebtedness we can incur. For more detailed information,
please see the copies of the amendments filed as exhibits to this report.
ITEM 6. EXHIBITS
(a) Exhibit
Number Description
------- -----------
4.1 Amendment No. 1 to First Lien Credit Agreement dated May 5, 2006
by and among Tecumseh Products Company and certain Lenders and
Issuers listed therein and Citicorp USA, Inc. as Administrative
Agent and Collateral Agent (incorporated by reference to Exhibit
4.1 to Registrant's original Quarterly Report on Form 10-Q for the
quarter ended March 31, 2006, File No. 0-452.)
4.2 Amendment No. 1 to Second Lien Credit Agreement dated May 5, 2006
by and among Tecumseh Products Company and certain Lenders listed
therein and Citicorp USA, Inc. as Administrative Agent and
Collateral Agent (incorporated by reference to Exhibit 4.1 to
Registrant's original Quarterly Report on Form 10-Q for the
quarter ended March 31, 2006, File No. 0-452.)
10.1 Management Incentive Plan as amended and restated on March 29,
2006, effective as of January 1, 2005 in part and as of January 1,
2006 in part (management contract or compensatory plan or
arrangement) (incorporated by
Page 37
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART II. OTHER INFORMATION
reference to Exhibit 10.1 to Registrant's original Quarterly
Report on Form 10-Q for the quarter ended March 31, 2006, File No.
0-452.)
10.2 Executive Deferred Compensation Plan adopted on March 29, 2006,
effective as of January 1, 2005 (management contract or
compensatory plan or arrangement) (incorporated by reference to
Exhibit 10.2 to Registrant's original Quarterly Report on Form
10-Q for the quarter ended March 31, 2006, File No. 0-452.)
10.3 Director Retention Phantom Share Plan as amended and restated on
March 29, 2006, effective as of January 1, 2005 (management
contract or compensatory plan or arrangement) (incorporated by
reference to Exhibit 10.3 to Registrant's original Quarterly
Report on Form 10-Q for the quarter ended March 31, 2006, File No.
0-452.)
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 38
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: December 19, 2006 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 39
EXHIBIT INDEX
Exhibit No. Description of Exhibits
- ----------- -----------------------
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.