SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2006 Commission File Number 0-452
TECUMSEH PRODUCTS COMPANY
(Exact Name of Registrant as Specified in its Charter)
Michigan 38-1093240
(State of Incorporation) (I.R.S. Employer Identification No.)
100 East Patterson Street
Tecumseh, Michigan 49286
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (517) 423-8411
Securities Registered Pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
- ------------------- ---------------------------
Class B Common Stock, $1.00 Par Value The Nasdaq Stock Market LLC
Class A Common Stock, $1.00 Par Value The Nasdaq Stock Market LLC
Class B Common Stock Purchase Rights The Nasdaq Stock Market LLC
Class A Common Stock Purchase Rights The Nasdaq Stock Market LLC
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark if the Registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.
Yes [ ] No [X]
Indicate by check mark if the Registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act.
Yes [ ] No [X]
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark if 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 Act). Yes [ ] No [X]
Certain shareholders, which, as of June 30, 2006, held an aggregate of 790,947
shares of Registrant's Class A Common Stock and 2,216,044 shares of its Class B
Common Stock might be regarded as "affiliates" of Registrant as that word is
defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended. If
such persons are "affiliates," the aggregate market value as of June 30, 2006
(based on the closing prices of $19.20 per Class A share and $15.87 per Class B
share, as reported on the NASDAQ Stock Market on such date) of 12,610,991 Class
A shares and 2,861,702 Class B shares held by non-affiliates was $287,546,238.
Numbers of shares outstanding of each of the Registrant's classes of
Common Stock at February 23, 2006:
Class B Common Stock, $1.00 Par Value: 5,077,746
Class A Common Stock, $1.00 Par Value: 13,401,938
Certain information in the definitive proxy statement to be used in connection
with the Registrant's 2007 Annual Meeting of Shareholders has been incorporated
herein by reference in Part III hereof.
TABLE OF CONTENTS
Page
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PART I
Item 1. Business...................................................... 5
Item 1A. Risk Factors.................................................. 15
Item 1B. Unresolved Staff Comments..................................... 20
Item 2. Properties.................................................... 20
Item 3. Legal Proceedings............................................. 20
Item 4. Submission of Matters to a Vote of Security Holders........... 23
PART II
Item 5. Market for the Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities.......... 24
Item 6. Selected Financial Data....................................... 25
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................. 27
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.... 54
Item 8. Financial Statements and Supplementary Data................... 56
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure................................... 99
Item 9A. Controls and Procedures....................................... 99
Item 9B. Other Information............................................. 101
PART III
Item 10. Directors and Executive Officers of the Company............... 101
Item 11. Executive Compensation........................................ 102
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters............................ 102
Item 13. Certain Relationships and Related Transactions, and Director
Independence............................................... 103
Item 14. Principal Accountant Fees and Services........................ 103
PART IV
Item 15. Exhibits and Financial Statement Schedules.................... 103
Signatures............................................................... 110
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PART I
ITEM 1. BUSINESS
GENERAL
Tecumseh Products Company (the "Company") is a full-line, independent, global
manufacturer of hermetic compressors for residential and commercial
refrigerators, freezers, water coolers, dehumidifiers, window air conditioning
units and residential and commercial central system air conditioners and heat
pumps; electric motors and components, including AC and DC motors, blowers, gear
motors and linear actuators for a wide variety of industrial and consumer
applications across a broad range of industries; and gasoline engines and power
train for lawn mowers, lawn and garden tractors, garden tillers, string
trimmers, snow throwers, industrial and agricultural applications and
recreational vehicles. We believe we are one of the largest independent
producers of hermetically sealed compressors in the world, one of the world's
leading manufacturers of small gasoline engines and power train products used in
lawn and garden applications, and one of the leading manufacturers of fractional
horsepower motors for the United States market. We group our products into three
principal market segments: Compressor Products, Electrical Component Products
and Engine & Power Train Products. The majority of our products are sold in
countries all around the world.
Compressor Products include a broad range of air conditioning and refrigeration
compressors, as well as refrigeration condensing units and complete
refrigeration systems. Our compressor products range from fractional horsepower
models used in small refrigerators and dehumidifiers to large compressors used
in unitary air conditioning applications. We sell compressors in four compressor
market segments: (i) household refrigerators and freezers; (ii) room air
conditioners; (iii) commercial and residential unitary central air conditioning
systems; and (iv) commercial refrigeration applications including freezers,
dehumidifiers, display cases and vending machines. We sell compressors to
original equipment manufacturers ("OEMs") and aftermarket distributors.
Electrical Component Products include AC and DC electric motors, blowers, gear
motors and linear actuators for a broad and diverse set of applications across
many industries. These markets include automotive, appliance and consumer
durables, heating and cooling equipment, computer and office equipment,
industrial machinery, commercial equipment, aerospace and healthcare. In
addition to motors, we also manufacture other electrical components that work in
tandem with electric and electronic devices to manage and regulate their
operation and provide connectivity and other motor parts for sale to external
customers. These products include overloads, relays, thermostats, terminals,
laminations and electronic circuit boards. In addition, we have developed an
uninterruptible alternative power system for use in mission critical facilities,
such as cell towers and data centers, where reliable power is a necessity. We
have uninterruptible power units undergoing internal and customer testing.
Engine & Power Train Products consist of (i) two- and four-cycle gasoline
engines for use in a wide variety of lawn and garden applications and other
consumer and light commercial applications and (ii) transmissions, transaxles
and related parts for use principally in lawn and garden tractors and riding
lawn mowers. We sell engine and power train products to OEMs and aftermarket
distributors.
We formerly reported a fourth segment, Pumps, but during 2006 we sold our Little
Giant Pump Company, which represented about 90% of our former pump business.
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FOREIGN OPERATIONS AND SALES
International sales and manufacturing are extremely important to our business as
a whole. In 2006, sales to customers outside the United States represented
approximately 52% of total consolidated net sales. In addition to North American
operations, compressor products are sold from Brazil, France, India and
Malaysia, engines and component parts are produced in the Czech Republic and
Brazil and electric motors are produced in Mexico, Thailand and Australia.
Products sold outside the United States are manufactured at both U.S. and
foreign plants. Tecumseh do Brasil, Ltda. ("Tecumseh do Brasil"), our Brazilian
compressor subsidiary, sells its products principally in Latin America, North
America, Europe, Africa and the Middle East. The Brazilian operation represents
a significant portion of our compressor business. In 2006, total sales generated
by Tecumseh do Brasil amounted to approximately 41% of total Compressor Products
segment sales.
Our European compressor subsidiary, Tecumseh Europe, S.A. ("Tecumseh Europe"),
generally sells the compressor products it manufactures in Europe, the Middle
East, Africa, Latin America and Asia. We also have two manufacturing facilities
in India that produce air conditioning and refrigeration compressors primarily
for the Indian appliance market with a growing amount of exports to North
America, the Middle East, the Far East and Africa.
The primary market for Electrical Component products is North America with some
sales of fractional horsepower motors in Australia, Europe and Asia. Motor
manufacturing operations outside the United States are located in Canada, Mexico
and Thailand, with some final assembly in Australia. Mexican operations are used
primarily to supply the North American market, while the Thai operations supply
Asia, Australia and North America.
In the engine business, we have two principal markets. The North American market
is served by our U.S. and Brazilian manufacturing operations. The European
market is served by U.S. export sales following the closure of our Italian
engine subsidiary, Tecumseh Europa, S.p.A. ("Tecumseh Europa") in December 2005.
In addition, the engine business has a manufacturing facility in the Czech
Republic that produces engine components for export to the U.S. market. Our
facility in Curitiba, Brazil produces engine components and sub-assemblies, as
well as full engine assemblies, and exports to both the U.S. and European
markets.
Our 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 U.S. government embargoes on
sales to certain countries. Our foreign manufacturing operations are subject to
other risks as well, 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 given the importance of Tecumseh do Brasil's
performance to our total operating results.
INDUSTRY SEGMENT AND GEOGRAPHIC LOCATION INFORMATION
The results of operations and other financial information by industry segment
and geographic location for each of the years ended December 31, 2006, 2005 and
2004 appear under the caption "Business Segment Information" in Note 9 to the
Consolidated Financial Statements which appear in Part II, Item 8, of this
report, "Financial Statements and Supplementary Data," and that information is
incorporated by reference into this Item 1. The information contained under the
caption "Business Segments," along with the discussion in the "Management's
Discussion and Analysis of Financial Condition and Results of Operations" under
the caption "Results of Operations" in this report should
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be read in conjunction with the business segment information presented in the
following sections entitled: Compressor Products, Electrical Component Products,
and Engine & Power Train Products.
COMPRESSOR PRODUCTS
Compressor Products is our largest business segment. A compressor is a device
that compresses a refrigerant gas. When the gas is later permitted to expand, it
absorbs and transfers heat, producing a cooling effect, which forms the basis
for a wide variety of refrigeration and air conditioning products. All of the
compressors we produce are hermetically sealed. Our current compressor line
consists primarily of reciprocating and rotary designs with a limited number of
scroll models.
Product Line
We manufacture and sell compressor and refrigeration systems to four different
markets - household refrigerators & freezers, air conditioning, commercial
refrigeration, and aftermarket distribution. Our lines of compressors range in
size from approximately 5,000 - 72,000 BTU/hour models used in stationary and
mobile air conditioning applications to 350 - 1,500 BTU/hour models used in
household refrigerators/freezers, along with 200 to 72,000 BTU/hour models for
commercial refrigeration applications, such as ice makers, vending machines,
food service equipment, display cases and refrigerated walk-in cold rooms.
We produce reciprocating compressors in the 200 - 72,000 BTU/hour for all
temperature ranges. We produce rotary compressors ranging from 5,000 to 32,000
BTU/hour for room and mobile air conditioning applications, as well as certain
commercial refrigeration applications. Rotary compressors generally provide
increased operating efficiency, lower equipment space requirements, and reduced
sound levels when compared to reciprocating piston models.
We have also started offering customers our scroll compressor and condensing
units utilizing scroll compressors especially designed for demanding commercial
refrigeration applications. The addition of scroll compressors to our product
portfolio provides greater versatility and options to our customers in a wider
range of applications and performance conditions. We are offering the scroll
compressor in the distribution product lines of the business, and are providing
samples to original equipment manufacturers.
The Compressor products segment also produces value-added subassemblies and
complete refrigeration systems that utilize its compressors and Fasco motors as
components. Such products include indoor and outdoor condensing units, and
multi-cell units and complete refrigeration systems that use both single speed
and variable speed AC/DC powered compressors. These products are sold to both
OEM and aftermarket distributors.
Manufacturing Operations
Compressor Products manufactured or assembled in our North American plants
accounted for approximately 22% of 2006 compressor sales. The balance are
produced at our manufacturing facilities in Brazil, France and India. The
compressor operations are substantially vertically integrated, and we
manufacture a significant portion of our component needs internally, including
electric motors, metal stampings and glass terminals. Raw materials are
purchased from a variety of non-affiliated suppliers. We utilize multiple
sources of supply, and the required raw materials and components are generally
available in sufficient quantities, although the costs of commodity raw
materials have increased substantially in recent years and are expected to
remain volatile in the future.
5
Sales and Marketing
We market our North American, Brazilian and Indian built compressors under the
"Tecumseh" brand and French built compressors under the "L'Unite Hermetique by
Tecumseh" brand. Other brands under which we market include "SILENSYS by
Tecumseh" and "VECTOR by Tecumseh." We sell our compressor products in North
America primarily through our own sales staff, although sales to aftermarket
customers are also made through independent sales. In certain foreign markets,
we also use local independent sales representatives and distributors.
A substantial portion of our sales of compressor products for room air
conditioners and for household refrigerators and freezers are to OEMs. Sales of
compressor products for unitary central air conditioning systems and commercial
refrigeration applications also include substantial sales to both OEM and
distributor customers.
We have over 1,200 customers for compressor products, the most significant of
which are commercial customers. In 2006, the two largest customers for
compressor products accounted for 6.4% and 4.7%, respectively, of total segment
sales, or 3.7% and 2.7%, respectively, of consolidated net sales. Loss of either
of these customers could have a material adverse effect on the results of
operations of the Compressor Products segment and, at least temporarily, on our
business as a whole. Generally, we do not enter into long-term contracts with
our customers in this segment. However, we do pursue long-term agreements with
selected major customers where a business relationship has existed for a
substantial period of time.
We export to over 110 countries. In 2006, approximately 22% of the compressor
products we produced in our U.S. plants were exported to foreign countries.
Approximately 37% of these exported products were sold in the Far and Middle
East.
Competition
All of the compressor markets in which we operate are highly competitive.
Participants compete on the basis of delivery, efficiency, noise level, price
and reliability. We compete not only with other independent compressor producers
but also with manufacturers of end products that have internal compressor
manufacturing operations.
North American Operations
The domestic unitary air conditioning compressor market consists of OEMs and a
significant compressor aftermarket. We compete primarily with two U.S.
manufacturers, Copeland Corporation, a subsidiary of Emerson Electric, Inc., and
Bristol Compressors, Inc., a subsidiary of Johnson Controls. Copeland
Corporation enjoys a larger share of the domestic unitary air conditioning
compressor business than either Bristol Compressors, Inc. or the Company.
Danfoss also joined this segment, with the acquisition of Scroll Technologies
from both Carrier and Johnson Controls in 2006.
Over the last several years there has been an industry trend toward the use of
scroll compressors in the high efficiency segment of the unitary air
conditioning market. Copeland Corporation and other compressor manufacturers
have had scroll compressors as part of their product offerings for some time.
Along with its own manufacturing capabilities, Copeland Corporation is also a
member of the Alliance Scroll manufacturing joint venture with two major U.S.
central air conditioning manufacturers, American Standard's Trane air
conditioning division and Lennox International, Inc.
6
We believe that the rotary and scroll compressors are important to maintaining a
position in the unitary air conditioning and commercial refrigeration markets,
and we continue to pursue development of both technologies in a manner that
limits our financial risk. As stated above, we are offering the scroll
compressor in the distribution product lines of the business, and are providing
samples to original equipment manufacturers.
In the domestic room air conditioning compressor market, we compete primarily
with foreign companies, as a majority of room air conditioners are now
manufactured outside the United States. We also compete to a lesser extent with
U.S. manufacturers. Competitors include Matsushita Electric Industrial
Corporation, Sanyo Electric Trading Company, L.G. Electronics, Inc., Mitsubishi,
Daikin, and others. We have increasingly struggled with price competition from
foreign companies during the last several years. Downward pressure on prices,
particularly in the room air conditioning market, has continued due to world
over-capacity and available supply of inexpensive Asian products both in North
America and in Europe.
In the domestic markets for water coolers, dehumidifiers, vending machines,
refrigerated display cases and other commercial refrigeration products, we
compete primarily with compressor manufacturers from the Far East, Europe and
South America, and to a lesser extent, the United States. Competitors include
Matsushita Electric Industrial Corporation, Danfoss, Inc., Embraco, S.A.,
Copeland Corporation, ACC and others.
The household refrigerator and freezer market is vertically integrated with many
appliance producers manufacturing a substantial portion of their compressor
needs. Our competitors include ACC Group (formerly the compressor operations of
AB Electrolux), Matsushita Electric Industrial Corporation, Embraco, S.A.,
Danfoss, Inc., and others.
European Operations
Tecumseh Europe sells the major portion of its manufactured compressors in
Europe and competes in those markets primarily with several large European
manufacturers, and to a lesser but increasing extent, with manufacturers from
the Far East and Brazil. Competitors include ACC Group, Embraco, S.A., Danfoss,
Inc., Emerson and others. Tecumseh Europe produces compressors primarily for the
commercial refrigeration market and distribution. European operations face the
same competitive factors as those in North America, including foreign
competition and a shrinking local customer base. Similar to the restructuring
actions completed over the past several years in North America, European
operations will need to consolidate facilities to improve their overall cost
structure.
Brazilian Operations
Tecumseh do Brasil competes directly with Embraco, S.A. in Brazil and with
Embraco and several other foreign manufacturers in Latin America. Historically,
Tecumseh do Brasil has sold the major portion of its manufactured compressors in
Latin America, North America, Europe, Africa and the Middle East. Significant
devaluations of the Brazilian Real in 1999 and 2002 set the stage for Tecumseh
do Brasil to better compete in foreign markets, resulting in approximately 66%,
66%, and 63% of its production being exported in 2006, 2005 and 2004,
respectively. However, during 2006 and 2005 the Brazilian Real appreciated
against the U.S. Dollar by 5.3% and 16%, respectively, representing a
significant departure from historical devaluation trends.
The operation in Brazil represents a significant and critical component of the
Compressor Group as a whole given its overall cost structure and the scope of
its operations. The Brazilian operation represented 41.2% and 40.0% of 2006 and
2005 sales, respectively. While it has historically
7
provided a disproportionate share of the Group's operating profit, in 2006 it
provided 52% of the segment's loss.
Indian Operations
Tecumseh Products India Private Ltd. has two compressor manufacturing facilities
in India that sell to regional markets and increasingly to global markets,
including Eastern Europe, the Middle East, the Far East and Africa. Major
competitors include the Indian manufacturers Copeland / Emerson., Carrier Aircon
Ltd., Godrej, Videocon, BPL and others. Tecumseh Products India Private Ltd.
produces compressors for the air conditioning, refrigerator and freezer, and
commercial refrigeration markets. In 2006, approximately 18.5% and 13.8% of its
sales were made to its two largest customers, respectively, and the loss of
these customers would have a significant impact on the results of operations of
this facility, and to a lesser extent, on the consolidated results of the
Compressor Products segment and the Company as a whole.
Research
Ongoing research and development is another method in which we strive to exceed
our competition. The ability to successfully bring new products to market in a
timely manner has rapidly become a critical factor in competing in the
compressor products business as a result of, among other things, the imposition
of energy efficiency standards and environmental regulations including those
related to refrigerant requirements. These factors are discussed below.
Regulatory Requirements
Hydrochlorofluorocarbon compounds ("HCFCs") are still used as a refrigerant in
many air conditioning systems. Under a 1992 international agreement, HCFCs will
be banned from new equipment beginning in 2010. Some European countries began
HCFC phase-outs as early as 1998, and some have fully eliminated the use of
HCFCs. Within the last several years, we have approved and released a number of
compressor models utilizing U.S. government approved hydrofluorocarbons ("HFC")
refrigerants such as R410A, which are considered more environmentally safe than
the preceding refrigeration compounds. HFCs are also currently under global
scrutiny and subject to possible future restrictions.
In the last few years, there has been an even greater political and consumer
movement, particularly from northern European countries, toward the use of
hydrocarbons ("HCs") and CO2 as alternative refrigerants, moving further away
from the use of chlorine (which depletes the ozone layer of the atmosphere) and
the use of fluorine (which contributes to the "green-house" effect).
Hydrocarbons are flammable compounds and have not been approved by the U.S.
government for air conditioning or household refrigerator and freezer
applications. CO2 is still in limited production and is used in niche markets.
It is not presently possible to estimate the level of expenditures that will be
required to meet future industry requirements or the effect on our competitive
position.
The U.S. National Appliance Energy Conservation Act of 1987 (the "NAECA")
requires specified energy efficiency ratings on room air conditioners and
household refrigerator/freezers. Proposed energy efficiency requirements for
unitary air conditioners were published in the U.S. in January 2001 and became
effective in January 2006. The European and Brazilian manufacturing communities
have issued energy efficiency directives that specify the acceptable level of
energy consumption for refrigerators and freezers. These efficiency ratings
apply to the overall performance of the specific appliance, of which the
compressor is one component. We have ongoing projects aimed at improving the
efficiency levels of our compressor products and have products available to meet
known energy efficiency requirements as determined by our customers.
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ELECTRICAL COMPONENT PRODUCTS
FASCO Motors Group is the largest single operation of the Electrical Component
Products group. Headquartered in Eaton Rapids, Michigan, FASCO is a leading
manufacturer in the U.S. fractional horsepower ("FHP") motors industry.
The FHP motors industry is large and diverse with an estimated size in excess of
$10 billion. The market is generally stable as many different manufacturers use
FHP motors as components of their applications. The pervasiveness of motors has
been due, in part, to rising disposable income, spending on appliance
"necessities" for replacement, remodeling and new construction, increased
heating efficiency standards, increased use of power options in vehicles, growth
in applications for motors in healthcare, leisure, exercise and home maintenance
products, a wide variety of industrial applications, decreases in motor size and
improvements in motor efficiency.
