April 3, 2007
Mr. Terence O'Brien
Accounting Branch Chief
U.S. Securities and Exchange Commission
100 F Street, N.E., Mail Stop 7010
Washington, D.C. 20549-7010
RE: TECUMSEH PRODUCTS COMPANY
FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005
FILED MARCH 15, 2006
FORM 10-K/A FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005
FORMS 10-Q FOR THE FISCAL QUARTERS ENDED MARCH 31, 2006,
JUNE 30, 2006 AND SEPTEMBER 30, 2006
FORMS 10-Q/A FOR THE FISCAL QUARTERS ENDED MARCH 31, 2006 AND
JUNE 30, 2006
FILE NO. 0-452
Dear Mr. O'Brien:
This letter is in response to your comment letter dated February 2, 2007,
addressed to Mr. James J. Bonsall, President and Chief Operating Officer of
Tecumseh Products Company. Your comments are reproduced below, followed in each
case by Tecumseh's response in italics.
Form 10-Q for the Fiscal Quarter Ended September 30, 2006
11. Income Taxes, page 23
1. Your response to prior comment 8 remains unclear. It appears that in
your amended Form 10-Q's for the quarters ended March 31, 2006 and
June 30, 2006, the tax benefit attributable to your US continuing
operations does not equal the tax expense reflected in discontinued
operations and other comprehensive income for the same periods.
However, we understand that the effective tax rate for your US
operations is 0%. As such, we would have expected that the tax benefit
and the tax expense would net to zero in the first and second quarters
of 2006. We note that in the third quarter of 2006, your accounting
was consistent with our expectations, based on your disclosure on page
32, which states:
Tax expense was recorded in discontinued operations and OCI . . .
and a tax benefit was recorded on the loss in continuing
operations to offset the expense recorded in OCI and discontinued
operations. The net result was an effective rate in the U.S.
federal jurisdiction of 0%.
However, it is unclear why this relationship would not exist in the
first and second quarters of 2006. Please advise, with references to
authoritative literature, as applicable. Please also tell us the
amount of the tax benefit on US continuing operations and the amount
of tax expense on US discontinued operations and US OCI for each
quarter in 2006. In addition, please explain how you determined each
of these amounts.
Mr. Terence O'Brien
U.S. Securities and Exchange Commission
April 3, 2007
Page 2 of 7
Answer:
The year to date amounts reported in each quarter of 2006 for tax
(provisions) and expense were as follows:
- -Dr (Cr.) in millions 1ST QTR 2ND QTR. 3RD QTR
- --------------------- ------- -------- -------
Continuing Operations - Federal (5.5) (8.9) (11.2)
Continuing Operations - Foreign 2.9 (2.9) 7.5
CONTINUING OPERATIONS - TOTAL (2.6) (11.8) (3.7)
Discontinued Operations - Federal (0.1) 7.6 8.5
Discontinued Operations - State 0.3 3.5 3.5
DISCONTINUED OPERATIONS - TOTAL 0.2 11.1 12.0
OTHER COMPREHENSIVE INCOME 5.6 2.9 2.7
In arriving at the tax provision attributable to US federal operations
recorded in the first quarter of 2006, we determined we could not
estimate our overall effective tax rate applicable for the year
because, based on our first quarter results by tax jurisdiction as
compared to forecast, and the fact that sourcing decisions were yet to
be finalized, our full-year forecast of profit before tax by tax
jurisdiction was not considered reliable at the time. As a result, the
tax provision for the quarter was prepared using actual first quarter
financial results (a "discrete" approach), which was determined to be
an appropriate method.
Since a loss was reported from continuing operations and income was
reported in other comprehensive income (OCI) in this first quarter,
the US federal tax benefit recorded in continuing operations was
allocated to OCI per paragraph 140 of FAS 109. This allocation
resulted in an effective rate for the US federal jurisdiction of 0%.
As indicated in our amended Form 10-Q for the quarter ended March 31,
2006, we incorrectly combined the income from foreign jurisdictions
with losses from foreign jurisdictions for which tax benefits are not
expected to be realizable. This correction resulted in approximately
$2.9 million in foreign income tax expense for continuing operations.
As such, the net income tax benefit from continuing operations of $2.6
million will not equal the $5.6 million in tax expense recorded in
OCI.
In the second quarter of 2006, we reported a gain in discontinued
operations, related to the sale of the Little Giant Pump business,
along with a gain in OCI and a loss from continuing operations, both
in a jurisdiction with a full valuation allowance. Since the forecast
of profit before tax by tax jurisdiction for the year had been updated
and was now considered to be more reliable than in the first quarter,
it was used in the calculation of the effective tax rate for the year.
US federal tax expense and benefit were appropriately allocated
amongst the three areas of income according to SFAS No. 109, paragraph
140, using the effective rate method, which limits the amount of
benefit recorded on the loss from continuing operations to no more
than the amount forecasted for the full year. Because the loss
forecasted for the full year from continuing operations of $28.6
million was greater than the loss for the quarter
Mr. Terence O'Brien
U.S. Securities and Exchange Commission
April 3, 2007
Page 3 of 7
of $24.8 million, the expense in discontinued operations ($7.6
million) and OCI ($2.9 million) exceeded the US Federal benefit ($8.9
million) in continuing operations.
Additionally, based on the corrected methodology for calculating the
foreign effective rate discussed above, we also recorded approximately
$2.9 million of foreign tax benefit, which increased the total benefit
in continuing operations to $11.8 million.
Finally, state tax expense was recorded for state income tax
liabilities related to the sale of Little Giant Pump Company, a US
business that files separate tax returns in states where no valuation
allowance was historically recorded, as a discrete period item. Thus,
we recorded state tax expense of $3.5 million in discontinued
operations which was not offset by a benefit in continuing operations.
For the third quarter of 2006, we continued to apply paragraph 140 of
FAS 109 for federal purposes to US continuing operations ($11.2
million), discontinued operations ($8.5 million) and OCI ($2.7
million). We also recorded foreign tax of $1.6 million based on the
method discussed above and recorded a $5.9 million valuation allowance
against deferred tax assets in Brazil for which we determined it was
no longer more likely than not that the deferred tax asset would be
realized.
2. With respect to your restatement, please address the following:
- Please clarify why the changes to the interim periods in 2005 and
2004 had no effect on the annual periods. We note that the
restatement related to income from foreign jurisdictions that was
inappropriately combined with losses from foreign jurisdictions
for which tax benefits are not expected to be realized. However,
it would appear that this issue would result in the
understatement of tax expense for annual periods, as well as
interim periods.
- Please tell us more about how the company originally allocated
income tax expense between continuing and discontinued operations
and the changes to your original accounting in the amended Form
10-Q for the quarter ended June 30, 2006.
Answer:
We restated our interim tax calculations for 2005 to comply with FIN
18, paragraph 22a, which states that:
"If in a separate jurisdiction an enterprise anticipates an "ordinary"
loss for the fiscal year or has an "ordinary" loss for the
year-to-date for which, in accordance with paragraphs 14 and 15 above,
no tax benefit can be recognized, the enterprise shall exclude
"ordinary" income (or loss) in that jurisdiction and the related tax
(or benefit) from the overall computations of the estimated annual
effective tax rate and interim period tax (or benefit). A separate
estimated annual effective tax rate shall be computed for that
jurisdiction and applied to "ordinary" income (or loss) in that
jurisdiction." As noted in the restated filings for 2005, we did not
initially apply FIN 18 properly, since losses from jurisdictions for
which no tax benefit can be recognized were combined with income from
the remaining jurisdictions in arriving at the estimated effective tax
rate that was applied to year to date income.
Mr. Terence O'Brien
U.S. Securities and Exchange Commission
April 3, 2007
Page 4 of 7
FIN 18 is used to calculate the effective tax rate only for quarterly
periods; it requires the use of forecasted profit or loss to arrive at
an estimated effective rate. Since full-year actual financial results
are available at the end of the year, FIN 18 does not apply, and
discrete calculations by jurisdiction are used to calculate the
effective tax. Therefore, the quarterly misstatements that occurred as
a result of the improper application of FIN 18 had no effect on the
full year calculations. We have consistently applied the year-end
methodology.
For a discussion of how we corrected our previous accounting for
interim income taxes, please refer to our response to comment #1.