Product Line
Electrical Component Products manufactures AC motors, DC motors, blowers,
gearmotors and linear actuators, and other components used in applications with
electric motors. Its products are used in a wide variety of applications in
markets that include automotive, appliance and consumer durables, heating and
cooling equipment, computer and office equipment, industrial machinery,
commercial equipment, aerospace and healthcare. Tecumseh believes that we have
products to serve approximately 20-25% of the market, with its primary focus on
high value-added products and services.
Manufacturing Operations
Currently, Electrical Component Products operates nine manufacturing or assembly
facilities located as follows: four in the United States, two in Mexico and one
each in Canada, Thailand and Australia. These facilities are to a large extent
vertically integrated; however, some component parts are purchased from outside
suppliers. We utilize multiple sources of supply, and the required raw
materials, including copper wire, steel, aluminum, zinc and components are
generally available in sufficient quantities. Commodity prices, however, have
been escalating rapidly over the last two years; over the course of 2005 and
2006, the prices of copper and aluminum have risen by 92% and 33% respectively.
Sales and Marketing
Electrical Component Products markets its products principally under the "FASCO"
brand. The FASCO brand name is well known and nearly a century old. FASCO sells
its products primarily through its own direct sales force supplemented by third
party sales representatives in certain markets. Approximately 85% of FASCO's
sales are to OEM customers. Sales professionals worldwide are assigned to
accounts based upon type of account and geographic region.
Electrical Component Products has over 3,000 customers for its products, the
largest of which are in the residential and commercial sector. Historically, the
top three customers have accounted for less than 15% of revenues, with the
largest customer accounting for approximately 5.3%. Loss of the largest customer
could have a material adverse effect on the results of Electrical Component
Products. In addition, certain of Electrical Component Products' customers are
competitors of Tecumseh's other business segments. Individually, none of these
customers exceed 5% of Electrical Component Products' total sales. Electrical
Component Products does not have long-term contracts with the majority of its
customers.
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Competition
All of the application markets in which Electrical Component Products competes
are highly competitive. Different competitors are present within each of the
application markets. Key competitors in the automotive market segment include
Daewoo, Bosch and Johnson Electric. Key competitors in residential and
commercial market segments include Regal-Beloit, Emerson and A.O. Smith. In the
linear actuator and gearmotor market segments, key competitors include
Merkle-Koff, Bison and Hubbell. Participants compete on various levels,
including motor design and application, customer service and price. Motor design
and application is critical because OEMs are constantly improving their product
lines, which often require new motor specifications. In general, end-use markets
today are looking for smaller, more efficient, faster, cooler-operating and
lighter motors. In addition to competing with other independent motor
manufacturers, we also compete to a lesser extent with manufacturers of end
products that have internal motor manufacturing operations.
ENGINE & POWER TRAIN PRODUCTS
Small gasoline engines account for a majority of the net sales of our Engine &
Power Train Products segment. These are used in a broad variety of consumer
products, including lawn mowers (both riding and walk-behind types), snow
throwers, small lawn and garden tractors, small power devices used in outdoor
chore products, generators, pumps and certain self-propelled vehicles. We
manufacture gasoline engines, both two- and four-cycle types, with aluminum
die-cast bodies ranging in size from 2 through 25 horsepower. Our power train
products include transmissions, transaxles and related parts used principally in
lawn and garden tractors and riding lawn mowers.
Manufacturing Operations
We manufacture or assemble engines and related components in three plants in the
United States, one plant in the Czech Republic and one plant in Brazil. All of
our power train products are currently manufactured in one facility in the
United States. Our operations in this segment are partially vertically
integrated as we produce our own carburetors. We purchase the aluminum
die-castings and plastic parts used in our engines and power train products. We
utilize multiple sources of supply, and the required raw materials and
components are generally available in sufficient quantities.
From 2004 to the current year, we recognized restructuring charges of $47.2
million related primarily to the closure of production facilities resulting in
write-downs of fixed assets and the relocation of certain engine and component
part production from domestic facilities to our facilities in the Czech Republic
and Brazil. As a result of these actions, manufacturing activities ceased at our
facilities in Corinth, Mississippi and Torino, Italy during 2005. We have also
announced that operations are expected to cease at our New Holstein, Wisconsin
facility during 2007.
Until recently, our Curitiba, Brazil facility, TMT Motoco, provided full engine
assemblies to supply worldwide demand for lawn and garden engines. However, in
March of 2007, TMT Motoco filed a request in Brazil for court permission to
pursue a judicial restructuring, similar to a U.S. filing for Chapter 11
bankruptcy protection. TMT Motoco has suspended operations and, with the consent
of its unions, has placed its employees on vacation furlough. For further
discussion of the events leading to TMT Motoco's decision to seek a judicial
restructuring, refer to "Adequacy of Liquidity Sources" and Note 10, "Debt."
Sales and Marketing
We market our Engine & Power Train Products worldwide under the "Tecumseh" and
"Peerless" brands. A substantial portion of our engines are incorporated into
lawn and garden and other
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consumer products under brand labels owned by OEMs and sold through
"do-it-yourself" home centers, mass merchandisers, department stores and lawn
and garden specialty retailers.
The majority of our Engine & Power Train Products are sold directly to OEMs. We
also sell engines and parts to our authorized dealers and distributors, who
service our engines, both in the United States and abroad. Marketing of Engine &
Power Train Products is handled by our own sales staff and by local sales
representatives in certain foreign countries. North America and Europe are the
principal markets for lawn and garden products, although engines are sold
throughout the world.
Sales in this segment can be significantly affected by environmental factors
affecting the respective selling seasons for the various types of equipment. For
example, snow thrower sales, and therefore the demand for our applicable
engines, show a strong correlation with the timing and amount of snowfall
received. Similarly, the frequency of weather-related and other interruptions to
power supplies, or the perceived threat of interruptions, affect the demand for
generators. Factors such as these are largely unpredictable, yet greatly
influence the year-to-year demand for engine products.
In 2006, the three largest (direct ship) customers for Engine & Power Train
Products accounted for 39.5%, 21.5%, and 7.0%, respectively, of segment sales,
or 7.1%, 3.9%, and 1.3%, respectively, of consolidated net sales. Some of the
engines provided to these customers are incorporated into end consumer products
that are sold by a number of large retailers, including Lowe's, Sears and Home
Depot, which represent a significant portion of industry sales. Loss of any of
this segment's three largest customers, and/or the loss of a significant retail
distributor, would have a material adverse effect on the results of operations
of this segment and, at least temporarily, on the Company and its business as a
whole.
Competition
We believe we are one of the largest consolidated producers of engines and
transmissions for the outdoor power equipment industry in North America and
Europe. However, we are only the third largest producer in these markets of
small gasoline engines for the lawn and garden applications. The largest such
producer, with a broader product range, is Briggs & Stratton Corporation. Other
producers of small gasoline engines include Honda Corporation, MTD, Kohler
Corporation and Kawasaki Motors Corp., among others.
Competition in our engine business is based principally on price, service,
product performance and features and brand recognition. As mass merchandisers
have captured a larger portion of the sales of lawn and garden products in the
United States, price competition and the ability to offer customized styling and
feature choices have become even more important.
Environmental Standards
The U.S. Environmental Protection Agency ("EPA") has developed national emission
standards covering the engines produced by the Company under a two-phased
approach. We currently produce competitively priced engines that comply with the
EPA's Phase I engine emission standards. The Phase II standards, which are more
stringent, are being phased in between the 2005 and 2008 model years, depending
on the size of the engine. A broad range of our engines has been certified to
comply with these emissions standards.
In addition to the U.S. EPA regulations, the California Air Resources Board
("CARB") has enacted Tier III regulations requiring additional reductions in
exhaust emissions and new controls on evaporative emissions. The CARB proposal
became effective in 2007. While the additional
11
requirements add cost to the engines sold in the State of California, it is not
possible at this time to determine the impact on our competitive position in the
State of California.
The European Community has implemented noise standards for some categories of
engine-powered equipment. These standards took effect in two stages: Stage I
began January 3, 2002 and Stage II took effect January 3, 2006. They regulate
the sound level of the complete product delivered to the end user. We currently
supply engines to and work with equipment manufacturers to assure that their
products comply with these standards. The European Community has also adopted
exhaust emission regulations that affect the engines sold into the European
Community. These regulations are being implemented in stages, with the first
stage initiated in August 2004. These regulations are similar to the U.S. EPA
regulations and as a result are not expected to impact our competitive position.
BACKLOG AND SEASONAL VARIATIONS
Most of our production is against short-term purchase orders, and backlog is not
significant.
Compressor Products, Engine & Power Train Products and Electrical Component
Products are subject to some seasonal variation among individual product lines.
In particular, sales for Engine & Power Train Products are higher in the first
quarter (for engines related to lawn & garden products) and third quarter (for
snowthrower engines), and Compressor Products sales are higher in the first and
second quarters (for customer needs prior to the commencement of warmer weather,
for both residential air conditioning products and commercial applications).
However, depending on relative performance among the groups, and external
factors such as foreign currency changes and global weather, trends can vary. In
the past two years, consolidated sales in the aggregate have not exhibited any
pronounced seasonal trend.
PATENTS, LICENSES AND TRADEMARKS
We own a substantial number of patents, licenses and trademarks and deem them to
be important to certain lines of our business; however, the success of our
overall business is not considered primarily dependent on them. In the conduct
of our business, we own and use a variety of registered trademarks, the most
familiar of which is the trademark consisting of the word "Tecumseh" in
combination with a Native American Indian head symbol.
RESEARCH AND DEVELOPMENT
We must continually develop new and improved products in order to compete
effectively and to meet evolving regulatory standards in all of its major lines
of business. We spent approximately $36.7 million, $30.6 million, and $34.0
million during 2006, 2005, and 2004, respectively, on research activities
relating to the development of new products and the development of improvements
to existing products. None of this research was customer sponsored.
EMPLOYEES
On December 31, 2006, we employed approximately 18,500 persons, 77% of whom were
employed in foreign locations. Approximately 700 of the U.S. employees were
represented by labor unions, with no more than 300 persons covered by the same
union contract. The majority of foreign location personnel are represented by
national trade unions. The number of our employees is subject to some seasonal
variation. During 2006, the maximum number of persons employed was approximately
20,900 and the minimum was approximately 17,700. Overall, we believe we
generally have a good relationship with our employees.
12
AVAILABLE INFORMATION
We provide public access to our annual report on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K, and amendments to these reports filed
with or furnished to the Securities and Exchange Commission (SEC) under the 1934
Act. These documents may be accessed free of charge through our website at the
following address: http://www.tecumseh.com/investor.htm. These documents are
provided as soon as practicable after filing with the SEC, although not
generally on the same day. These documents may also be found at the SEC's
website at http://www.sec.gov.
ITEM 1A. RISK FACTORS
Set forth below and elsewhere in this Annual Report on Form 10-K are some of the
principal risks and uncertainties that could cause our actual business results
to differ materially from any forward-looking statements contained in this
Report. These risk factors should be considered in addition to our cautionary
comments concerning forward-looking statements in this Report, including
statements related to markets for our products and trends in our business that
involve a number of risks and uncertainties. Our separate sections in Item 7
below, "Disclosure Regarding Forward-Looking Statements," and Note 2, "Liquidity
and Management Plans," of the Notes to Financial Statements should be considered
in addition to the following statements.
THE JUDICIAL RESTRUCTURING OF OUR BRAZILIAN ENGINE MANUFACTURING SUBSIDIARY
MAY ADVERSELY AFFECT THE ENGINE GROUP AS A WHOLE, OTHER SUBSIDIARIES, OR
THE PARENT COMPANY.
Our Brazilian engine manufacturing subsidiary, TMT Motoco, is pursuing a
judicial restructuring, similar to a U.S. Chapter 11 bankruptcy filing. TMT
Motoco will remain in possession of its assets during the restructuring process.
The filing in Brazil constituted an event of default with our domestic lenders.
On April 9, 2007 we obtained further amendments to our First and Second Lien
Credit Agreements that cured the cross-default provisions triggered by the
filing in Brazil. These amendments are included as Exhibits to a Current Report
on Form 8-K that we filed on April 10, and further discussed in "Adequacy of
Liquidity Sources" and Note 10, "Debt."
TMT Motoco is currently in the process of delineating its restructuring plan,
which must be submitted to the Brazilian court within sixty days of the date the
restructuring request was granted. Our management continues to assess the
potential impact, if any, on the Engine Group as a whole or on our other
businesses. With respect to the Engine Group, there is still uncertainty as to
the impact this restructuring will have our long-term manufacturing
configuration in order to ensure ongoing supply of lawn and garden products to
our customers. With respect to our other subsidiaries, we are working to protect
these other businesses from any adverse effects of the events at TMT Motoco to
the greatest extent possible. In particular, we are working to ensure that our
Brazilian compressor subsidiary, Tecumseh do Brasil ("TdB"), maintains its
credit facilities and continues to successfully meet its obligations to its
suppliers and customers. However, since TdB maintains its credit facilities with
some of the same banks that were affected by the restructuring of TMT Motoco, we
cannot assure you that these lenders will continue to extent their credit
facilities to TdB. In 2006, total sales generated by TdB amounted to
approximately 41% of total Compressor Products segment sales; any withdrawal of
its credit facilities would have a material adverse effect on the Compressor
Group, and on the company as a whole.
WE MAY NOT MEET OUR 2007 BUSINESS PLAN UPON WHICH OUR BANK COVENANTS ARE
BASED.
In order to meet our 2007 financial covenants, we must realize significant
improvements over our reported 2006 results. To avoid defaults under financial
covenants, we have been forced to amend or
13
refinance our U.S. credit agreements for five out of the last seven fiscal
quarters. While our current agreements provide somewhat wider latitude than we
have enjoyed under prior agreements, and our business plan for the upcoming year
does not predict any defaults, we cannot continue to sustain losses at current
levels without consuming our available capital resources and again failing to
meet financial covenants.
If we default under our U.S. credit agreements, either through failing to meet
financial covenants or in some other way, our lenders could elect to stop making
the advances we need to fund daily operations, could declare all the debt we owe
them immediately due and payable, and could proceed against their collateral.
Under those circumstances, we might elect or be compelled to enter bankruptcy
proceedings, in which case our shareholders could lose the entire value of their
investment in our common stock.
OUR LEVERAGE MAY IMPAIR OUR OPERATIONS AND FINANCIAL CONDITION.
As of December 31, 2006, our total consolidated debt was $380.5 million. Our
debt could have important consequences, including increasing our vulnerability
to general adverse economic and industry conditions; requiring a substantial
portion of our cash flows from operations be used for the payment of interest
rather than to fund working capital, capital expenditures, acquisitions and
general corporate requirements; limiting our ability to obtain additional
financing; and limiting our flexibility in planning for, or reacting to, changes
in our business and the industries in which we operate.
The agreements governing our debt include covenants that restrict, among other
things, our ability to incur additional debt; pay dividends on or repurchase our
equity; make investments; and consolidate, merge or transfer all or
substantially all of our assets. Our ability to comply with these covenants may
be affected by events beyond our control, including prevailing economic,
financial and industry conditions. These covenants may also require that we take
action to reduce our debt or to act in a manner contrary to our business
objectives. We cannot assure you that we will meet any future financial tests or
that the lenders will waive any failure to meet those tests.
WE MAY DISPOSE OF SOME OF OUR LINES OF BUSINESS OR BECOME EVEN MORE
LEVERAGED.
Our Second Lien Credit Agreement requires us to accrue additional paid-in-kind
("PIK") interest if we do not reduce the principal balance according to a
specified, but not required, schedule. If funds from operations combined with
proceeds of potential asset sales are insufficient to meet the payment schedule,
the resulting PIK interest will increase our total debt, thus increasing the
leverage risks described above.
If we choose to sell any of our businesses or product lines thereof, the
proceeds will be used to reduce our indebtedness. The degree of favorable impact
to our lines of credit at the time of sale will be dependent on the magnitude of
the assets sold. As well, there will be a long-term effect on our future cash
flows and results of operations, as well as ongoing compliance with our debt
covenants, including compliance with modified EBITDA covenants as defined by our
bank agreements (our "Adjusted EBITDA").
WE ARE SUBJECT TO CURRENCY EXCHANGE RATE AND OTHER RELATED RISKS.
We conduct operations in many areas of the world involving transactions
denominated in a variety of currencies. We are subject to currency exchange rate
risk to the extent that our costs are denominated in currencies other than those
in which we earn revenues. In particular, this situation exists for us with
respect to our Brazilian operations, which have sales denominated in the U.S.
dollar
14
and the Euro. In 2006, total sales generated by Tecumseh do Brasil amounted to
approximately 41% of total Compressor Products segment sales.
In addition, since our financial statements are denominated in U.S. dollars,
changes in currency exchange rates between the U.S. dollar and other currencies
have had, and will continue to have, an impact on our earnings. While we
customarily enter into financial transactions to mitigate these risks, we cannot
assure that currency exchange rate fluctuations will not adversely affect our
results of operations and financial condition. In addition, while the use of
currency hedging instruments may provide us with protection from adverse
fluctuations in currency exchange rates, by utilizing these instruments we
potentially forego the benefits that might result from favorable fluctuations in
currency exchange rates.
We also face risks arising from the imposition of exchange controls and currency
devaluations. Exchange controls may limit our ability to convert foreign
currencies into U.S. dollars or to remit dividends and other payments by our
foreign subsidiaries or businesses located in or conducted within a country
imposing controls. Currency devaluations result in a diminished value of funds
denominated in the currency of the country instituting the devaluation. Actions
of this nature, if they occur or continue for significant periods of time, could
have an adverse effect on our results of operations and financial condition in
any given period.
OUR BUSINESSES OPERATE IN HIGHLY COMPETITIVE MARKETS.
Our businesses generally face substantial competition in each of their
respective markets. We compete on the basis of product design, quality,
availability, performance, customer service and price. Present or future
competitors may have greater financial, technical or other resources which could
put us at a disadvantage in the affected business or businesses. We cannot
assure you that these and other factors will not have a material adverse effect
on our results of operations.
In particular, our three business segments operate in environments where
worldwide productive capacities exceed global demand and customers and
competitors are establishing new productive capacities in low cost countries,
including China. These trends have resulted in the need for us to restructure
our operations by removing excess capacities, lowering our cost of purchased
inputs and shifting productive capacities to low cost countries in order to
improve our overall cost structure, restore margins and improve our competitive
position in our major markets. There is no guarantee that these initiatives,
which have included plant closures, headcount reductions, expanded operations in
low-cost countries (including China, India and Brazil) and global sourcing
initiatives, will be successful in setting the stage for improvement in
profitability in the future.
MATERIAL COST INFLATION COULD ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.
We are experiencing material cost inflation in a number of our businesses. We
are striving for greater productivity improvements and implementing increases in
selling prices to help mitigate cost increases in base materials such as copper,
aluminum, steel, resins, as well as other input costs including ocean freight,
fuel, health care and insurance. We also are continuing to implement our
excellence in operations initiatives in order to continuously reduce our costs.
We cannot assure you, however, that these actions will be successful to manage
our costs or increase our productivity. Continued cost inflation or failure of
our initiatives to generate cost savings or improve productivity may negatively
impact our results of operations.
15
SEASONALITY OF SALES AND WEATHER CONDITIONS MAY ADVERSELY AFFECT OUR
FINANCIAL RESULTS.
We experience seasonal and weather-related fluctuations in demand in each of our
segments. End-user demand for equipment, particularly air conditioners, lawn and
garden products, portable power generators and snow throwers, follows weather
trends, water patterns (such as heavy droughts or flooding) or can be related to
natural catastrophes. We cannot assure you that seasonality and weather
conditions will not have a material adverse effect on our results of operations.
OUR RESULTS OF OPERATIONS MAY BE NEGATIVELY IMPACTED BY LITIGATION.
Our business exposes us to potential litigation, especially product liability
suits that are inherent in the design, manufacture, and sale of our products.
These claims can be expensive to defend and can divert the attention of
management and other personnel for significant periods of time, regardless of
the ultimate outcome.
As we self-insure a portion of product liability claims, an unsuccessful defense
of a product liability claim or series of successful claims could materially and
adversely affect our product reputation and our financial condition, results of
operations, and cash flows. Even if we are successful in defending against a
claim relating to our products, claims of this nature could cause our customers
to lose confidence in our products and our Company.
WE ARE EXPOSED TO POLITICAL, ECONOMIC AND OTHER RISKS THAT ARISE FROM
OPERATING A MULTINATIONAL BUSINESS.
Sales outside of North America, including export sales from North American
businesses, accounted for approximately 52% of our net sales in 2006. Further,
certain of our businesses obtain raw materials and finished goods from foreign
suppliers. Accordingly, our business is subject to the political, economic and
other risks that are inherent in operating in numerous countries. These risks
include:
- the difficulty of enforcing agreements and collecting receivables
through foreign legal systems;
- trade protection measures and import or export licensing
requirements;
- tax rates in certain foreign countries that exceed those in the
U.S. and the imposition of withholding requirements on foreign
earnings;
- the imposition of tariffs, exchange controls or other
restrictions;
- difficulty in staffing and managing widespread operations and the
application of foreign labor regulations;
- the protection of intellectual property in foreign countries may
be more difficult;
- required compliance with a variety of foreign laws and
regulations; and
- changes in general economic and political conditions in countries
where we operate, particularly in emerging markets.
Our business success depends in part on our ability to anticipate and
effectively manage these and other risks.
16
OUR OPERATIONS ARE SUBJECT TO EXTENSIVE ENVIRONMENTAL LAWS AND REGULATIONS.
Our plants and operations are subject to increasingly stringent environmental
laws and regulations in all of the countries in which we operate, including laws
and regulations governing emissions to air, discharges to water and the
generation, handling, storage, transportation, treatment and disposal of waste
materials. While we believe that we are in compliance in all material respects
with these environmental laws and regulations, we cannot assure that we will not
be adversely impacted by costs, liabilities or claims with respect to existing
or subsequently acquired operations, under either present laws and regulations
or those that may be adopted or imposed in the future. We are also subject to
laws requiring the cleanup of contaminated property. If a release of hazardous
substances occurs at or from any of our current or former properties or at a
landfill or another location where we have disposed of hazardous materials, we
may be held liable for the contamination, and the amount of such liability could
be material.
WE MAY BE ADVERSELY IMPACTED BY WORK STOPPAGES AND OTHER LABOR MATTERS.
As of December 31, 2006, we employed approximately 18,500 persons worldwide.
Approximately 700 of our U.S. employees are represented by various unions under
collective bargaining agreements with various unions. The majority of foreign
location personnel are represented by national trade unions. While we have no
reason to believe that we will be impacted by work stoppages and other labor
matters, we cannot assure you that future issues with our labor unions will be
resolved favorably or that we will not encounter future strikes, further
unionization efforts or other types of conflicts with labor unions or our
employees. Any of these factors may have an adverse effect on us or may limit
our flexibility in dealing with our workforce. In addition, many of our
customers have unionized work forces. Work stoppages or slow-downs experienced
by our customers could result in slow-downs or closures at vehicle assembly
plants where our engines are installed. If one or more of our customers
experience a material work stoppage, it could have a material adverse effect on
our business, results of operations and financial condition.
OUR PRODUCTS ARE SUBJECT TO RECALL FOR PERFORMANCE RELATED ISSUES.
We incur product recall costs when we decide, either voluntarily or
involuntarily, to recall a product through a formal campaign to solicit the
return of specific products due to a known or suspected performance issue. Costs
typically include the cost of the product, part or component being replaced,
customer cost of the recall and labor to remove and replace the defective part
or component. When a recall decision is made, we estimate the cost of the recall
and record a charge to earnings in that period. In making this estimate,
judgment is required as to the quantity or volume to be recalled, the total cost
of the recall campaign, the ultimate negotiated sharing of the cost between us
and the customer and, in some cases, the extent to which the supplier of the
part or component will share in the recall cost. As a result, these estimates
are subject to change. Due to the nature of these actions, several recalls
experienced simultaneously or one of particular significance could materially
and adversely affect our financial condition, results of operation and cash
flows.
INCREASED OR UNEXPECTED PRODUCT WARRANTY CLAIMS COULD ADVERSELY AFFECT US.
We provide our customers a warranty on products we manufacture. Our warranty
generally provides that products will be free from defects for periods ranging
from 12 months to 36 months. If a product fails to comply with the warranty, we
may be obligated, at our expense, to correct any defect by repairing or
replacing the defective product. Although we maintain warranty reserves in an
amount based primarily on the number of units shipped and on historical and
anticipated warranty claims, there can be no assurance that future warranty
claims will follow historical patterns or that we can accurately anticipate the
level of future warranty claims. An increase in the rate of warranty claims or
17
the occurrence of unexpected warranty claims could materially and adversely
affect our financial condition, results of operations and cash flows.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2. PROPERTIES
Our headquarters are located in Tecumseh, Michigan, approximately 50 miles
southwest of Detroit. At December 31, 2006 we had 42 properties worldwide
occupying approximately 9.2 million square feet with the majority, approximately
8.3 million square feet, devoted to manufacturing. Eighteen facilities with
approximately 5.4 million square feet were located in eight countries outside
the United States. The following table shows the approximate amount of space
devoted to each of our three principal business segments.
Approximate Floor
Industry Segment Area in Square Feet
- ---------------- -------------------
Compressor Products ............ 4,941,000
Electrical Component Products .. 1,853,000
Engine & Power Train Products .. 2,238,000
Other .......................... 181,000
All owned and leased properties are suitable, well maintained and equipped for
the purposes for which they are used. We consider that our facilities are
suitable and adequate for the operations involved.
ITEM 3. LEGAL PROCEEDINGS
LITIGATION WITH TODD W. HERRICK AND HIS ASSOCIATES
On March 6, 2007, the Company and three members of its board of directors were
named as subjects of a lawsuit filed by Todd W. Herrick, our former Chief
Executive Officer, and Herrick Foundation (a Michigan non-profit corporation) in
the Circuit Court for the County of Lenawee, Michigan. The lawsuit sought to
overturn actions taken by our board of directors at their February 28, 2007
meeting. On March 15, 2007, the Company filed a separate lawsuit in the United
States District Court for the Eastern District of Michigan against Todd W.
Herrick, Herrick Foundation and its Board of Trustees (consisting of Todd
Herrick, Kent Herrick and Michael Indenbaum), and Toni Herrick (a trustee along
with Todd Herrick of various Herrick trusts) (collectively, "Herrick entities")
seeking the suspension of the Herrick entities' stock voting rights.
On April 2, 2007, a settlement agreement was signed by the Company, the three
members of the board of directors named in the suit, and the Herrick entities,
fully settling both lawsuits. The terms of the settlement agreement were
disclosed in a Current Report on Form 8-K that we filed on April 10, 2007.
JUDICIAL RESTRUCTURING FOR BRAZILIAN ENGINE MANUFACTURING SUBSIDIARY
On March 22, 2007, TMT Motoco, our Brazil-based engine manufacturing subsidiary,
filed a request in Brazil for court permission to pursue a judicial
restructuring. The requested protection under Brazilian bankruptcy law is
similar to a U.S. filing for Chapter 11 protection in that during such a
restructuring TMT Motoco would remain in possession of its assets and its
creditors could not
18
impose an involuntary restructuring on it. TMT's restructuring request was
granted by the court on March 28.
TMT Motoco requested the judicial restructuring following the rejection of its
request for a temporary stay pending its appeal of a Brazilian court's decision,
entered on March 15, 2007, denying its request to impose financial restructuring
terms on two of its lenders.
TMT Motoco has suspended operations and, with the consent of its unions, has
placed its employees on vacation furlough.
TMT Motoco and a majority of its lenders had previously signed an out-of-court
restructuring agreement extending payment dates for TMT Motoco's debt on the
same terms sought to be imposed on the two dissenting lenders in the court
action. In conjunction with its March 15th ruling, the Brazilian court lifted a
stay that had previously prevented one of the dissenting banks from pursuing
collection proceedings. The court also implemented sweep procedures for TMT
Motoco's bank accounts. These actions had the effect of accelerating TMT
Motoco's debt to the dissenting bank, making it all due and payable and enabling
the bank to pursue its remedies for collection under Brazilian law. TMT Motoco
had also asked the Brazilian court for injunctive relief to suspend the outcome
of the ruling pending its appeal; that request, however, was denied. TMT
Motoco's appeal has been withdrawn.
The filing in Brazil constituted an event of default with our domestic lenders.
On April 9, 2007 we obtained further amendments to our First and Second Lien
Credit Agreements that cured the cross-default provisions triggered by the
filing in Brazil. The details of these agreements are discussed below in
"Adequacy of Liquidity Sources" and in Note 10, "Debt."
ENVIRONMENTAL PROCEEDINGS
We have 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 our 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 2003, we 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 our 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, we have 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. We believe 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, we completed the
transfer of title to the Sheboygan Falls, Wisconsin property to PRS.
The total cost of the Liability Transfer Agreement to us, including the cost of
the insurance policies, was $39.2 million. We 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. We continue to maintain an
additional
19
reserve of $0.5 million to reflect our 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 we 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, we have removed the asset and
$39.2 million of the liability from the balance sheet. While we believe the
arrangements with PRS are sufficient to satisfy substantially all of our
environmental responsibilities with respect to the Site, these arrangements do
not constitute a legal discharge or release of our 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 Wisconsin
Department of Natural Resources (the "WDNR"), and may be greater or lower than
the amount accrued.
With respect to other environmental matters, we have 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 our 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 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.
Concurrently, on December 29, 2004, the Company and two of its subsidiaries and
TRC entered into an Exit Strategy Agreement (the "Agreement"), whereby we
transferred to TRC substantially all of our 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 us.
As required by the Agreement, we 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 $41.0 million. The policy lists us 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. We believe that the Policy provides
additional assurance that the responsibilities, obligations, and liabilities
transferred and assigned by us 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 our liabilities, we believe 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 our
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 we had voluntarily agreed.
In cooperation with the WDNR, we also conducted an investigation of soil and
groundwater contamination at our Grafton, Wisconsin plant. It was determined
that contamination from
20
petroleum and degreasing products used at the plant were contributing to an
off-site groundwater plume. We 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 December 31, 2006, we had accrued $2.2
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, we are 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 December 31, 2006 and 2005, we had accrued $3.3 million and
$3.5 million, respectively, for environmental remediation, including $0.5
million in both periods relating to the Sheboygan River and Harbor Superfund
Site. As these matters continue toward final resolution, amounts in excess of
those already provided may be necessary to discharge us from 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 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.
We are 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
and asbestos-related claims, incidental to our business.
HORSEPOWER LABEL LITIGATION
A lawsuit filed against us and other defendants in Circuit Court in Illinois
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. On March 30,
2007, the Court entered an order dismissing Plaintiffs' complaint subject to the
ability to re-plead certain claims pursuant to a detailed written order to
follow. While we believe we have meritorious defenses and intend to assert them
vigorously, there can be no assurance that we will prevail. We also may pursue
settlement discussions. It is not possible to reasonably estimate the amount of
our ultimate liability, if any, or the amount of any future settlement, but the
amount could be material to our financial position, consolidated results of
operations and cash flows.
OTHER LITIGATION
We are 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 us,
management does not believe that the disposition of these other matters will
have a material adverse effect on our consolidated financial position or results
of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of 2006 to a vote of security
holders through the solicitation of proxies or otherwise.
21
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
Our Class A and Class B common stock trades on the The NASDAQ Stock Market LLC
under the symbols TECUA and TECUB, respectively. Total shareholders of record as
of February 21, 2007 were approximately 347 for Class A common stock and 341 for
Class B common stock. Under the terms of our First and Second Lien credit
agreements, no dividends could be paid after February 6, 2006 and prior to
December 31, 2006, and after that date minimum amounts of credit availability
were required. We have no near-term expectation to resume dividend payments.
There were no equity securities sold by the Company during the period covered by
this report. We have no equity securities authorized for issuance under
compensation plans. We did not repurchase any of our equity securities during
2006.
MARKET PRICE AND DIVIDEND INFORMATION
Range of Common Stock Prices and Dividends for 2006
Sales Price
---------------------------------
Class A Class B Cash
--------------- --------------- Dividends
Quarter Ended High Low High Low Declared
- ------------- ------ ------ ------ ------ ---------
March 31 ...... $25.66 $21.45 $22.53 $18.42 $--
June 30 ....... 25.32 17.02 21.77 15.14 --
September 30 .. 21.16 13.83 18.15 13.44 --
December 31 ... 18.91 14.62 18.34 14.71 --
Range of Common Stock Prices and Dividends for 2005
Sales Price
---------------------------------
Class A Class B Cash
--------------- --------------- Dividends
Quarter Ended High Low High Low Declared
- ------------- ------ ------ ------ ------ ---------
March 31 ...... $48.38 $38.02 $45.60 $36.25 $0.32
June 30 ....... 41.07 25.83 40.30 26.14 0.32
September 30 .. 30.91 21.01 31.13 20.38 --
December 31 ... 24.00 18.65 21.92 16.01 --
22
ITEM 6. SELECTED FINANCIAL DATA
The following is a summary of certain of our financial information.
YEARS ENDED DECEMBER 31,
----------------------------------------------------
(Dollars in millions, except per share data) 2006 2005 2004 2003 2002
-------- -------- -------- -------- --------
Net sales .................................. $1,769.1 $1,740.7 $1,797.4 $1,705.3 $1,234.4
Cost of sales and operating expenses ....... 1,674.0 1,635.3 1,582.6 1,506.9 1,074.0
Selling and administrative expenses ........ 180.5 168.7 184.1 141.3 89.3
Impairments, restructuring charges,
and other items ......................... 32.3 121.0 21.5 69.3 10.3
-------- -------- -------- -------- --------
Operating income (loss) .................... (117.7) (184.3) 9.2 (12.2) 60.8
Interest expense ........................... (46.0) (24.8) (22.7) (22.8) (5.8)
Interest income and other, net ............. 11.2 9.6 14.0 21.1 15.1
-------- -------- -------- -------- --------
Income (loss) before taxes and
cumulative effect of accounting
change .................................. (152.5) (199.5) 0.5 (13.9) 70.1
Tax provision (benefit) .................... (22.5) 26.9 (0.2) (5.6) 24.6
-------- -------- -------- -------- --------
Income (loss) before cumulative effect
of accounting change .................... (130.0) (226.4) 0.7 (8.3) 45.5
Cumulative effect of accounting change
for goodwill, net of tax ................ -- -- -- -- (3.1)
-------- -------- -------- -------- --------
Net income (loss) from continuing
operations .............................. (130.0) (226.4) 0.7 (8.3) 42.4
-------- -------- -------- -------- --------
Income from discontinued operations,
net of tax .............................. 49.7 2.9 9.4 8.4 8.6
Net income (loss) .......................... ($80.3) (223.5) $ 10.1 $ 0.1 $ 51.0
======== ======== ======== ======== ========
Basic and diluted earnings (loss) per
share:
Earnings (loss) per share from
continuing operations ................... ($7.03) ($12.25) $ 0.04 ($0.45) $ 2.46
Earnings per share from discontinued
operations, net of tax .................. 2.69 0.16 0.51 0.46 0.47
-------- -------- -------- -------- --------
Basic and diluted earnings (loss) per
share ................................... ($4.34) ($12.09) $ 0.55 $ 0.01 $ 2.93
======== ======== ======== ======== ========
Cash dividends declared per share .......... -- $ 0.64 $ 1.28 $ 1.28 $ 1.28
Weighted average number of shares
outstanding (in thousands) .............. 18,480 18,480 18,480 18,480 18,480
Cash and cash equivalents .................. $ 81.9 $ 116.6 $ 227.9 $ 344.6 $ 333.1
Working capital ............................ 226.3 402.0 505.7 545.5 503.7
Net property, plant and equipment .......... 552.4 578.6 554.8 554.6 570.5
Total assets ............................... 1,782.7 1,800.5 2,062.8 2,105.8 2,063.0
Long-term debt ............................. 217.3 283.0 317.3 327.6 298.2
Stockholders' equity ....................... 798.4 814.4 1,018.3 1,004.8 978.9
Capital expenditures ....................... 62.1 113.3 84.0 82.8 73.9
Depreciation and amortization .............. 80.1 92.3 102.9 97.6 65.1
23
Impairments, restructuring charges, and other items included:
2006 operating net loss included $32.3 million ($1.75 per share) of
restructuring, impairment and other charges. $27.1 million of this amount was
recorded by the Engine Group as part of its ongoing restructuring programs, for
impairment charges for long-lived assets ($24.1 million) and other restructuring
charges ($3.0 million). $2.8 million in asset impairments were recorded by the
Electrical Components Group for various plant consolidation activities. Finally,
the Compressor Group recorded $2.4 million in restructuring charges, for
impairment of long-lived assets ($2.2 million) and related charges ($0.2
million) at two of its facilities in Mississippi.
2005 net loss included $121.0 million ($6.55 per share) of restructuring,
impairment and other charges. Of this amount, $108.0 million related to
impairment of the goodwill associated with the 2002 acquisition of FASCO (which
is included in the Electrical Components segment), an impairment charge of $2.7
million related to the goodwill associated with the 2001 acquisition of the
Engine & Power Train's Czech Republic operations and a $2.7 million impairment
charge related to the intangible assets associated with the 2001 acquisition of
Manufacturing Data Systems, Inc., a technology business not associated with any
of the Company's three main segments. In addition to these impairments, we
incurred $7.6 million in asset impairment and restructuring charges. The Italian
Engine & Power Train operations recorded $1.4 million of termination costs
during the third quarter related to previously announced intent to reduce its
workforce by 115 persons. We then recorded a $3.0 million charge upon the
closure of this operation at the end of December reflecting our net investment
in that operation. The remaining charges include $0.9 million recorded by the
North American Compressor operations related to additional moving costs for
previously announced actions and $2.3 million of asset impairment charges across
several segments for manufacturing equipment idled through facility
consolidations and the reduction to fair value of land and buildings associated
with closed plants.
2004 net income included $21.5 million ($14.0 million net of tax or $0.77 per
share) of restructuring, impairment and other charges. Of this amount, $8.7
million ($5.6 million net of tax or $0.30 per share) was related to
restructuring programs related to the North American Compressor, Indian
Compressor and Electrical Components businesses; $14.6 million ($9.6 million net
of tax or $0.53 per share) was related to environmental costs involving our New
Holstein, Wisconsin facility; and $1.8 million ($1.2 million net of tax or $0.06
per share) in gain was related to the final curtailment of medical benefits
related to former hourly employees of the Sheboygan Falls, Wisconsin Plant.
2003 net income included $69.3 million ($55.0 million net of tax or $2.98 per
share) of restructuring, impairment and other charges. Of this amount, $13.6
million ($8.7 million net of tax or $0.47 per share) was related to
environmental costs at our Sheboygan Falls, Wisconsin facility; $32.0 million in
charges and $5.8 million in gains equaling a net charge of $26.2 million ($16.8
million net of tax or $0.91 per share) related to restructuring actions
involving the Engine & Power Train business. Additionally, $29.5 million before
and after tax (or $1.60 per share) related to an impairment of goodwill
associated with our European Compressor operations.