Management's Discussion and Analysis of the Financial Condition and Results of
Operations, page 28
Liquidity and Capital Resources, page 40
3. We note your disclosure that your average days sales outstanding has
increased at September 30, 2006, as compared to December 31, 2005, due, in part,
to more extended payment terms to certain key customers in your Engine & Power
Train segment. In future filings, please address the following:
- Disclose the reasons for the extended payment terms.
- Disclose the effect of the extended payment terms on your
liquidity and capital resources. Refer to disclosures required by
SAB 104.
- Disclose the extent to which your sales for the quarter ended
September 30, 2006, were positively affected by the extended
payment terms, as well as the extent to which these increased
sales in the quarter ended September 30, 2006 will negatively
affect your sales in future periods (i.e., the extent to which
those sales would have occurred in later periods absent the
extended payment terms).
In your response, please show us what your future disclosures will
look like.
Answer:
The statement in our third quarter Form 10-Q indicating that the
Engine Group has more extended payment terms to certain key customers
was not meant to imply that this was a recent or temporary extension
of those payment terms, as this is not the case. Rather, it was meant
to illustrate that the payment terms of certain Engine Group customers
are longer when compared to the average payment term to a customer of
the Group, which approximates 45 days. As those Engine customers
become a greater proportion of the overall accounts receivable balance
in certain periods, it has the effect of extending the average balance
for days sales outstanding.
Days sales outstanding increased to 60 days for the Engine Group as of
September 30, 2006 from 50 at December 31, 2005, primarily due to two
factors. First, payment terms with our largest Engine customer are net
60 days. At December 31, 2005, that customer accounted for
approximately 50% of our accounts receivable balance, and had an
average time to collection of 62 days. At September 30, 2006, the same
customer accounted for approximately 60% of total accounts receivable
for the Engine Group, and had an average time to collection of 68
days. The increased weighting of that customer, as well as
Mr. Terence O'Brien
U.S. Securities and Exchange Commission
April 3, 2007
Page 5 of 7
the extension of time to collection, accounts for a 5.5 DSO increase
for the Engine Group as a whole. Second, because of the bankruptcy of
our Europa engine division, our inter-company accounts receivable with
that division was reclassified to trade accounts receivable. This
increased our September, 2006 trade accounts receivable by $3.5
million, or approximately 3.5 days.
The variables that drive the days sales outstanding metric will differ
from period to period. However, we will make sufficient disclosures in
future filings to enable the readers of our financial statements to
understand those variables.
Significant Accounting Policies and Critical Accounting Estimates, page 45
4. We note your response to comment 1 in our letter dated October 19,
2006 and the corresponding disclosure in your September 30, 2006 Form
10-Q. We note that you used a discount rate of 8.15% as of September
30, 2006 and 9.25% as of December 31, 2005. We further note with the
new $100 million Second Lien Credit Agreement and the amended February
6, 2006 First Lien Credit Agreement, your weighted average interest
rate is 10.4%. Please explain to us how you estimated your discount
rate and why you believe the rate used as of September 30, 2006 is
reasonable. Your explanation should include a discussion of how your
cost of debt and cost of equity (i.e., cost of capital) were
considered in your estimate of the discount rate. Finally, also
provide us with an explanation as to why the discount rate decreased
from December 31, 2005 to September 30, 2006.
Furthermore, in future filings, please disclose the amount by which
the fair value of each of your reporting units exceeds carrying value
when there is not a material difference between the two values. For
the two reporting units within your Compressor segment, please
disclose the amount of goodwill for each reporting unit and the amount
of tangible and intangible assets. This information will allow an
investor to understand the value of the assets at risk for impairment
and how close to potential impairment those assets are. Please provide
us with the disclosure you intend to include in future filings.
Answer:
In selecting the appropriate discount rate to utilize in our goodwill
valuation estimates, we have relied upon guidance taken from FAS 142.
Paragraph 24 of FAS 142 states that "Those cash flow estimates shall
incorporate assumptions that marketplace participants would use in
their estimates of fair value." Accordingly, rather than utilizing a
company-specific rate, we have considered it more appropriate to
consistently apply an externally derived market-rate approach.
Specifically, the discount rates utilized in the goodwill valuation
analysis are derived from published resources such as Ibbotson.
Although those published rates are lower than our current weighted
average cost of capital, until recently they have been higher.