2002 net income included $10.3 million ($6.6 million net of tax or $0.36 per
share) in restructuring charges. Of this amount, the Engine & Power Train
business had a charge of $5.8 million ($3.7 million net of tax or $0.20 per
share) which included $4.1 million for costs, mostly write-downs of fixed
assets, associated with the relocation of engine component manufacturing, and
the discontinuation of production activities at its Grafton, Wisconsin facility
and $1.7 million for additional environmental cleanup costs, primarily
additional past response costs levied by the EPA for its Sheboygan, Wisconsin
facility. Additionally, the Compressor business had a charge of $4.5 million
($2.8 million net of tax or $0.15 per share) for costs related to the relocation
of additional
24
rotary compressor lines from the U.S. to Brazil, primarily the write-off of
certain unusable equipment.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CAUTIONARY STATEMENTS RELATING TO FORWARD LOOKING STATEMENTS
The following information should be read in connection with the information
contained in the Consolidated Financial Statements and Notes to Consolidated
Financial 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) the ability of the Company to maintain adequate liquidity in
total and within each foreign operation; ii) the success of our ongoing effort
to bring costs in line with projected production levels and product mix; iii)
weather conditions affecting demand for air conditioners, lawn and garden
products, portable power generators and snow throwers; iv) availability and cost
of materials, particularly commodities, including steel, copper and aluminum,
whose cost can be subject to significant variation; v) financial market changes,
including fluctuations in interest rates and foreign currency exchange rates;
vi) actions of competitors; vii) changes in business conditions and the economy
in general in both foreign and domestic markets; viii) the effect of terrorist
activity and armed conflict; ix) economic trend factors such as housing starts;
x) emerging governmental regulations; xi) the ultimate cost of resolving
environmental and legal matters; xii) our ability to profitably develop,
manufacture and sell both new and existing products; xiii) 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; xiv) the extent
of any business disruption caused by work stoppages initiated by organized labor
unions; xv) potential political and economic adversities that could adversely
affect anticipated sales and production in Brazil; xvi) potential political and
economic adversities that could adversely affect anticipated sales and
production in India, including potential military conflict with neighboring
countries; xvii) our ability to reduce a substantial amount of costs in the
Engine & Power Train group associated with excess capacity, and xviii) 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.
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 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 endeavoring to maintain
and expand our business with our existing customers in our more
25
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 has introduced a scroll-style compressor to serve commercial markets
throughout the globe, and it has begun producing a new expanded range rotary
compressor in India for global applications. Our Electrical Components Group has
expanded its range of Brushless DC ("BLDC") variable speed motor products. 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 52% of total
consolidated net sales in 2006. The Company's dependence on sales in foreign
countries entails certain commercial and political risks, including currency
fluctuations, unstable economic or political conditions in some areas and the
possibility of various government interventions into trade policy. We have
experienced some of these factors and continue to carefully pursue these
markets.
Our operating results are indicative of the environment that manufacturers face
in today's global economy. The addition of new productive capacities in low-cost
locations, like China, has resulted in new capacities and deflationary pricing
in many of the market segments in which we operate. Like many of our customers
and competitors, we have restructured older operations to remain cost
competitive, including the movement of productive capacities to low-cost
locations or nearer to customer facilities. These restructurings involve
significant costs, in both financial and human terms. In addition, many of our
markets are subject to macroeconomic 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. Until recently, our Curitiba, Brazil facility, TMT Motoco, provided
full engine assemblies to supply worldwide demand for lawn and garden engines.
In November of 2006, TMT Motoco executed a restructuring agreement with the
majority of its lenders, whereby scheduled maturities of its debt were deferred
for eighteen months, with subsequent amortization over the following eighteen
months. One of its lenders, representing less than 20% of TMT Motoco's
outstanding debt, did not concur with the restructuring agreement, and filed a
motion in Brazilian court seeking to collect its debt. In March of 2007, the
Brazilian court overturned the restructuring agreement. As a result, TMT Motoco
is pursuing a judicial restructuring, similar to a U.S. Chapter 11 bankruptcy
filing. TMT Motoco will remain in possession of its assets during the
restructuring process.
The filing in Brazil constituted an event of default with our domestic lenders.
On April 9, 2007 we obtained further amendments to our First and Second Lien
Credit Agreements that cured the cross-default provisions triggered by the
filing in Brazil. The details of these agreements are discussed below in
"Adequacy of Liquidity Sources" and in Note 10, "Debt."
Our management continues to assess the potential impact, if any, on our other
businesses. We are working to protect these other businesses from any adverse
effects of the events at TMT Motoco to the greatest extent possible. In
particular, we are working to ensure that our Brazilian compressor subsidiary,
Tecumseh do Brasil, maintains its credit facilities and continues to
successfully meet its obligations to its suppliers and customers. Tecumseh do
Brasil provided a significant portion of total Compressor Products segment
production during 2006.
26
As a global manufacturer with production in 11 countries and sales in over 110
countries throughout the world, our results are sensitive to changes in foreign
currency exchange rates. In total, those movements were not favorable to us
during 2005 and 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, and as a
result have secured approximately 32% of our currency requirements for the
Compressor business unit for the upcoming year. However, these hedging programs
only reduce exposure to currency movements over the limited time frame of three
to fifteen months. Ultimately, long term changes in currency exchange rates have
lasting effects on the relative competitiveness of operations located in certain
countries versus competitors located in different countries.
Lastly, commodity prices increased very rapidly during 2004, 2005 and 2006. Due
to competitive markets and the rapid escalation of these costs, we were not able
to fully recover these cost increases through price increases and other cost
savings. Increases in certain raw material, energy and commodity costs had a
material adverse impact on our operating results during these periods. For
example, from January 1, 2005 through December 31, 2006, the prices of copper
and aluminum have increased approximately 92% and 33%, respectively. 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, including
seeking mechanisms that would result in more timely adjustment of pricing in
reaction to changing material costs. 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. As we raise prices to cover cost increases, it
is possible that our customers may react by choosing to purchase their
requirements from alternative suppliers.
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 cash flows in the past; however, seasonal patterns and the need to build
inventories to manage production transfers during restructuring programs have
recently caused higher working capital needs. As we complete these restructuring
programs, we expect our need for these higher working capital levels to be
reduced. Our cash flow is also highly sensitive to the price of copper and other
commodities and our ability to recover higher commodity costs. While we have
been proactive in addressing the volatility of these costs, including executing
forward purchase contracts to cover approximately 75% of our anticipated copper
requirements for 2007, continued rapid escalation of these costs would
nonetheless have an adverse effect on our results of operations both in the near
and long term. Any such increases in cost that could not be recovered through
advances in selling prices would make it more difficult for us to achieve our
business plans and to remain in compliance with the adjusted EBITDA covenants
included in our financing arrangements. We are currently in compliance with
these covenants, and have amended our First and Second Lien Credit agreements to
become compliant with the cross-default provisions of those agreements. Our
continued compliance with our covenants is dependent on a significant
improvement in our operating results from those reported in 2006. Failure to
maintain compliance with these covenants would have a material adverse effect on
our financial position, results of operations and cash flows. See "Adequacy of
Liquidity Sources" for additional discussion. 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.
27
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.
Finally, there have been recent developments in our top management structure, as
well as the composition of our board of directors. Our new Second Lien Credit
Agreement, established in November of 2006, included a commitment to create an
advisory committee to assist our board of directors in working with a nationally
recognized executive recruiting firm and to recommend to the board qualified
candidates for various executive management positions, including the Chief
Executive Officer position. The committee, consisting of two members of our
board of directors, as well as a representative from our second lien lender, has
engaged a search firm and is currently in the process of interviewing candidates
for this position.
On January 19, 2007, a special committee of our board of directors appointed
James J. Bonsall interim President and Chief Operating Officer, a new position.
Mr. Bonsall will function as our principal executive officer until a new Chief
Executive Officer is appointed. Todd W. Herrick, our former Chief Executive
Officer, stepped aside from that position in January.
Subsequent to these actions, on March 6, 2007, the Company and three members of
its board of directors were named as subjects of a lawsuit filed by Todd W.
Herrick, our former Chief Executive Officer, and Herrick Foundation (a Michigan
non-profit corporation) in the Circuit Court for the County of Lenawee,
Michigan. The lawsuit sought to overturn actions taken by our board of directors
at their February 28, 2007 meeting. On March 15, 2007, the Company filed a
separate lawsuit in the United States District Court for the Eastern District of
Michigan against Todd W. Herrick, Herrick Foundation and its Board of Trustees
(consisting of Todd Herrick, Kent Herrick and Michael Indenbaum), and Toni
Herrick (a trustee along with Todd Herrick of various Herrick trusts)
(collectively, "Herrick entities") seeking the suspension of the Herrick
entities' stock voting rights.
On April 2, 2007, a settlement agreement was signed by the Company, the three
members of the board of directors named in the suit, and the Herrick entities,
fully settling both lawsuits. The terms of the settlement agreement were
disclosed in a Current Report on Form 8-K that we filed on April 10, 2007.
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" above, "Results of Operations" below, and "Risk Factors" in Item 1A.
28
RESULTS OF OPERATIONS
A summary of our operating results as a percentage of net sales is shown below
(dollar amounts in millions):
FISCAL YEAR ENDED DECEMBER 31, 2006 VS. FISCAL YEAR ENDED DECEMBER 31, 2005
Fiscal Year Ended December 31,
(dollars in millions) 2006 % 2005 %
-------- ----- -------- -----
Net sales ............................................ $1,769.1 100.0% $1,740.7 100.0%
Cost of sales and operating expenses ................. 1,674.0 94.6% 1,635.3 93.9%
Selling and administrative expenses .................. 180.5 10.2% 168.7 9.7%
Impairments, restructuring charges, and other items .. 32.3 1.8% 121.0 7.0%
-------- --------
Operating loss ....................................... (117.7) (6.6%) (184.3) (10.6%)
Interest expense ..................................... (46.0) (2.6%) (24.8) (1.4%)
Interest income and other, net ....................... 11.2 0.6% 9.6 0.5%
-------- --------
Loss before taxes .................................... (152.5) (8.6%) (199.5) (11.5%)
Tax provision (benefit) .............................. (22.5) 1.3% 26.9 (1.5%)
-------- --------
Net loss from continuing operations .................. ($130.0) (7.3%) ($226.4) (13.0%)
======== ========
Net sales in the year ended December 31, 2006 increased $28.4 million or 1.6%
versus the same period of 2005. Excluding the increase in sales due to the
effect of changes in foreign currency translation of $41.9 million, net sales
decreased 0.8% from the prior year. Increases in sales volume in the Compressor
and Electrical Components Groups were more than offset by a substantial decline
in volumes in the Engine & Power Train segment.
Gross profit and gross margin were $95.1 million and 5.4% in the year ended
December 31, 2006, as compared to $105.4 million and 6.1% in the fiscal year
ended December 31, 2005. Gross profit was negatively affected by the impact of
commodity costs, which were $27.8 million higher in the current year net of
pricing adjustments. While pricing increases helped to mitigate the impact of
the commodity increases, due to the rapid escalation of commodity pricing none
of the segments were able to achieve complete recovery for the full year. Gross
profit was also negatively affected by unfavorable foreign exchange rates,
particularly the Brazilian Real. Currency costs, net of hedging, impacted 2006
results unfavorably by $21.8 million. Production and purchasing inefficiencies
in our Juarez, Mexico facility, due to Oracle implementation issues and improper
material resource planning exacerbated by high levels of personnel turnover,
resulted in unfavorable costs year-on-year of approximately $10.5 million. These
unfavorable results were somewhat offset by purchasing and other operational
improvements of $19.0 million, driven primarily by restructuring efforts in the
Engine Group. A favorable court ruling resulting in the reversal of a reserve
for non-income taxes in Brazil also contributed $6.6 million to 2006 results.
Gross profit was favorably impacted in both periods by net pension benefit
income that was recorded as a result of the over-funding of the majority of our
pension plans. This income totaled $12.8 million and $13.1 million in 2006 and
2005 respectively.
Selling, general and administrative expenses were $11.8 million or 7.0% higher
in the fiscal year ended December 31, 2006 compared to the prior fiscal year. As
a percentage of net sales, selling, general and administrative expenses were
10.2% and 9.7% in the fiscal years ended December 31, 2006 and December 31,
2005, respectively. The increase was primarily related to AlixPartners' fees
29
of $21.1 million for consulting services provided to our Engine & Power Train
business, compared to $7.8 million in 2005. Corporate expenses also increased by
$7.1 million, due primarily to increases in costs for consulting and auditing
costs ($4.9 million) and the roll-out of our new ERP platform ($1.5 million).
These cost increases were somewhat offset by improvements in warranty costs
($6.7 million) and engineering costs ($3.2 million) in the Engine Group.
Impairments, restructuring charges and other items were $32.3 million in 2006.
$27.1 million of this amount was recorded by the Engine Group, for impairment
charges for long-lived assets ($24.1 million) and other restructuring charges
($3.0 million). $2.8 million in asset impairments were recorded by the
Electrical Components Group for various plant consolidation initiatives.
Finally, the Compressor Group recorded $2.4 million in restructuring charges,
for impairment of long-lived assets ($2.2 million) and related charges ($0.2
million) at two of its facilities in Mississippi.
2005 results included an impairment charge of $108.0 million generated from the
goodwill associated with the acquisition of FASCO (which is included in the
Electrical Components segment), an impairment charge of $2.7 million related to
the goodwill associated with the Engine & Power Train's Czech Republic
operations and a $2.7 million impairment charge related to the intangible assets
at Manufacturing Data Systems, Inc. ("MDSI"), a technology business not
associated with any of our three main segments.
The failure to achieve the 2005 business plan, coupled with expected market
conditions, deterioration of volumes and our inability to recover higher
commodity and transportation costs through price increases resulted in revised
expected cash flows for FASCO. Based on the revised estimates of cash flow,
FASCO's estimated fair value had deteriorated from the previous assessment and,
as a result, a goodwill impairment of $108.0 million was recognized.
Our annual fourth quarter goodwill assessment in 2005 also revealed that the
expected cash flows were lower than had previously been estimated for both the
Engine & Power Train Group's Czech Republic operation and at MDSI, resulting in
goodwill impairments at each of those locations that represented the entire
carrying value recorded.
In addition to these impairments, we incurred $7.6 million in asset impairment
and restructuring charges during the fiscal year ended December 31, 2005. The
Italian Engine & Power Train operations recorded $1.4 million of termination
costs during the third quarter related to a previously announced intent to
reduce its workforce by 115 persons. We then recorded a $3.0 million charge upon
the closure of this operation at the end of December reflecting our net
investment in that operation.
The remaining 2005 charges include $0.9 million recorded by the North American
Compressor operations related to additional moving costs for previously
announced actions and $2.3 million of asset impairment charges across several
segments for manufacturing equipment idled through facility consolidations and
the reduction of carrying value of closed plants to fair value.
Interest expense amounted to $46.0 million in the fiscal year ended December 31,
2006 compared to $24.8 million in the comparable period of 2005. The increase
was primarily related to higher average interest rates applicable to our
borrowings both in the United States and in a number of our foreign locations.
In addition, $6.7 million in one-time costs associated with the write-off of
previously capitalized loan origination costs affected results. These write-offs
were the result of our bank refinancing in the first quarter ($3.7 million) and
again in the fourth quarter ($3.0 million) of 2006.
30
Interest income and other, net amounted to $11.2 million in the fiscal year
ended December 31, 2006 compared to $9.6 million in the same period 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 our interest in Kulthorn Kirby Public
Company Limited, a manufacturer of compressors based in Thailand, during the
first quarter. The sale of the stock was completed in conjunction with the end
of a licensing agreement between our Compressor operations and Kulthorn Kirby.
The consolidated statement of operations reflects a $22.5 million income tax
benefit for the fiscal year ended December 31, 2006. Income taxes are recorded
pursuant to SFAS No. 109, "Accounting for Income Taxes," which 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 or discontinued operations), tax expense is
first allocated to the other sources of income with a related benefit recorded
in continuing operations. The full year results of 2006 reflected a tax benefit
in continuing operations and tax expense in other comprehensive income and
discontinued operations. After giving consideration for the allocation of taxes
across these categories, our net effective tax rate for U.S. continuing
operations was 0% in both 2006 and 2005. The net effective tax rate for foreign
continuing operations was (14.7%) and (23.2%) in 2006 and 2005 respectively.
At December 31, 2006 and 2005, full valuation allowances are recorded for net
operating loss carryovers for those tax jurisdictions in which the preponderance
of negative evidence would indicate that these deferred tax assets would not be
recoverable. Valuation allowances were also established against remaining
foreign deferred tax assets in Brazil in 2006 (aggregating approximately $5.9
million) due to negative evidence resulting in a determination that it is no
longer more likely than not that the assets will be realized.
We recorded income tax expense of $26.9 million on a loss before taxes of $199.5
million for the fiscal year ended December 31, 2005. The primary differences in
our tax rate for fiscal 2006 as compared with 2005 were the non-deductibility of
the goodwill and other intangible asset impairments recognized in 2005 and the
recognition of deferred tax asset valuation allowances during the third quarter
of 2005 related to the Brazilian Engine operations ($7.1 million) and U.S.
jurisdiction ($18.2 million), as the preponderance of negative evidence
indicated that these deferred tax assets would not be recoverable. Excluding the
impairments and valuation allowances, the unusual result was also the product of
not providing benefits on losses in jurisdictions where the preponderance of
negative evidence would indicate that these deferred tax assets would not be
recoverable.
The effective tax rate in future periods may vary from the 35% used in prior
years based upon changes in the mix of profitability between the jurisdictions
where benefits on losses are not provided versus other jurisdictions where
provisions and benefits are recognized. In addition, circumstances could change
such that additional valuation allowances may become necessary on deferred tax
assets in various jurisdictions.
Net loss in the fiscal year ended December 31, 2006 was $130.0 million, or $7.03
per share, as compared to net loss of $226.4 million, or $12.25 per share, in
the fiscal year ended December 31, 2005. The current period improvement was
primarily the result of the absence of further goodwill impairments in the
current year and lower deferred tax asset valuation allowances when compared to
the prior year.
31
REPORTABLE OPERATING SEGMENTS
The financial information presented below is for our three reportable operating
segments for the periods presented: Compressor, Engine & Power Train, and
Electrical Components. 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 our remaining pump business does not meet the definition
of reporting segment as defined by SFAS No. 131, "Segment Reporting," we no
longer report a Pump Products segment, and operating results of the remaining
pump business are included in Other for segment reporting purposes.
The sale of our 100% ownership interest in Little Giant Pump Company was
completed on April 21, 2006 for $120.7 million. As noted above, its results for
the twelve months ended December 31, 2006, 2005, and 2004 are included in income
from discontinued operations. We recognized a pre-tax gain on the sale of $78.0
million. The gain on the sale is presented in income from discontinued
operations and amounted to $49.7 million net of tax ($2.69 per share). The gross
proceeds from the sale were used to repay debt.
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 9, Business Segments.
Compressor Products
Compressor business sales in the fiscal year of 2006 increased 10.1% to $1,002.7
million from $910.9 million in 2005. Excluding the increase in sales due to the
effects of foreign currency translation of $39.6 million, sales increased by
5.7% in 2006. Full year sales reflected year-on-year increase in commercial
compressors (up $69.8 million), residential air conditioning (up $23.2 million),
and refrigeration and freezer compressors (up $21.9 million). While the sales
increase in the commercial product line was attributable to price advances, the
increases in residential air conditioning and in refrigeration and freezer
compressors were due to higher volumes, with unit sales improving by 25% and 20%
respectively. The improvements in compressors for residential air conditioning
were attributable to increases in volumes with key OEM's, due in part to new
product introductions as well as enhanced customer service programs. The
increases in the refrigeration and freezer product lines were primarily in
India, where we are experiencing rapid growth in new and profitable markets.
Compressor business operating loss and the related margin on net sales for the
fiscal year ended December 31, 2006 amounted to $4.5 million and 0.4% compared
to operating profit of $18.8 million and 2.1% for 2005. The effects of foreign
currency exchange rates caused a decline of $22.2 million.
32
During the fiscal year ended December 31, 2006, the U.S. Dollar was on average
5.3% weaker versus the Brazilian Real and 11.9% weaker versus the Euro than
during 2005. Compressor segment operating margin also deteriorated due to
unfavorable commodity costs. Advances in selling prices to offset increases in
commodity costs were primarily implemented in the latter half of the year, and
were not sufficient to mitigate the increase, with a net unfavorable impact to
operating results of $10.8 million. On the other hand, in the fourth quarter of
2006, the Compressor Group's Brazilian facility received a favorable court
ruling, deeming certain non-income-based taxes it had accrued on its balance
sheet as unconstitutional. The reversal of this accrual resulted in a favorable
net impact to operating results of $6.6 million for the fourth quarter and full
year 2006. The implementation of other productivity improvements over the course
of the year also yielded a favorable impact to operating profitability of $2.8
million.
Electrical Component Products
Sales for the fiscal year 2006 increased 4.8% to $429.9 million compared to
$410.1 million in 2005. Sales were higher in the residential and commercial
markets (up 7.0% in 2006) due to HVAC-related sales in the first three quarters
of the year, although these advances were due to pricing, as unit volumes were
approximately flat year on year. Sales in the automotive motor market, while
improving in the latter half of the year, were lower in the first and second
quarters as a result of lower build schedules and market share losses by our
customer at their respective OEM's. Sales in the automotive market segment were
1.9% lower for 2006 in dollar terms and 8.9% lower in terms of units sold.
Electrical Components operating loss and margin for the fiscal year of 2006
amounted to $4.7 million and 1.1% compared to an operating profit of $7.5
million and 1.8% in 2005. Full year results were impacted significantly by
commodity costs, resulting in a decline of $10.7 million net of price increases.
The group's Juarez, Mexico facility experienced significant productivity issues
in the latter half of the year, including Oracle implementation issues and
inefficient materials management exacerbated by high levels of personnel
turnover, affecting operating profitability unfavorably by $10.5 million.
However, other Electrical Components locations experienced gains in purchasing
initiatives and productivity improvements, contributing $8.9 million to results
for the current year.
Engine & Power Train Products
Engine & Power Train business sales declined 21.1% to $319.0 million in the
fiscal year ended December 31, 2006 compared to $404.1 million in the
corresponding period of 2005. The most significant decline in the year was
attributable to the loss of sales of $29.1 million into the European market from
our former Italian subsidiary, which was shut down at the end of 2005. A
year-over-year decline in sales volumes of engines used for generators reflected
the lack of a significant hurricane or other storm activity during the 2006
season, and was down $22.7 million versus the same period in 2005. In addition,
sales volumes of engines for snowthrowers declined $18.6 million as compared to
the full year 2005. Lower orders ahead of the snow season due to customer
concern regarding anticipated snowfall levels was exacerbated by lack of
significant snowfall in key geographic areas. In units sold, volumes of
snowthrower engines sold in 2006 lagged 2005 by approximately 15.0%. The
remaining sales decline was primarily attributable to a decrease in transmission
business, due to a reduction in volume with a major customer.
Engine & Power Train business operating loss in the fiscal year ended December
31, 2006 amounted to $53.8 million compared to a loss of $75.1 million in the
corresponding period of 2005. Included in the 2006 results were AlixPartners'
fees of $21.1 million (compared to $7.8 million in 2005) and a $3.5 million gain
from the sale of the Douglas, Georgia engine facility in the first quarter of
2006. Excluding these two items, operating results improved by approximately
46.2% in 2006. The
33
improvements reflected lower fixed costs associated with plant closures and
other productivity improvements, offset by the losses in margin from reduced
sales volume.
The significant costs associated with excess capacities in the U.S. and Europe
contributed substantially to the Engine & Power Train losses in 2005. The excess
capacity situation was exacerbated by the shift of production to our Brazilian
manufacturing facility resulting in duplicate capacities. We completed this
transition in 2006.
FISCAL YEAR ENDED DECEMBER 31, 2005 VS. FISCAL YEAR ENDED DECEMBER 31, 2004
Fiscal Year Ended December 31,
(dollars in millions) 2005 % 2004 %
-------- ----- -------- -----
Net sales ............................................ $1,740.7 100.0% $1,797.4 100.0%
Cost of sales and operating expenses ................. 1,635.3 93.9% 1,582.6 88.1%
Selling and administrative expenses .................. 168.7 9.7% 184.1 10.2%
Impairments, restructuring charges, and other items .. 121.0 7.0% 21.5 1.2%
-------- --------
Operating income (loss) .............................. (184.3) (10.6%) 9.2 0.5%
Interest expense ..................................... (24.8) (1.4%) (22.7) (1.3%)
Interest income and other, net ....................... 9.6 0.5% 14.0 0.8%
-------- --------
Income (Loss) before taxes ........................... (199.5) (11.5%) 0.5 *
Tax provision (benefit) .............................. 26.9 1.5% (0.2) *
-------- --------
Net income (loss) from continuing operations ......... ($226.4) (13.0%) $ 0.7 *
======== ========
* Less than 0.1%
Net sales in the year ended December 31, 2005 decreased $56.7 million or 3.2%
versus the same period of 2004, including an increase in sales of $55.6 million
resulting from the effect of changes in foreign currency exchange rates. This
was primarily due to lower volumes in the Compressor and Engine & Power Train
segments.
Gross profit and gross margin were $105.4 million and 6.1% in the year ended
December 31, 2005, as compared to $214.8 million and 11.9% in the fiscal year
ended December 31, 2004. Gross profit was negatively affected by the impact of
commodity costs, which were $98.6 million higher in relative terms. Pricing
increases helped to mitigate the impact of this increase, though neither the
Electrical Components nor Engine & Power Train segments were able to achieve
complete recovery. Gross profit was also negatively affected by unfavorable
foreign exchange rates, particularly the Brazilian Real.
Gross profit was favorably impacted in both periods by net pension benefit
income that was recorded as a result of the over-funding of the majority of our
pension plans. This income totaled $13.1 million and $14.3 million in 2005 and
2004 respectively.
Selling, general and administrative expenses were $15.4 million or 8.4% lower in
the fiscal year ended December 31, 2005 compared to the prior fiscal year. As a
percentage of net sales, selling, general and administrative expenses were 9.7%
and 10.2% in the fiscal years ended December 31, 2005 and December 31, 2004,
respectively. The completion of the amortization of non-compete agreements
associated with our 2002 acquisition of FASCO contributed $7.5 million to the
decrease in selling, general and administrative expenses in 2005.
34
2005 results included an impairment charge of $108.0 million related to the
goodwill associated with the acquisition of FASCO (which is included in the
Electrical Components segment), an impairment charge of $2.7 million related to
the goodwill associated with the acquisition of the Engine & Power Train's Czech
Republic operations and a $2.7 million impairment charge related to the
intangible assets associated with the acquisition of Manufacturing Data Systems,
Inc., a technology business not associated with any of the Company's three main
segments.
The failure to achieve the business plan, coupled with expected market
conditions, caused us to perform a mid-year assessment of the assumptions
utilized to determine FASCO's estimated fair value in the impairment assessment
performed at December 31, 2004. The deterioration of volumes and our inability
to recover higher commodity and transportation costs through price increases
resulted in revised expected cash flows for FASCO. Based on the revised
estimates of cash flow, FASCO's estimated fair value had deteriorated from the
previous assessment and, as a result, a goodwill impairment of $108.0 million
was recognized.
During our annual fourth quarter assessment, the expected cash flows were lower
than had previously been estimated resulting in goodwill impairment of $2.7
million in the Engine & Power Train Group operations and other intangible
impairment of $2.7 million at Manufacturing Data Systems, Inc., both
representing the entire carrying value recorded. The issues with the Czech
Republic operation are indicative of what we are experiencing throughout the
Engine and Power Train segment, but reflects decisions made in the fourth
quarter regarding as to where certain products will be produced in future years
and uncertainty as to our ability to bring costs down enough to meet previous
cash flow forecasts. The decreased expectations related to Manufacturing Data
Systems, Inc. reflect the fact that the operation had failed to meet key
development targets and had been recently unsuccessful in developing a market
for certain products introduced in 2005.
In addition to these impairments, we incurred $7.6 million in asset impairment
and restructuring charges during the fiscal year ended December 31, 2005. The
Italian Engine & Power Train operations recorded $1.4 million of termination
costs during the third quarter related to previously announced intent to reduce
its workforce by 115 persons. We then recorded a $3.0 million charge upon the
closure of this operation at the end of December reflecting our net investment
in that operation.
The remaining charges include $0.9 million recorded by the North American
Compressor operations related to additional moving costs for previously
announced actions and $2.3 million of asset impairment charges across several
segments for manufacturing equipment idled through facility consolidations and
the reduction of carrying value of closed plants to fair value.
In 2004, we recorded charges of $8.7 million related to restructuring programs
in the North American Compressor, Indian Compressor and Electrical Components
businesses; $14.6 million related to environmental costs involving our New
Holstein, Wisconsin facility; and a $1.8 million gain related to the final
curtailment of medical benefits related to former hourly employees of the
Sheboygan Falls, Wisconsin Plant.
Interest expense amounted to $24.8 million in the fiscal year ended December 31,
2005 compared to $22.7 million in the comparable period of 2004. The increase
was primarily related to higher average interest rates applicable to our
borrowings both in the United States and in a number of our foreign locations,
in addition to reflecting the impact of the loss of benefit previously provided
by interest rate swaps exchanging fixed rates for variable.
35
Interest income and other, net amounted to $9.6 million in the fiscal year ended
December 31, 2005 compared to $14.0 million in the same period of 2004. This
decrease resulted primarily from lower average deposits in Brazil and the United
States.
We recorded income tax expense of $26.9 million on a loss before taxes of $199.5
million for the fiscal year ended December 31, 2005, as compared with a tax
benefit of $0.2 million on a profit before taxes of $0.5 million for the
corresponding period in 2004. The primary differences in our tax rate for fiscal
2005 as compared with the corresponding period were the non-deductibility of the
goodwill and other intangible asset impairment recognized in 2005 and the
recognition of deferred tax asset valuation allowances during the third quarter
of 2005 related to the Brazilian Engine operations ($7.1 million) and U.S.
($18.2 million), as the preponderance of negative evidence indicated that these
deferred tax assets would not be recoverable. Excluding the impairments and
valuation allowances, the unusual result was also the product of not providing
benefits on losses in jurisdictions where the preponderance of negative evidence
would indicate that these deferred tax assets would not be recoverable.
Net loss in the fiscal year ended December 31, 2005 was $226.4 million, or
$12.25 per share, as compared to net income of $0.7 million, or $0.04 per share,
in the fiscal year ended December 31, 2004. The current period decline was
primarily the result of the impact of the goodwill impairment, other impairments
and restructuring costs and deferred tax asset valuation allowances described
above. Additional factors discussed throughout the Reportable Operating Segments
discussion that follows contributed to the operating loss experienced, even
after excluding the impairments, restructuring charges, and deferred tax asset
valuation allowances.
REPORTABLE OPERATING SEGMENTS
The financial information presented below is for our three reportable operating
segments for the periods presented: Compressor, Engine & Power Train, and
Electrical Components. 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 9, Segment
Reporting.
Compressor Products
Compressor business sales in the fiscal year of 2005 increased 3.5% to $910.9
million from $880.2 million in 2004. The increase for the period was
attributable to the effect of foreign currency translation that increased sales
by $56.3 million. Excluding the effect of foreign currency fluctuation, volume
increases of aftermarket products and compressor products that are primarily
manufactured by us in our Brazilian and Indian facilities and sold into the
original equipment markets for residential refrigerators and freezers were more
than offset by declines in sales of compressors used in room air conditioners
and commercial applications. Aftermarket volumes
36
improved based on favorable relative weather conditions, and refrigeration and
freezer volume gains were driven by economic forces providing greater demand for
the product. Air volumes decreased with the shift to products we did not offer
at that time.
Compressor business operating income and the related margin on net sales for the
fiscal year ended December 31, 2005 amounted to $18.8 million and 2.1% compared
to $60.5 million and 6.9% for 2004. The effects of foreign currency exchange
rates caused a decline of $35.9 million. During the fiscal year ended December
31, 2005, the U.S. Dollar was on average 16% weaker versus the Brazilian Real
and 14% stronger versus the Euro than during 2004. Compressor segment operating
margin also deteriorated due to an unfavorable mix of sales and higher commodity
and transportation costs.
Electrical Component Products
Sales for the fiscal year of 2005 amounted to $410.1 million compared to $422.6
million in 2004. Volume declines totaled $27.0 million and were particularly
significant in the automotive seat actuator, blowers, and residential and
commercial aftermarket.
Electrical Components operating income and margin for the fiscal year of 2005
amounted to $7.5 million and 1.8% compared to $11.3 million and 2.7% in 2004.
The decline in operating income in the period largely resulted from lower sales
volumes ($10.6 million), higher commodity costs ($16.3 million), and
unanticipated operational inefficiencies primarily related to the closure of the
St. Clair facility ($1.2 million), partially offset by lower amortization of
intangible assets of $7.5 million.
Engine & Power Train Products
Engine & Power Train business sales declined 15.9% to $404.1 million in the
fiscal year ended December 31, 2005 compared to $480.9 million in the
corresponding period of 2004. Loss of business totaling $35.8 million on walk
behind rotary lawn applications led the decline in sales. Volumes were also
lower in the transaxle business and in other engine lines utilized on certain
utility products. These volume declines were somewhat offset by increased sales
of engines used in generators.
Engine & Power Train business operating loss in the fiscal year ended December
31, 2005 amounted to $75.1 million compared to a loss of $21.2 million in the
corresponding period of 2004. The decline in year to date results reflects
increases in commodity costs of $12.4 million and other costs of $22.3 million,
including costs of $8.0 million associated with two product recalls and fees of
$7.8 million associated with the work of AlixPartners whom the Company engaged
during the third quarter of 2005 to assist in the restructuring plans of the
Engine & Power Train Group.
The significant costs associated with excess capacities in the U.S. and Europe
contributed substantially to the Engine & Power Train losses. The excess
capacity situation was exacerbated by the current shift of production to our
Brazilian manufacturing facility resulting in duplicate capacities.
37
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 11 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 December 31, 2006 and December 31, 2005, we had accrued $3.3 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. The plans focused on
improving the group's profitability. The plans included eliminating significant
duplicate capacity, among other cost reduction efforts. We believe the
participation by AlixPartners has allowed us to progress in effecting these
changes in a shorter time frame than it otherwise could have achieved. During
2006 and 2005, we incurred $21.1 million and $7.8 million respectively related
to fees earned by AlixPartners during the year.
On December 9, 2006, we entered into a new letter agreement with AlixPartners
and its affiliate, AP Services, LLC. This agreement provides for AlixPartners to
continue to provide interim management, financial advisory, and consulting
services for our Engine and Power Train Group, but alters the amounts and timing
of payments that would be due to AlixPartners over the following nine months.
The new agreement replaces provisions that determined an amount of "success" fee
based upon computations of cost savings with a mutually agreed upon fixed amount
so that we would have greater certainty concerning our future cash outflows.
On January 19, 2007, in connection with the management changes described in Item
10, we entered into an addendum to our agreement with AP Services LLC that,
among other things, added additional tasks to be performed by AP Services,
including providing the services of James J. Bonsall to serve as our interim
President and Chief Operating Officer. A copy of this addendum was included with
the Current Report on Form 8-K that we filed on January 25, 2007.
We expect that fees paid to AlixPartners will be substantially reduced in 2007,
as their work at the Engine & Power Train Group is essentially complete.
However, due to the appointment of Mr. Bonsall as our interim President and
Chief Operating Officer, fees for his services will continue to be incurred
until such time as a permanent CEO is identified, as well as through any
transition period incorporated in that process.
38
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, when available, and
borrowings under available credit facilities. A substantial portion of our
operating income can be generated by foreign operations. In those circumstances,
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
2006 vs. 2005
Cash used by operating activities was $94.4 million in the fiscal year of 2006
as compared to cash provided by operations of $16.0 million in 2005. The use of
cash in 2006 reflected both our operating loss and net investments in working
capital. Included in operating loss for 2006 was the gain on the sale of the
Little Giant Pump Company of $49.7 million and the associated gain from the
curtailment of its pension plan of $8.5 million. In addition, inventories
increased by $18.9 million since the beginning of the year, attributable in part
to Oracle implementation issues and inefficient materials management exacerbated
by high levels of personnel turnover associated with a facility in Mexico.
Accounts receivable in 2006 increased by $7.4 million from the beginning of the
year. This increase was the result of receivables, on average, requiring an
additional four days to collect as of December 31, 2006 as compared to the end
of 2005. This increase was driven in part by the Engine & Power Train segment,
whose days sales outstanding increased from 50 at the end of the 2005 to 54 as
of December 31, 2006. A key customer at the Engine Group, comprising 49% and 50%
of its total outstanding accounts receivable balance at the end of 2006 and 2005
respectively, increased its average time to pay by six days over the course of
2006, thus lengthening the average time to collection for that segment. Days
sales outstanding also increased in the Electrical Components Group, from 52
days at the end of 2005 to 58 days at the end of 2006. A greater percentage of
the accounts receivable balance for Electrical Components at the end of 2006 was
for automotive customers, who on average pay on more extended payment terms than
other customers for the group.
The cash used to fund operations, fund capital expenditures and repay amounts
originally borrowed under the new debt arrangements was predominantly provided
by proceeds from the sale of Little Giant Pump Company. The sale of our 100%
ownership interest in Little Giant Pump Company was completed on April 21, 2006
for $120.7 million. Approximately 63% of the gross proceeds were applied against
the First Lien borrowing and 37% against the Second Lien borrowing.
Average days sales outstanding were 59 days at December 31, 2006 versus 55 days
at December 31, 2005, before giving effect to receivables sold. Days inventory
on hand were 82 days at December 31, 2006, up from 79 days at December 31, 2005,
due to the factors discussed above.
Cash flows provided by investing activities were $70.9 million in fiscal 2006 as
compared to a use of cash of $109.8 million in 2005. Of the overall change of
$180.7 million, $51.2 million was related to lower capital expenditures in 2006
compared to significant new product expansions in India and Brazil in 2005, and
$131.5 million related to higher proceeds received from the sale of assets
during 2006. Included in such sales was our 100% interest in Little Giant Pump
Company for $120.7 million, the sale of our 7% interest in Kulthorn Kirby Public
Company Limited stock for $4.7 million and the sale of our former Douglas,
Georgia manufacturing facility for $3.5 million. In addition, during the first
quarter, we acquired a small Australian-based company, which owned patents
related
39
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 amortizable intangible assets.
Cash flows used in financing activities were $9.2 million in fiscal 2006 as
compared to $24.0 million in 2005. During the first quarter 2006, the remaining
outstanding balances of our Senior Guaranteed Notes, Revolving Credit Facility
and Industrial Revenue Bonds were replaced by a new financing package that
included a $275 million First Lien Credit Agreement (amended in the fourth
quarter to $250 million) and a $100 million Second Lien Credit Agreement
(replaced in the fourth quarter by a different Second Lien Credit Agreement).
During the second quarter 2006, proceeds from the sale of Little Giant Pump
Company were used to repay a portion of our borrowings under the First and
Second Lien Credit Agreements, based upon formulas contained in the agreements.
2005 vs. 2004
Cash provided by operating activities was $16.0 million in the fiscal year of
2005 as compared to cash provided by operations of $5.2 million in 2004.
Improvements in working capital management, particularly in the second half of
the year, were utilized to fund operating activities. We also used existing cash
balances during the year to prepay $50 million of our Senior Guaranteed Notes,
pay dividends, and fund capital expenditures.
Cash flows used in investing activities were $113.3 million in fiscal 2005 as
compared to $84.0 million in 2004, reflecting a $29.3 million increase in
capital expenditures in 2005, primarily related to new product expansions in
Brazil and India.
Cash flows used in financing activities were $24.0 million in fiscal 2005 as
compared to $58.9 million in 2004, primarily reflecting the repayment of $50
million of our Senior Guaranteed Notes in the first quarter net of additional
foreign borrowings during 2005 versus repayments in 2004. We also paid dividends
in the first and second quarters amounting to $11.8 million. We did not pay a
dividend during the third or fourth quarters of 2005 and under our new credit
facilities were prohibited from paying a dividend in 2006.
CAPITALIZATION
In addition to cash provided by operating activities when available, 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 fiscal years ended December 31, 2006 and December 31, 2005, our average
outstanding debt balance was $373.0 million and $375.8 million, respectively.
During the second quarter of 2006 we entered into interest rate swap agreements,
effectively converting $90 million of variable rate debt to fixed rate debt. The
weighted average long-term interest rate, including the effect of hedging
activities, was 9.2% and 6.2% for 2006 and 2005 respectively. Among other
factors, the change in the weighted average, long-term interest rate for the
respective periods reflected the increase in the borrowing rate applicable to
our new borrowing arrangements. This restructuring resulted in a weighted
average rate of 10.0% as of December 31, 2006, as compared to the original
interest rate of 4.6% under our Senior Guaranteed Notes at the beginning of the
year and 8.8% under our First and Second Lien Agreements as originally
structured in February of 2006. In part, the increase was due to a greater
percentage of our overall debt structure being carried under our Second Lien
Agreement, ($100 million versus $54.6 million prior to the fourth quarter
restructuring) and less under the First Lien Agreement.