The company has historically applied the Ibbotson rate for the SIC
code 3, representing a composite rate for manufacturing firms. The
decline in discount rate from December 31, 2005 to September 30, 2006
reflects the change in the discount rate for SIC code 3 as published
by Ibbotson.
Mr. Terence O'Brien
U.S. Securities and Exchange Commission
April 3, 2007
Page 6 of 7
Per the Staff's request, in future filings we will segregate the
amounts reported for the two Compressor Group business units that
carry goodwill. We anticipate making the following disclosure in our
Annual Report on Form 10-K for the year ended December 31, 2006:
COMPRESSOR COMPRESSOR ELECTRICAL ENGINE &
(in millions) EUROPE INDIA COMP. POWER TRAIN PUMPS TOTAL
---------- ---------- ---------- ----------- ----- -------
Balance at Jan. 1, 2005 ............ $ 11.5 $ 7.1 $216.9 $ 2.9 $5.1 $ 243.5
Impairment ......................... (108.0) (2.7) (110.7)
Foreign currency translation ....... (1.5) (0.2) (0.2) (1.9)
------ ----- ------ ------ ---- -------
Balance at Dec. 31, 2005 ........... 10.0 6.9 108.9 -- 5.1 130.9
Sale of Little Giant Pump Company .. (5.1) (5.1)
Foreign currency translation ....... 1.2 0.1 (0.1) 1.2
------ ----- ------ ------ ---- -------
Balance at Dec. 31, 2006 ........... $ 11.2 $ 7.0 $108.8 -- -- $ 127.0
====== ===== ====== ====== ==== =======
All intangible assets are associated with the Electrical Components
segment, and this fact is disclosed in our Form 10-K and will also be
included in future filings.
In assessing whether any of the reporting units that carry goodwill
have fair values that do not exceed carrying values by a material
amount, we have used a sensitivity analysis that evaluates the change
in fair value with a 1.0% increase or decrease in the discount rate, a
disclosure that was requested by the Staff in a previous comment
letter. Performing this analysis has resulted in the following
anticipated disclosure in our Annual Report on Form 10-K for the year
ended December 31, 2006:
"Based on the goodwill analysis performed for the year ended December
31, 2006, 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 valuation with Change in valuation with
1.0% decrease in discount 1.0% increase in discount
rate rate
------------------------- -------------------------
Compressor Segment - Europe $ 4.7 ($4.4)
Compressor Segment - India 4.3 (4.0)
Electrical Components - Fasco 14.7 (20.5)
'For the Fasco business unit, if the discount rate were to increase by
1.0%, the fair value of the business unit would decrease by
approximately $20 million. This rate increase would result in the
calculated fair value of the business exceeding its carrying value by
$3.2 million. The other two business units that have goodwill show
fair values sufficiently greater than the carrying value such that a
1.0% increase in discount rate does not place the goodwill at or near
risk of impairment.
'While we currently believe that the fair value of all of our
reporting units exceeds carrying value under the discounted cash flow
model, materially different assumptions regarding future performance
of our reporting units, the selected discount rate or the
Mr. Terence O'Brien
U.S. Securities and Exchange Commission
April 3, 2007
Page 7 of 7
intention to continue to operate the reporting units could result in
significant impairment losses."
We intend to provide similar disclosures in future filings as appropriate.
Please respond to these comments within 10 business days or tell us when you
will provide us with a response. Please furnish a letter on EDGAR that keys your
responses to our comments and provides any requested information. Detailed
response letters greatly facilitate our review. Please understand that we may
have additional comments after reviewing your responses to our comments.
In addition, please be advised that the Division of Enforcement has access to
all information you provide to the staff of the Division of Corporation Finance
in our review of your filing or in response to our comments on your filing.
Tecumseh Products acknowledges that:
- The company is responsible for the adequacy and accuracy of the
disclosure in the filing;
- Staff comments or changes to disclosure in response to staff comments
do not foreclose the Commission from taking any action with respect to
the filing; and
- The company may not assert staff comments as a defense in any
proceeding initiated by the Commission or any person under the federal
securities laws of the United States.
Regards,
TECUMSEH PRODUCTS COMPANY
/s/ James S. Nicholson
- ------------------------------------
James S. Nicholson
Vice President, Treasurer and Chief
Financial Officer
JSN/kvk