40
As further discussed in Note 10 to the financial statements, the Senior
Guaranteed Notes and the revolving credit facility were successfully refinanced
on February 3, 2006. Proceeds were also used to repay the remaining amounts
outstanding under the Industrial Revenue Bonds. The Senior Guaranteed Notes and
Revolving Credit Facility were replaced by a new financing package that included
a $275 million First Lien Credit Agreement (reduced to $250 million as part of
the fourth quarter restructuring) and a $100 million Second Lien Credit
Agreement. The agreements provided for security interests in certain of our
assets and specific financial covenants related to an Adjusted EBITDA metric,
capital expenditures and fixed charge coverage. Additionally, under the terms of
the agreements, no dividends could be paid prior to December 31, 2006, and
minimum amounts of credit availability are required thereafter.
On November 3, 2006 we signed amendments to these lending arrangements. The
principal terms of the November 3 amendments were described in a Current Report
on Form 8-K we filed on November 8, 2006. On November 13, 2006, we signed a new
$100 million Second Lien Credit Agreement with Tricap Partners LLC, replacing
our previous Second Lien Credit Agreement, as well as a corresponding further
amendment to our February 6, 2006 First Lien Credit Agreement. Finally, on
December 11, 2006, we obtained further amendments to these agreements in order
to approve a restructuring of our lending arrangements with our Brazilian engine
manufacturing facility. The principal terms of the December 11 amendments were
described on a Current Report on Form 8-K we filed on December 15, 2006.
In March of 2007, our Brazilian manufacturing facility, TMT Motoco, received an
unfavorable ruling in Brazilian court regarding the requested restructuring of
its lending arrangements referenced above. TMT Motoco subsequently filed a
request in Brazil for court permission to pursue a judicial restructuring,
similar to a U.S. filing for Chapter 11 bankruptcy protection. The filing in
Brazil constituted an event of default with our domestic lenders. On April 9,
2007 we obtained further amendments to our First and Second Lien Credit
Agreements that cured the cross-default provisions triggered by the filing in
Brazil. For further discussion of the TMT Motoco restructuring and the
amendments to our First and Second Lien Credit Agreements, refer to "Adequacy of
Liquidity Sources" below, and Note 10, "Debt," of the Notes to the Consolidated
Financial Statements.
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 $46.5 million and $32.1 million as of December 31, 2006 and
December 31, 2005, respectively. We cannot provide any assurances that these
facilities will be available or utilized in the future.
Adequacy of Liquidity Sources
Historically, cash flows from operations and borrowing capacity under previous
credit facilities were sufficient to meet our long-term debt maturities,
projected capital expenditures and anticipated working capital requirements.
However, in 2006 cash flows from operations were negative and the Company has
had to rely on existing cash balances, proceeds from credit facilities and asset
sales to fund its needs.
Throughout the first three quarters of 2006, our main domestic credit facilities
were provided under two credit agreements we signed on February 6, 2006: a $275
million First Lien Credit Agreement and a $100 million Second Lien Credit
Agreement. Both agreements provided for security interests in substantially all
of our assets and specific financial covenants related to EBITDA (as defined
41
under the agreements and hereafter referred to as our "Adjusted EBITDA"),
capital expenditures, fixed charge coverage, and limits on additional foreign
borrowings.
During 2006 our results from operations continued to be impacted by unfavorable
events that caused actual Adjusted EBITDA for the twelve-month period ended
September 30, 2006, calculated to be $5.1 million, to fall short of the $21.0
million required under the credit agreements before the amendments and
replacement second lien agreement described below. As a result, we sought, and
on November 3, 2006 signed, amendments to our lending arrangements with our
first and second lien lenders. The principal terms of the November 3 amendments
were described in a Current Report on Form 8-K we filed on November 8, 2006.
On November 13, 2006 we signed a new $100 million Second Lien Credit Agreement
with Tricap Partners LLC and a corresponding further amendment to our February
6, 2006 First Lien Credit Agreement. The new second lien facility provided us
with additional liquidity and more lenient financial covenants. We borrowed $100
million under the new Second Lien Credit Agreement and used the proceeds to
repay in full the outstanding balance of $54.6 million under the old Second Lien
Credit agreement, plus a 2.0% prepayment premium, and to repay $40.0 million of
borrowings under the First Lien Credit Agreement. Both the First Lien Credit
Agreement as amended and the new Second Lien Credit Agreement have three year
terms.
Interest on the new Second Lien Agreement is equal to LIBOR plus 6.75% plus paid
in kind ("PIK") interest of 1.5%. PIK interest accrues monthly on the
outstanding debt balance and is paid when the associated principal is repaid.
This compares to the previous second lien arrangement, as amended, of cash
interest of LIBOR plus 7.5% plus PIK interest of 2.0%.
While the new Second Lien Agreement has more favorable interest terms than its
predecessor, our weighted average cost of borrowing under the current agreements
is higher than it was before the November 13 refinancing. This is attributable
to a greater proportion of our total debt being borrowed under the Second Lien
Agreement ($100 million versus $54.6 million) and less under the First Lien
Agreement. Giving effect to our new and amended arrangements, our weighted
average interest rate for all long-term borrowings as of December 31, 2006 is
10.0% compared to 8.8% prior to the November 13 refinancing.
Other interest rate related terms of the new Second Lien Credit Agreement are
also more favorable than the former second lien arrangement, as amended. The new
Second Lien Credit Agreement provides for additional PIK interest at the rate of
5.0% if outstanding debt balances are not reduced by certain specified dates.
This additional PIK interest would apply to the difference between a target
amount of aggregate reduction in debt and the actual amount of first and second
lien debt reduction according to the following milestones:
Milestone Date Aggregate Reduction
- -------------- -------------------
June 30, 2007 $20.0 million
September 30, 2007 $40.0 million
December 31, 2007 $60.0 million
The new Second Lien Credit Agreement also provided for an additional 2.5% in PIK
interest if certain assets are not sold by December 31, 2007.
Sources of funds to make the principal reductions could include, but are not
limited to, cash from operations, reductions in working capital, or asset sales.
42
In addition, the new Second Lien Credit Agreement includes a commitment to
create an advisory committee to assist our board of directors in working with a
nationally recognized executive recruiting firm and to recommend to the board
qualified candidates for various executive management positions, including the
Chief Executive Officer position. The committee, consisting of Mr. Risley and
Mr. Banks of our board of directors, as well as a representative from our second
lien lender, has engaged a search firm and is currently in the process of
interviewing candidates for this position.
On January 19, 2007, a special committee of our board of directors appointed
James J. Bonsall interim President and Chief Operating Officer, a new position.
Mr. Bonsall will function as our principal executive officer until a new Chief
Executive Officer is appointed. Todd W. Herrick, our former Chief Executive
Officer, stepped aside from that position in January.
Some of our major shareholders (Herrick Foundation, of which Todd W. Herrick and
Kent B. Herrick are members of the Board of Trustees, and two Herrick family
trusts, of which Todd W. Herrick is one of the trustees) entered into option
agreements with Tricap to induce Tricap to make the new second lien financing
available to us. We have recorded these option agreements, valued at $3.7
million, as part of the loan origination fees, with a credit to paid in capital,
associated with the new Second Lien credit agreement with Tricap. Those loan
costs are being amortized as interest expense over the remaining term of the
debt.
In our November 15, 2006 Form 8-K, we disclosed that we were in negotiations
with our lenders in Brazil to reschedule maturities of our current lending
arrangements for our Brazilian engine manufacturing subsidiary, TMT Motoco. TMT
Motoco has its own financing arrangements with Brazilian banks under which it
was required to pay principal installments of various amounts throughout the
remainder of 2006 through 2009. Historically, the subsidiary has experienced
negative cash flows from operations indicating that it may not have sufficient
liquidity on its own to make all required debt repayments as originally
scheduled.
On November 21, 2006, lenders representing greater than 60% of the outstanding
amounts borrowed, executed a restructuring agreement whereby scheduled
maturities were deferred for eighteen months, with subsequent amortization over
the following eighteen months. Other provisions of the agreement included a
pledge of certain of the assets of TMT Motoco, and a parent guarantee of the
obligation, which would only become effective after full repayment of the Second
Lien debt.
Two banks representing less than 40% of the outstanding balances did not
participate in the restructuring agreement. We ceased further payments to those
banks effective November 15, 2006 and began seeking remedies available to us
under Brazilian law that would require those banks to abide by the terms of the
restructuring agreement. While the non-payments constituted a default under the
debt agreements, the lenders under our First and Second Lien Credit Agreements
waived, for a time, any cross-default that otherwise would have resulted from
our failing to make a required payment on these Brazilian loans.
The agreement with the Brazilian banks was subject to the approval of our First
and Second Lien credit holders. This approval was obtained through amendments to
our existing agreements, which were effective on December 11, 2006. The
principal terms of the December 11 amendments were described on a Current Report
on Form 8-K we filed on December 15, 2006. Terms of the amendments included fees
paid of $1.5 million. In addition, the availability reserve of $10.0 million
instituted under a previous amendment to the First Lien Credit Agreement became
permanent.
On March 15, 2007, the Brazilian court denied TMT Motoco's request to impose the
terms of its restructuring agreement on the dissenting banks. In conjunction
with its ruling, the Brazilian court
43
also lifted a stay that had previously prevented one of the dissenting banks
from pursuing collection proceedings. The court also implemented sweep
procedures for TMT Motoco's bank accounts. These actions had the effect of
accelerating TMT Motoco's debt to that dissenting bank, making it all due and
payable and enabling the bank to pursue its remedies for collection under
Brazilian law.
As a result of these rulings, on March 22, 2007 TMT Motoco filed a request in
Brazil for court permission to pursue a judicial restructuring, similar to a
U.S. filing for Chapter 11 bankruptcy protection. The court granted its
permission for the restructuring request on March 28.
As a result of the requested judicial restructuring in Brazil, all of the TMT
Motoco debt ($88.7 million) has been classified on our Consolidated Balance
Sheet as of December 31, 2006 as current.
The filing in Brazil constituted an event of default with our domestic lenders.
On April 9, 2007 we obtained further amendments to our First and Second Lien
Credit Agreements that cured the cross-default provisions triggered by the
filing in Brazil.
As part of the April 9, 2007 amendment to our First and Second Lien Credit
Agreements, the minimum cumulative Adjusted EBITDA levels (measured from October
1, 2006) for the fourth quarter 2006 and 2007 quarterly periods (in millions)
were set at:
Quarterly Period Ending First Lien Agreement Second Lien Agreement
- ----------------------- -------------------- ---------------------
December 31, 2006 ($14.9) ($16.9)
March 31, 2007 ($8.0) ($10.0)
June 30, 2007 $ 17.0 $ 15.0
September 30, 2007 $ 42.0 $ 40.0
December 31, 2007 $ 62.0 $ 60.0
These levels of Adjusted EBITDA are subject to further adjustment if certain
business units or products lines are sold during the period. In addition, other
terms of the amendments included limitations on the amounts of capital
expenditures and professional fees during the term of the agreements. If a
permanent Chief Executive Officer has not been hired by May 1, 2007, the
amendment to our Second Lien credit agreement also includes a 2.5% per annum
step-up in cash interest rate from that day forward until such time as a
permanent CEO is hired. However, the additional interest is not assessed if the
CEO candidate has not assumed his or her duties due either to a personal
emergency or inability to reach agreement on terms of employment.
We paid $625,000 in fees, plus expenses, to the First Lien lender upon execution
of the agreement. In addition to fees paid of $750,000, plus expenses, to the
Second Lien lender, we also granted warrants to purchase a number of shares of
Class A Common Stock equal to 7% of our fully diluted common stock. These
warrants, valued at $7.7 million, expire five years from the date of the
execution of this amendment to the Second Lien credit agreement. This cost will
be recorded as interest expense in the second quarter of 2007.
As discussed above, the First and Second Lien agreements contain cumulative
Adjusted EBITDA covenants for which measurement occurs at each of the five
quarterly periods beginning October 1, 2006 and ending December 31, 2007. We
were in compliance with these covenants at December 31, 2006, and in order to
remain in compliance during 2007 we will need to realize net improvements in our
reported results.
In response to these challenges, we began the implementation of a plan to
restore the business to a better financial condition, which began eighteen
months ago with the hiring of an outside consultant,
44
AlixPartners, to turn around the Engine & Power Train Group. AlixPartners
implemented a restructuring plan that reduced the reported 2005 operating loss
for the Engine & Power Train Group from $75.1 million to $53.8 million in 2006
(2006 segment operating loss also included $21.1 million in expense for fees to
AlixPartners). An improvement approximating that realized in 2006 for the Engine
Group is expected for 2007. As mentioned above, a Managing Director with
AlixPartners, James Bonsall, has recently been appointed as President and Chief
Operating Officer of the Company, and he will be responsible, until such time as
these responsibilities are transitioned to a permanent Chief Executive Officer,
for leading our management toward our goal of achieving identified improvements
aggregating $50 million for the Compressor, Electrical and Corporate Groups.
While we expect to meet our plan during 2007 and thereby maintain compliance
with the Adjusted EBITDA covenants and our other covenants for the next twelve
months (attainment of the 2007 budget would result in exceeding the Adjusted
EBITDA covenant for the year ending December 31, 2007 by approximately $35
million), there are a number of factors that could potentially arise that could
result in shortfalls to our plan and our covenant targets. These factors include
continued unfavorable macroeconomic trends, such as increases in commodity
prices or further strengthening of the Brazilian real, the inability to obtain
sales price increases from customers, and the inability to restructure
operations in a manner that generates sufficient positive operational cash
flows. Non-compliance with such covenants would allow our lenders to demand
immediate repayment of all outstanding borrowings under the agreements. Any
inability on our part to comply with our financial covenants, obtain waivers for
non-compliance or obtain alternative financing to replace the current agreements
would have a material adverse effect on our financial position, results of
operations and cash flows. We are also concerned about the amount of debt we are
carrying in this challenging operating environment as we seek to improve our
Company's financial performance. As a result, we will continue to evaluate the
feasibility of asset sales as a means to reduce our total indebtedness and to
increase liquidity. In addition to improving financial results, the 2007 plan
also includes a reduction of capital expenditures by approximately fifty percent
from the 2006 expenditure level.
See Part I, Item 1A, "Risk Factors," in this report for further discussion of
some of the most significant risks posed by our current liquidity issues.
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
We do not believe we have any off-balance sheet arrangements that have, or are
reasonably likely to have, a material effect on us; although, as disclosed in
Note 13 to the Consolidated Financial Statements, we are contingently liable
with respect to some export receivables sold in Brazil, and as disclosed in Note
11, we are contingently liable if costs of remediation of the Sheboygan Falls,
Wisconsin plant site were to exceed the $100 million Remediation Cost Cap
insurance we purchased.
We have minimal capital and operating leases, as substantially all employed
facilities and equipment are owned. Currently, we have no multi-year purchase
commitments for capital items. Purchases of equipment are typically procured
within a year and are subject to annual management approval.
After giving effect to the reclassification of the TMT Motoco debt to current
and the amendments to the First and Second Lien agreements, our maturities by
period for our contractual obligations are as follows:
45
Payments due by Period (in millions)
Total Less than 1 year 1-3 Years 3-5 Years More than 5 Years
------ ---------------- --------- --------- -----------------
Debt Obligations $380.5 $163.2 $216.7 $ 0.6 --
Interest Payments on Debt* $ 38.1 $ 76.1 $76.1 *
* Debt levels are assumed to remain constant. Interest rate is assumed to
remain constant at the current weighted average rate of 10.0%.
These scheduled maturities do not consider any of the targeted debt reductions
that are incorporated, but not mandated, in our credit agreements.
SIGNIFICANT ACCOUNTING POLICIES AND CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements requires that management make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and revenues and expenses during the
period. Management bases its estimates on historical experience and other
assumptions that it believes to be reasonable under the circumstances, the
results of which form the basis for making judgments about carrying values of
assets and liabilities that are not readily apparent from other sources.
Management continually evaluates the information used to make these estimates as
our business and the economic environment change. The use of estimates is
pervasive throughout our financial statements, but the accounting policies and
estimates management considers most critical are as follows:
Impairment of Long-Lived Assets
It is our policy to review our long-lived assets for possible impairment
whenever events and circumstances indicate that the carrying value of an asset
may not be recoverable. Such events could include loss of a significant customer
or market share, the decision to relocate production to other locations within
the Company, or the decision to cease production of specific models of product.
We recognize losses relating to the impairment of long-lived assets when the
future undiscounted cash flows are less than the asset's carrying value or when
the assets become permanently idle. Assumptions and estimates used in the
evaluation of impairment are consistent with our business plan, including
current and future economic trends, the effects of new technologies and foreign
currency movements are subject to a high degree of judgment and complexity. All
of these variables ultimately affect management's estimate of the expected
future cash flows to be derived from the asset or group of assets under
evaluation, as well as the estimate of their fair value. Changes in the
assumptions and estimates, or our inability to achieve our business plan, may
affect the carrying value of long-lived assets and could result in additional
impairment charges in future periods.
As discussed above, during the years ended December 31, 2006, 2005 and 2004 we
recognized impairments of our long-lived assets of $28.0 million, $2.4 million
and $5.1 million respectively, related to restructuring activities. As we
continue our plans to restructure our business and meet plan operating and
liquidity targets, a decision may be reached to sell certain assets for amounts
less than the carrying values that were established under a held and used model.
46
Deferred Tax Assets
As of December 31, 2006, we had no recoverable deferred tax assets recorded on
our financial statements. In periods where such assets are recorded, 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 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. In the third quarter of 2006, valuation allowances
were established against remaining foreign deferred tax assets in Brazil
(aggregating approximately $5.9 million) due to negative evidence (including a
continuation of losses recognized during 2006) which resulted in a determination
that it was no longer more likely than not that the assets would be realized.
Goodwill and Other Intangible Assets
We have goodwill and other intangible assets recorded from acquisitions. These
assets are subject to periodic evaluation for impairment when circumstances
warrant, or at least once per year. With respect to goodwill, impairment is
tested in accordance with SFAS No. 142, "Goodwill and Other Intangibles" by
comparison of the carrying value of the reporting unit to its estimated fair
value. As there are not quoted prices for our reporting units, fair value is
estimated based upon a present value technique using estimated discounted future
cash flows. Intangible assets other than goodwill are also subject to periodic
evaluation for impairment and are equally sensitive to changes in the underlying
assumptions and estimates.
Fair value of our goodwill and other intangible assets is estimated based upon a
present value technique using discounted future cash flows, forecasted over a
five year period, with residual growth rates forecasted at 3.0% thereafter. We
use 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 our valuation model, we
evaluate 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 2006 projected growth rates
of approximately 25.5% and 7.9% in 2007 and 2008 respectively, before moderating
to a 5.0% residual growth rate. This higher than average growth rate is due to
the introduction of new product in India. For the FASCO business within the
Electrical Components Group, the rates were approximately 1.4% and 3.8% in 2007
and 2008, thereafter adjusting to 3.0%, and the Europe reporting unit of the
Compressor Group projected growth rates of approximately 4.8% and 0.6% 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. We make 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
47
driven by multiple external factors, including weather conditions affecting
demand; (ii) product costs, particularly commodities such as copper; (iii)
currency exchange fluctuations; (iv) successful implementation of our plan to
increase or enhance productivity; (v) fluctuations in sales volumes, which can
be driven by multiple external factors, including weather conditions affecting
demand; (vi) interest rate fluctuations; and (vii) the intention to continue to
operate the reporting unit. 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.
Consistent with paragraph 24 of SFAS No. 142, "Goodwill and Other Intangible
Assets," discount rates utilized in the goodwill valuation analysis are derived
from published resources such as Ibbotson. The rates utilized were 8.16% at
December 31, 2006 and 9.25% at December 31, 2005 for all business units for
which goodwill is currently recorded.
Operating Profit 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 of 3.4% in 2007 and 3.3% thereafter. The India reporting unit
forecasted operating profit at 1.6% of sales in 2007 and 2.6% thereafter, and
the reporting unit within the Electrical Components Group with goodwill
operating profit percentages of 0.0% in 2007, 3.0% in 2008, 6.4% in 2009, 5.2%
in 2010, 6.4% in 2011, and 7.8% thereafter.
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 1.0% decrease Change in valuation with 1.0% increase
in discount rate in discount rate
-------------------------------------- --------------------------------------
Compressor Segment - Europe $ 4.7 ($4.4)
Compressor Segment - India 3.2 (3.0)
Electrical Components - Fasco 16.1 (15.1)
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 $15 million.
This rate increase would result in the carrying value of the business exceeding
its calculated fair value by $4.4 million, and the Company would complete a Step
2 analysis per SFAS 142. 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 intention to continue to operate the reporting
units could result in significant impairment losses.
At December 31, 2006, we had $127.0 million of goodwill and $53.0 million of
other intangible assets recorded in our consolidated financial statements. Of
the goodwill balance, $18.2 million related to the Compressor business and
$108.8 million related to the Electrical Components business. The entire other
intangible balance is related to the Electrical Components business.
48
Accrued and Contingent Liabilities
We have established reserves for environmental and legal contingencies in
accordance with SFAS No. 5. A significant amount of judgment and use of
estimates is required to quantify our ultimate exposure in these matters. The
valuation of reserves for contingencies is reviewed on a quarterly basis at the
operating and corporate levels to assure that we are properly reserved. Reserve
balances are adjusted to account for changes in circumstances for ongoing issues
and the establishment of additional reserves for emerging issues. While
management believes that the current level of reserves is adequate, changes in
the future could impact these determinations.
We are involved in a number of environmental sites where we are either
responsible for, or participating in, a cleanup effort. As of December 31, 2006,
we had accrued a total of $3.3 million and paid approximately $0.1 million in
connection with these sites during 2006. For additional information on
environmental liabilities, including the Sheboygan River and Harbor Superfund
and Hayton Area Remediation Project sites, see Note 11 to the Financial
Statements.
Employee Related Benefits
The measurement of post-employment obligations and costs is dependent on a
variety of assumptions. These assumptions include, but are not limited to, the
expected rates of return on plan assets, determination of discount rates for
re-measuring plan obligations, determination of inflation rates regarding
compensation levels and health care cost projections. The assumptions used vary
from year-to-year, which will affect future results of operations. Any
differences among these assumptions and our actual return on assets, financial
market-based discount rates, and the level of cost sharing provisions will also
impact future results of operations.
We develop our demographics and utilize the work of actuaries to assist with the
measurement of employee related obligations. The discount rate assumption is
based on investment yields available at year-end on corporate long-term bonds
rated AA by Moody's. The expected return on plan assets reflects asset
allocations; investment strategy and the views of investment managers and other
large pension plan sponsors. We have experienced actual returns which are good
approximations of those estimated, but a decline of 0.5% would have an impact of
almost $3.0 million. The inflation rate for compensation levels reflects our
actual long-term experience. The inflation rate for health care costs is based
on an evaluation of external market conditions and our actual experience in
relation to those market trends. Assuming no changes in any other assumptions, a
0.5% decrease in the discount rate and the rate of return on plan assets would
increase 2006 expense by $2.3 million and $3.0 million, respectively.
Due to the significant over-funding of the majority of U.S. pension plans and
the resulting favorable return on plan assets, we recognized a net periodic
benefit for pensions in our financial statements of $12.8 million and $13.1
million in 2006 and 2005, respectively. In the first quarter of 2007, we
announced revisions to our Salaried Retirement Plan. At December 31, 2006, this
Plan reported approximately $132 million in overfunding, out of a total of $220
million for all our pension plans that have plan assets in excess of
obligations. On May 1, 2007, we will implement a new retirement program for all
Tecumseh salaried employees. We expect that this conversion will make net cash
available in late 2007 or 2008 to the Company of approximately $55 million,
while still fully securing the benefits under the old Plan and funding the new
Plan for several future years.
See Note 4 of the Notes to Consolidated Financial Statements for more
information regarding costs and assumptions for post-employment benefits.
49
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Accounting for Uncertainty in Income Taxes
In June 2006, the FASB issued Financial Interpretation No. 48 ("FIN 48"),
"Accounting for Uncertainty in Income Taxes" an interpretation of FASB Statement
of Financial Accounting Standards No. 109 ("SFAS 109"), "Accounting for Income
Taxes." This interpretation clarifies the accounting for income taxes recognized
in accordance with SFAS 109 with respect to recognition and measurement for tax
positions that are taken or expected to be taken in a tax return. FIN 48 is
effective on January 1, 2007, and its impact on our consolidated financial
statements is not expected to be material.
Fair Value Measurements
In September 2006, the FASB issued Statement No. 157, "Fair Value Measurements"
("SFAS 157"), to provide enhanced guidance for using fair value to measure
assets and liabilities. The Standard also expands disclosure requirements for
assets and liabilities measured at fair value, how fair value is determined, and
the effect of fair value measurements on earnings. The Standard applies whenever
other authoritative literature require (or permit) certain assets or liabilities
to be measured at fair value, but does not expand the use of fair value. SFAS
157 is effective beginning January 1, 2008, and we are currently evaluating the
impact of this pronouncement on our consolidated financial statements.
OUTLOOK
Information in this "Outlook" section should be read in conjunction with the
cautionary statements and discussion of risk factors included elsewhere in this
report.
The outlook for 2007 is subject to the same variables that have negatively
impacted us throughout 2006. 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, we do not expect these factors to
become any more favorable in the foreseeable future. Certain key commodities,
including copper and aluminum, continue to trade at elevated levels compared to
recent history. From January 1, 2006 through December 31, 2006, the price of
aluminum increased approximately 19%. Despite a moderation of copper pricing in
the last quarter of the year, cost for that commodity has nonetheless increased
approximately 32% since the beginning of 2006. We currently hold more than 75%
of our total projected copper requirements for 2007 in the form of forward
purchase contracts, which will provide us with substantial (though not total)
protection from further price increases during the year but also will detract
from our ability to benefit from any price decreases. In any case, the cost of
copper to the business will continue to run significantly higher than in 2005
and prior years. Lack of storm activity has significantly reduced sales of
engines used for generators and has left us and the industry with above normal
inventory levels. The Brazilian Real continues to strengthen against the dollar,
and as of December 31, 2006 had strengthened 5.3% since the beginning of the
year.
Accordingly, we expect to continue to incur losses in the first quarter of 2007,
as we do not expect improvements in any of the key factors noted above.
Specifically, the Compressor and Electrical Components groups' first quarter
results are expected to lag the results of the comparable 2006 period.
On the other hand, despite the expectation of continued lower levels of sales in
the Engine & Power Train group because of unfavorable market conditions, results
in that group are expected to improve over the first quarter of 2006 excluding
restructuring charges. This improvement continues to be
50
driven by the overall restructuring efforts undertaken by AlixPartners. As part
of these efforts, as previously mentioned, we have recently announced the
upcoming closure of our engine facility in New Holstein, Wisconsin. Although the
impairments taken in the fourth quarter of 2006 represent substantially all of
the expected charges related to the Engine & Power Train Group restructuring,
some charges, expected to be relatively minor, will be incurred in 2007 in order
to account for employee severance costs at the New Holstein facility. The
restructuring plan for our Brazilian engine subsidiary, TMT Motoco, is in its
earliest stages; however, at this time there is no expectation that there will
be any impact on the closure of the New Holstein facility.
As further continuous improvement initiatives are executed across all our
business segments, it is possible that additional assets will become impaired.
While no such actions have been approved, they could have a significant effect
on our consolidated financial position and future results of operations.
To respond to the continued losses and consumption of capital resources, we
continue to seek price increases to cover our increased input costs, and expect
that further employee headcount reductions, consolidation of productive capacity
and rationalization of product platforms will be necessary. While no specific
actions have been approved, we believe that such actions will contribute to
restoring our profitability, will help to mitigate such negative external
factors as currency fluctuation and increased commodity costs, and will result
in improved operating performance in all business segments in 2007. These
actions also could result in restructuring and/or asset impairment charges in
the foreseeable future and accordingly, could have a significant effect on our
consolidated financial position and future results of operations.
In addition, we are also concerned about the amount of debt we are carrying
during this period of unfavorable operating environment. Our weighted average
interest rate for long-term debt in 2006 was 3% higher than in 2005, resulting
in significantly higher interest expense on approximately similar levels of
debt. As well, the new Second Lien Credit Agreement provides for additional paid
in kind ("PIK") interest at the rate of 5.0% if outstanding debt balances are
not reduced by certain specified dates.
The new Second Lien Credit Agreement also provides for an additional 2.5% in PIK
interest if certain assets are not sold by December 31, 2007. Sources of funds
to make the principal reductions could include, but are not limited to, cash
from operations, reductions in working capital, or asset sales.
Our success in generating cash flow will depend, in part, on our ability to
efficiently manage working capital. Seasonal patterns and the need to build
inventories to manage production transfers during restructuring programs have
recently caused higher working capital needs. As we complete these restructuring
programs, we expect our need for these higher working capital levels to be
reduced.
As part of addressing the company's liquidity needs, we are planning
substantially lower levels of capital expenditures in 2007. Capital expenditures
in the upcoming year are projected to be approximately $28 million less than in
2006 and $80 million less than in 2005. This reduction in capital expenditures
will further conserve our cash flows, allowing for additional potential to
reduce our outstanding debt.
We are also evaluating the potential sale of product lines or divisions of the
Company. The proceeds from any such sales would be used to reduce our
indebtedness.
Finally, we are in the process of executing a conversion of our Salaried
Retirement Plan to a new Plan. The existing Plan is substantially over-funded.
We expect that this conversion will make net
51
cash available in late 2007 or 2008 to the Company of approximately $55 million,
while still fully securing the benefits under the old Plan and funding the new
Plan for several future years.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market 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 our risk management activities do not
totally eliminate these risks. Consequently, these fluctuations can have a
significant effect on results.
Credit Risk - Financial instruments which potentially subject us to
concentrations of credit risk are primarily cash investments and accounts
receivable. We place our cash investments, when available, in bank deposits and
investment grade, short-term debt instruments (predominately commercial paper)
with reputable credit-worthy counterparties and, by policy, limits the amount of
credit exposure to any one counterparty.
We use contemporary credit review procedures to approve customer credit.
Customer accounts are actively monitored, and collection efforts are pursued
within normal industry practice. Management believes that concentrations of
credit risk with respect to receivables are somewhat limited due to the large
number of customers in our customer base and their dispersion across different
industries and geographic areas. However, in the Engine & Power Train Group, the
manufacture of small gasoline engine-powered lawn and garden equipment is
dominated, to a large extent, by three to four manufacturers. We sell to all of
these manufacturers and, as a result, a significant portion of the Group's open
accounts receivable at any time is comprised of amounts due from these
manufacturers.
A portion of export accounts receivable of our Brazilian subsidiary is sold at a
discount. Discounted receivables sold in the Brazilian subsidiary at December
31, 2006 and 2005 were $46.5 million and $32.1 million, respectively, and the
discount rate was 7.45% in 2006 and 8.56% in 2005. We maintain an allowance for
losses based upon the expected collectability of all accounts receivable,
including receivables sold.
Interest Rate Risk - We are subject to interest rate risk, primarily associated
with our borrowings. Our $250 million First Lien Credit Agreement and $100
million Second Lien Credit Agreement are variable-rate debt. Our remaining
borrowings consist of variable-rate borrowings by our foreign subsidiaries. We
entered into variable to fixed interest rate swaps with notional amounts
totaling $90 million. This resulted in 24% of our total debt at December 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 we
intend to hold these obligations to maturity unless refinancing conditions are
favorable. Alternatively, while changes in interest rates do not affect the fair
value of our 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 $2.9 million.
Commodity Price Risk - We use commodity forward purchasing contracts to help
control the cost of traded commodities, namely copper and aluminum, used as raw
material in the production of motors, electrical components and engines. Company
policy allows management to contract commodity
52
forwards for a limited percentage of projected raw material requirements up to
fifteen months in advance. Commodity contracts at our divisions and subsidiaries
are essentially purchase contracts designed to fix the price of the commodities
during the operating cycle. Our practice has been to accept delivery of the
commodities and consume them in manufacturing activities. At December 31, 2006
and 2005, we held a total notional value of $62.1 million and $61.8 million,
respectively, in commodity forward purchasing contracts. 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.
Foreign Currency Exchange Risk - We are 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, we do not attempt to
hedge the foreign currency translation fluctuations in the net investments in
our foreign subsidiaries. We do, 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
management to hedge known receivables or payables and forecasted cash flows up
to a year in advance. It is our policy not to purchase financial and/or
derivative instruments for speculative purposes. At December 31, 2006 and 2005,
we held foreign currency forward contracts with a total notional value of $130.4
million and $173.0 million, respectively. Based on our current level of
activity, we believe that a strengthening of the Brazilian Real against the U.S.
Dollar impacts our operating profit by approximately $10 million.
53
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Report of Independent Registered Public Accounting Firm ................. 57
Financial Statements
Consolidated Statements of Operations for the years ended December 31,
2006, 2005 and 2004................................................ 60
Consolidated Balance Sheets at December 31, 2006 and 2005............. 61
Consolidated Statements of Cash Flows for the years ended December 31,
2006, 2005 and 2004................................................ 62
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2006, 2005 and 2004................................... 63
Notes to Consolidated Financial Statements............................ 64
All schedules are omitted because they are not applicable or the required
information is shown in the financial statements or notes thereto.
54
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Tecumseh Products Company:
We have completed integrated audits of Tecumseh Product Company's consolidated
financial statements and of its internal control over financial reporting as of
December 31, 2006, in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Our opinions, based on our audits,
are presented below.
Consolidated financial statements
In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of
Tecumseh Products Company and its subsidiaries at December 31, 2006 and 2005,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2006 in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with the
standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit of financial statements includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 4 to the consolidated financial statements, the Company
changed the manner in which it accounts for defined benefit pension and other
postretirement plans effective December 31, 2006.
As discussed in Note 2 to the consolidated financial statements, the Company has
suffered recurring losses from operations. Management's plans in regard to this
matter are also described in Note 2.
Internal control over financial reporting
Also, we have audited management's assessment, included in Management's Report
on Internal Control over Financial Reporting appearing under Item 9A, that
Tecumseh Products Company did not maintain effective internal control over
financial reporting as of December 31, 2006, because of the effect of a material
weakness related to ineffective controls over the completeness and accuracy of
interim income taxes based on criteria established in Internal Control -
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). The Company's management is responsible for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting.
Our responsibility is to express opinions on management's assessment and on the
effectiveness of the Company's internal control over financial reporting based
on our audit.
We conducted our audit of internal control over financial reporting in
accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that
55
we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. An audit of internal control over financial reporting
includes obtaining an understanding of internal control over financial
reporting, evaluating management's assessment, testing and evaluating the design
and operating effectiveness of internal control, and performing such other
procedures as we consider necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
A material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected. The following material weakness has been identified and included in
management's assessment as of December 31, 2006: 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 would not be
prevented or detected. Accordingly, management has determined that this control
deficiency represents a material weakness.
This material weakness was considered in determining the nature, timing, and
extent of audit tests applied in our audit of the 2006 consolidated financial
statements, and our opinion regarding the effectiveness of the Company's
internal control over financial reporting does not affect our opinion on those
consolidated financial statements.
56
In our opinion, management's assessment that Tecumseh Products Company did not
maintain effective internal control over financial reporting as of December 31,
2006, is fairly stated, in all material respects, based on criteria established
in Internal Control - Integrated Framework issued by the COSO. Also, in our
opinion, because of the effect of the material weakness described above on the
achievement of the objectives of the control criteria, Tecumseh Products Company
has not maintained effective internal control over financial reporting as of
December 31, 2006, based on criteria established in Internal Control -
Integrated Framework issued by the COSO.
PricewaterhouseCoopers LLP
Detroit, Michigan
April 9, 2007
57
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
(Dollars in millions, except per share data) 2006 2005 2004
-------- -------- --------
Net sales ................................................ $1,769.1 $1,740.7 $1,797.4
Cost of sales and operating expenses .................. 1,674.0 1,635.3 1,582.6
Selling and administrative expenses ................... 180.5 168.7 184.1
Impairments, restructuring charges, and other items ... 32.3 121.0 21.5
-------- -------- --------
Operating income (loss) .................................. (117.7) (184.3) 9.2
Interest expense ...................................... (46.0) (24.8) (22.7)
Interest income and other, net ........................ 11.2 9.6 14.0
-------- -------- --------
Income (Loss) from continuing operations before taxes .... (152.5) (199.5) 0.5
Tax provision (benefit) ............................... (22.5) 26.9 (0.2)
-------- -------- --------
Net income (loss) from continuing operations ............. ($130.0) ($226.4) $ 0.7
Income from discontinued operations, net of tax ....... 49.7 2.9 9.4
-------- -------- --------
Net income (loss) ........................................ ($80.3) ($223.5) $ 10.1
======== ======== ========
Basic and diluted earnings (loss) per share:
Income (loss) from continuing operations .............. ($7.03) ($12.25) $ 0.04
Income from discontinued operations, net of tax ....... 2.69 0.16 0.51
-------- -------- --------
Net income (loss) per share .............................. ($4.34) ($12.09) $ 0.55
======== ======== ========
Weighted average shares (in thousands) ................... 18,480 18,480 18,480
======== ======== ========
Cash dividends declared per share ........................ $ 0.00 $ 0.64 $ 1.28
======== ======== ========
The accompanying notes are an integral part of these Consolidated Financial
Statements.
58
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
-------------------
(Dollars in millions, except share data) 2006 2005
-------- --------
ASSETS
Current Assets:
Cash and cash equivalents ............................... $ 81.9 $ 116.6
Accounts receivable, trade, less allowance for doubtful
accounts of $10.1 million in 2006 and $11.3 million
in 2005 .............................................. 219.5 211.1
Inventories ............................................. 353.4 346.8
Deferred and recoverable income taxes ................... 40.6 43.4
Other current assets .................................... 38.0 89.2
-------- --------
Total current assets .............................. 733.4 807.1
-------- --------
Property, Plant, and Equipment, net ........................ 552.4 578.6
Goodwill ................................................... 127.0 130.9
Other intangibles .......................................... 53.0 54.8
Prepaid pension expense .................................... 202.5 185.3
Other assets ............................................... 114.4 43.8
-------- --------
Total assets ...................................... $1,782.7 $1,800.5
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable, trade ................................. $ 216.0 $ 187.3
Short-term borrowings ................................... 163.2 82.5
Accrued liabilities:
Employee compensation ................................ 35.2 33.9
Product warranty and self-insured risks .............. 37.9 42.6
Other ................................................ 57.0 58.8
-------- --------
Total current liabilities ......................... 509.3 405.1
Long-term debt ............................................. 217.3 283.0
Deferred income taxes ...................................... 28.6 25.0
Other postretirement benefit liabilities ................... 166.0 210.9
Product warranty and self-insured risks .................... 13.6 14.5
Accrual for environmental matters .......................... 1.3 1.5
Pension liabilities ........................................ 14.9 15.2
Other ...................................................... 33.3 30.9
-------- --------
Total liabilities ................................. 984.3 986.1
-------- --------
Stockholders' Equity
Class A common stock, $1 par value; authorized 75,000,000
shares; issued 13,401,938 shares in 2006 and 2005 .... 13.4 13.4
Class B common stock, $1 par value; authorized 25,000,000
shares; issued 5,077,746 shares in 2006 and 2005 ..... 5.1 5.1
Paid in Capital ......................................... 3.7 --
Retained earnings ....................................... 726.3 806.6
Accumulated other comprehensive income (loss) ........... 49.9 (10.7)
-------- --------
Total stockholders' equity ........................ 798.4 814.4
-------- --------
Total liabilities and stockholders' equity ........ $1,782.7 $1,800.5
======== ========
The accompanying notes are an integral part of these Consolidated Financial
Statements.
59
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
(Dollars in millions) 2006 2005 2004
------- -------- -------
Cash Flows from Operating Activities:
Net income (loss) ............................................... ($80.3) ($223.5) $ 10.1
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization ................................ 80.1 92.3 102.9
Non-cash restructuring charges and other items ............... 30.9 115.0 5.0
Gain on sale of discontinued operations ...................... (49.7) -- --
(Gain) loss on disposal of property and equipment ............ (5.6) 2.4 4.5
Accounts receivable .......................................... (7.4) 7.3 27.2
Inventories .................................................. (18.9) 39.3 (79.8)
Payables and accrued expenses ................................ 1.2 0.7 (28.9)
Employee retirement benefits ................................. (24.2) (16.9) (15.5)
Deferred and recoverable taxes ............................... 7.1 41.5 9.1
Net effect of environmental payment .......................... -- -- (1.8)
Other ........................................................ (27.6) (42.1) (27.6)
------- -------- -------
Cash (Used in) Provided by Operating Activities ........... (94.4) 16.0 5.2
------- -------- -------
Cash Flows from Investing Activities:
Capital expenditures ............................................ (62.1) (113.3) (84.0)
Business acquisitions, net of cash acquired ..................... (2.0) -- --
Proceeds from sale of assets .................................... 135.0 3.5 3.6
------- -------- -------
Cash Provided by (Used In) Investing Activities ........... 70.9 (109.8) (80.4)
------- -------- -------
Cash Flows from Financing Activities:
Dividends paid .................................................. -- (11.8) (23.6)
Debt issuance costs ............................................. (14.4)
Repayment of Senior Guaranteed Notes ............................ (250.0) (50.0) --
Repayment of Industrial Development Revenue Bonds ............... (10.5) -- --
Proceeds from First Lien credit agreement ....................... 230.2 -- --
Repayments of First Lien credit agreement ....................... (117.1)
Proceeds from old Second Lien credit agreement .................. 100.0 -- 22.9
Repayments of old Second Lien credit agreement .................. (100.0) -- --
Proceeds from new Second Lien credit agreement .................. 100.0 -- --
Other borrowings, (repayments), net ............................. 52.6 37.8 (58.2)
------- -------- -------
Cash Used In Financing Activities ......................... (9.2) (24.0) (58.9)
------- -------- -------
Effect of Exchange Rate Changes on Cash ............................ (2.0) 6.5 17.4
------- -------- -------
Decrease In Cash and Cash Equivalents ........................... (34.7) (111.3) (116.7)
Cash and Cash Equivalents:
Beginning of Period ....................................... 116.6 227.9 344.6
------- -------- -------
End of Period ............................................. $ 81.9 $ 116.6 $ 227.9
======= ======== =======
Supplemental Schedule of Noncash Investing and Financing Activities:
Shareholder Option issued in conjunction with debt refinancing ..... $ 3.7
Paid-In-Kind Interest .............................................. 0.2
The accompanying notes are an integral part of these Consolidated Financial
Statements.
60
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Dollars in millions)
ACCUMULATED
CLASS A CLASS B OTHER TOTAL
$1 PAR $1 PAR PAID IN RETAINED COMPREHENSIVE STOCKHOLDERS'
VALUE VALUE CAPITAL EARNINGS INCOME/(LOSS) EQUITY
------- ------- ------- -------- ------------- -------------
BALANCE, DECEMBER 31, 2003 ....................... $13.4 $5.1 $ -- $1,055.4 ($69.1) $1,004.8
COMPREHENSIVE INCOME:
Net income ....................................... 10.1 10.1
Unrealized loss on investment holdings (net of
tax of $0.0) .................................. (0.1) (0.1)
Minimum pension liability (net of tax of $0.1) ... (0.3) (0.3)
Gain on derivatives (net of tax of $0.1) ......... 0.4 0.4
Translation adjustments (net of tax of $14.6) .... 27.0 27.0
--------
TOTAL COMPREHENSIVE INCOME .................... 37.1
Cash dividends ................................... (23.6) (23.6)
----- ---- ---- -------- ------- --------
BALANCE, DECEMBER 31, 2004 ....................... 13.4 5.1 -- 1,041.9 (42.1) 1,018.3
COMPREHENSIVE INCOME:
Net loss ......................................... (223.5) (223.5)
Unrealized gain on investment holdings (net of
tax of $0.0) .................................. 4.1 4.1
Minimum pension liability (net of tax of $0.0) ... 0.2 0.2
Gain on derivatives (net of tax of $4.4) ......... 8.1 8.1
Translation adjustments (net of tax of $0.0) ..... 19.0 19.0
--------
TOTAL COMPREHENSIVE LOSS ...................... (192.1)
Cash dividends ................................... (11.8) (11.8)
----- ---- ---- -------- ------- --------
BALANCE, DECEMBER 31, 2005 ....................... 13.4 5.1 -- 806.6 (10.7) 814.4
COMPREHENSIVE INCOME (LOSS):
Net loss ......................................... (80.3) (80.3)
Unrealized gain (loss) on investment holdings
(net of tax of $0.0) .......................... (4.0) (4.0)
Gain (loss) on derivatives (net of tax of $2.8) .. (6.3) (6.3)
Translation adjustments (net of tax of $7.6) ..... 31.3 31.3
--------
TOTAL COMPREHENSIVE LOSS ...................... (59.3)
Shareholder Option ............................... 3.7 3.7
Impact of the adoption of FAS 158 for pension
plans (net of tax of $0.0) .................... 39.6 39.6
----- ---- ---- -------- ------- --------
BALANCE, DECEMBER 31, 2006 ....................... $13.4 $5.1 $3.7 $ 726.3 $ 49.9 $ 798.4
===== ==== ==== ======== ======= ========
The accompanying notes are an integral part of these Consolidated Financial
Statements.
61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN MILLIONS)
NOTE 1. ACCOUNTING POLICIES
Business Description - Tecumseh Products Company (the "Company") is a full line,
independent global manufacturer of hermetic compressors for residential and
commercial refrigerators, freezers, water coolers, dehumidifiers, window air
conditioning units and residential and commercial central system air
conditioners and heat pumps; electric motors; and gasoline engines and power
trains for lawn mowers, lawn and garden tractors, garden tillers, string
trimmers, snow throwers, industrial and agricultural applications and
recreational vehicles.
Principles of Consolidation - The consolidated financial statements include the
accounts of the Company and its subsidiaries. All significant intercompany
transactions and balances have been eliminated.
Foreign Currency Translation - All of our foreign subsidiaries, with the
exception of certain Mexican operations, use the local currency of the country
of operation as the functional currency. Our Mexican operations (where the local
currency has not been designated as the functional currency) are remeasured into
the U.S. Dollar. Assets and liabilities are translated into U.S. Dollars at
year-end exchange rates while revenues and expenses are translated at average
monthly exchange rates. The resulting translation adjustments are recorded in
other comprehensive income or loss, a component of stockholders' equity.
Realized foreign currency transaction gains and losses and translation
adjustments in foreign countries which use the U.S. Dollar as the functional
currency are included in cost of sales and operating expenses and amount to a
net gain of $6.3 million in 2006, a net loss of $3.6 million in 2005, and a net
loss of $4.9 million in 2004.
Cash Equivalents - Cash equivalents consist of commercial paper and other
short-term investments that are readily convertible into cash with original
maturities of three months or less.
Inventories - Inventories are valued at the lower of cost or market, on the
first-in, first-out basis. Cost in inventory includes purchased parts and
materials, direct labor and applied manufacturing overhead.
Property, Plant and Equipment - Expenditures for additions, major renewals and
betterments are capitalized and expenditures for maintenance and repairs are
charged to expense as incurred. For financial statement purposes, depreciation
is determined using the straight-line method at rates based upon the estimated
useful lives of the assets, which generally range from 15 to 40 years for
buildings and from 2 to 12 years for machinery, equipment and tooling.
Depreciation expense was $72.3 million, $86.8 million, and $94.1 million in
2006, 2005 and 2004, respectively.
Goodwill and Intangible Assets - In accordance with SFAS No. 142, "Goodwill and
Other Intangible Assets," goodwill and intangible assets deemed to have
indefinite lives are no longer amortized but are subject to impairment testing
on at least an annual basis. We perform our annual impairment testing during the
fourth quarter each year. The impairment test compares the estimated fair value
of the reporting unit to its carrying value to determine if there is any
potential impairment. If the estimated fair value is less than the carrying
value, an impairment loss is recognized to the extent that the estimated fair
value of the goodwill within the reporting unit is less than the carrying value.
Other intangible assets are amortized over their estimated useful lives. See
Note 5 for additional disclosures related to goodwill and other intangible
assets.
62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Revenue Recognition - Revenues from the sale of our products are recognized once
the risk and rewards of ownership have transferred to the customers, which, in
most cases, coincide with shipment of the products. For other cases involving
export sales, title transfers either when the products are delivered to the port
of embarkation or received at the port of the country of destination.
Shipping and Handling - Shipping and handling fee revenue is not significant.
Shipping and handling costs are included in cost of goods sold.
Income Taxes - Income taxes are accounted for using the liability method under
which deferred income taxes are determined based upon the estimated future tax
effects of differences between the financial statement and tax basis of assets
and liabilities, as measured by the currently enacted tax rates.
Derivative Financial Instruments - Derivative financial instruments are
occasionally utilized to manage risk exposure to movements in foreign exchange
rates. From time to time, we enter into forward exchange contracts to obtain
foreign currencies at specified rates based on expected future cash flows for
each currency. Changes in the value of derivative financial instruments are
measured at the balance sheet date and recognized in current earnings or other
comprehensive income depending on whether the derivative is designated as part
of a hedge transaction and, if it is, the type of transaction. We do not hold
derivative financial instruments for trading purposes.
Product Warranty - Provision is made for the estimated cost of maintaining
product warranties at the time the product is sold based upon historical claims
experience by product line.
Self-Insured Risks - Provision is made for the estimated costs of known and
anticipated claims under the deductible portions of our health, liability and
workers' compensation insurance programs. In addition, provision is made for the
estimated cost of post-employment benefits.
Environmental Expenditures - Expenditures for environmental remediation are
expensed or capitalized, as appropriate. Costs associated with remediation
activities are expensed. Liabilities relating to probable remedial activities
are recorded when the costs of such activities can be reasonably estimated and
are not discounted or reduced for possible recoveries from insurance carriers.
Earnings (Loss) Per Share - Basic and diluted earnings (loss) per share are
equivalent. Earnings (loss) per share are computed based on the weighted average
number of common shares outstanding for the periods reported. The weighted
average number of common shares used in the computations was 18,479,684 in 2006,
2005 and 2004.
Research, Development and Testing Expenses - Company sponsored research,
development and testing expenses related to present and future products are
expensed as incurred and were $36.7 million, $30.6 million, and $34.0 million in
2006, 2005 and 2004, respectively. Such expenses consist primarily of salary and
material costs and are included in cost of sales and operating expenses.
Estimates - The preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts
during the reporting period and at the date of the financial statements.
63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Significant estimates include accruals for product warranty, deferred tax
assets, self-insured risks, pension and postretirement benefit obligations and
environmental matters, as well as the evaluation of goodwill and long-lived
asset impairment. Actual results could differ materially from those estimates.
NOTE 2. LIQUIDITY AND MANAGEMENT PLANS
We reported net losses from continuing operations for the years ended December
31, 2006 and 2005 of $130.0 million and $226.4 million, respectively. In
addition, while reporting cash and cash equivalents aggregating $81.8 million at
December 31, 2006, we reported a decrease in cash and cash equivalents of $34.7
million and $111.3 million for the years ended December 31, 2006 and 2005,
respectively.
Our results reflect the impact of the global economy in which we compete and
related risks, including but not limited to the development by competitors of
capacity in lower cost countries, rapidly rising costs in several key
commodities used in our products (since January 1, 2005 the prices of copper and
aluminum have risen 92% and 33%, respectively) and exposure to changes in
certain foreign currency rates such as the Brazilian Real and the Euro.
In response to these risks, we began the implementation of a plan to restore the
business to a better financial condition, which began eighteen months ago with
the hiring of an outside consultant, AlixPartners, to turn around the Engine &
Power Train Group. AlixPartners implemented a restructuring plan that reduced
the reported 2005 operating loss for the Engine & Power Train Group from $75.1
million to $53.8 million in 2006 (2006 segment operating loss also included
$21.1 million in expense for fees to AlixPartners). Assumptions in preparing the
2007 budget are subject to a high degree of judgment and complexity. The 2007
budget reflects improvements in operating income approximating $94 million over
that reported for the year ended December 31, 2006. Management believes that $36
million of the budgeted improvements in operating income have a high probability
of realization due to the nature of the budgeted improvements (such as avoidance
of one-time costs incurred in 2006 or results of actions already taken).
Management is committed to achieve the remaining net $58 million of budgeted
improved operating results, including price increases aggregating $78 million,
mix/volume revenue increase of $13 million, productivity improvements
aggregating $34 million, and managing certain commodity and currency cost
increases, which are budgeted to be $43 million and $33 million, respectively,
above 2006 levels.
We have restructured our credit agreements with the First and Second Lien
Holders in five of the last seven quarters. The most recent amendment was agreed
upon April 9, 2007, which eliminated the cross default clause in our domestic
credit agreements for our Brazilian engine manufacturing subsidiary, caused by
non-payment of debt by that subsidiary, which is further discussed in Note 10.
On March 22, 2007, the Brazilian engine manufacturing subsidiary filed a request
for a judicial restructuring (similar to a U.S. filing under Chapter 11) and
management's 2007 plan does not include any debt repayments for this subsidiary.
As discussed in Note 10, the First and Second Lien agreements contain cumulative
Adjusted EBITDA covenants for which measurement occurs at each of the five
quarterly periods beginning October 1, 2006 and ending December 31, 2007. We
were in compliance with this covenant at December 31, 2006, and in order to
remain in compliance during 2007 we will need to realize the significant budget
improvements in our reported results referred to above. In addition to improving
financial results, the 2007 plan also includes a reduction of capital
expenditures by approximately fifty percent from the 2006 expenditure level.
64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
While we expect to meet our plan during 2007 and thereby maintain compliance
with the Adjusted EBITDA covenants and our other covenants for the next twelve
months (attainment of the 2007 budget would result in exceeding the Amended
adjusted EBITDA covenant for the year ending December 31, 2007 by approximately
$35 million), there are a number of factors that could potentially arise that
could result in shortfalls to our plan and our covenant targets. These factors
include continued unfavorable macroeconomic trends above those already reflected
in the 2007 budget, such as increases in commodity prices or further
strengthening of the Brazilian real, the inability to obtain sales price
increases from customers, and the inability to restructure operations in a
manner that generates sufficient positive operational cash flows. Non-compliance
with such covenants would allow our lenders to demand immediate repayment of all
outstanding borrowings under the agreements. We may not have sufficient cash on
hand to satisfy this demand. Further, if we are unable to remain in compliance
with such covenants, we may not have sufficient cash to fund operations.
Accordingly, any inability on our part to comply with our financial covenants,
obtain waivers for non-compliance or obtain alternative financing to replace the
current agreements would have a material adverse effect on our financial
position, results of operations and cash flows. We are also concerned about the
amount of debt we are carrying in this challenging operating environment as we
seek to improve our Company's financial performance. As a result, we will
continue to evaluate the feasibility of asset sales as a means to reduce our
total indebtedness and to increase liquidity.
NOTE 3. ACCUMULATED OTHER COMPREHENSIVE INCOME
Accumulated other comprehensive income (loss) is shown in the Consolidated
Statements of Stockholders' Equity and includes the following:
(in millions) 2006 2005
----- ------
Foreign currency translation adjustments .......... $ 8.0 ($23.3)
Gain (loss) on derivatives ........................ 2.4 8.7
Minimum pension liability adjustments ............. -- (0.1)
Unrealized gain (loss) on investment holdings ..... -- 4.0
Postretirement and postemployment benefits:
Prior Service (Cost) Credit .................... 36.6 --
Net Actuarial Gain (Loss) ...................... 3.3 --
Net Transition Asset (Obligation) .............. (0.4) --
----- ------
Total postretirement and postemployment benefits .. 39.5 --
----- ------
$49.9 ($10.7)
===== ======
NOTE 4. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS
The Company has defined benefit retirement plans that cover substantially all
domestic employees. Plans covering salaried employees generally provide pension
benefits that are based on average earnings and years of credited service. Plans
covering hourly employees generally provide pension benefits of stated amounts
for each year of service. We sponsor a retiree health care benefit plan,
including retiree life insurance, for eligible salaried employees and their
eligible dependents. At certain divisions, we also sponsor retiree health care
benefit plans for hourly retirees and their eligible dependents. The retiree
health care plans, which are unfunded, provide for coordination of benefits with
Medicare and any other insurance plan covering a participating retiree or
dependent, and have lifetime maximum benefit restrictions. Some of the retiree
health care plans are
65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
contributory, with some retiree contributions adjusted annually. We have
reserved the right to interpret, change or eliminate these health care benefit
plans.
On September 29, 2006, SFAS No. 158, "Employers' Accounting for Defined Benefit
Pension and Other Postretirement Plans" (SFAS 158) was issued. SFAS 158 requires
companies to recognize the funded status of their defined postretirement benefit
plans as a net asset or liability on the balance sheet. Each overfunded plan is
recognized as an asset and each unfunded or underfunded plan is recognized as a
liability. Any unrecognized past service cost, experience gains/losses, or
transition obligations are reported as a component of accumulated other
comprehensive income in stockholders' equity.
SFAS 158 was effective with balance sheets reported as of December 31, 2006, and
its impact on our balance sheet was material. As of December 31, 2006, we had
net unrecognized assets totaling $39.6 million (consisting of $2.5 million
related to U.S. pension plans, $1.2 million related to foreign pension plans,
and $35.9 million related to OPEB plans). Due to the adoption of SFAS 158, this
unrecognized amount was recorded in Accumulated Other Comprehensive Income,
thereby increasing consolidated net assets and shareholders' equity by
approximately $39.6 million. The change in accounting principle has no impact on
our net earnings, cash flow, liquidity, debt covenants, or plan funding
requirements.
The following table summarizes the effect of the adoption of SFAS 158 on our
consolidated balance sheet as of December 31, 2006:
(in millions) PRIOR TO SFAS 158 SFAS 158 ADJUSTMENTS POST SFAS 158
----------------- -------------------- -------------
Prepaid benefit costs............................ $ 200.1 $ 2.4 $ 202.5
Accrued benefit cost............................. (228.0) 37.2 (190.8)
Accumulated other comprehensive (income) loss ... 0.1 (39.6) (39.5)
------- ------ -------
Net amount recognized ($27.8) -- ($27.8)
======= ====== =======
We currently use September 30 as the measurement date (the date upon which plan
assets and obligations are measured) to facilitate the preparation and reporting
of pension and postretirement plan data. Information regarding the funded status
and net periodic benefit costs is reconciled to or stated as of the fiscal year
end of December 31. SFAS 158 eliminates a company's ability to select a date to
measure plan assets and obligations that is prior to its year-end balance sheet
date. This provision of SFAS 158 will become effective with our fiscal year
ended December 31, 2008. We do not anticipate adopting this provision of SFAS
158 prior to that time.
During the second quarter of 2005, we announced some changes to certain of our
retiree medical benefits. Included among these changes were plans to phase in
retiree contributions and raise plan deductibles (both as of January 1, 2006).
We also implemented plans to eliminate Post-65 prescription drug benefits
starting January 1, 2008 and discontinue all retiree medical benefits for anyone
hired after January 1, 2006. As a result of these actions, we performed a
re-measurement of the plan liability at June 30, 2005, factoring in applicable
plan changes, as well as a reduction in the discount rate used in the
calculation from 5.85% to 5.5%, resulting in a decrease in the liability of
$32.2 million. The amortization of the benefit related to these changes
recognized in the fourth quarter of 2005 was $1.4 million.
66
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Amounts recognized for both U.S.-based and foreign pension plans in the
consolidated balance sheets as of December 31 consist of:
PENSION BENEFIT OTHER BENEFIT
--------------- ---------------
(in millions) 2006 2005 2006 2005
----- ------ ------ ------
Prepaid benefit cost 202.5 $185.3 -- --
Accrued benefit cost (15.9) (2.4) (176.5) (232.7)
Accumulated other comprehensive (income) loss (3.6) 0.1 (35.9) --
----- ------ ------ ------
Net amount recognized 183.0 $183.0 (212.4) (232.7)
===== ====== ====== ======
The estimated net experience gain and prior service credit that will be
amortized from accumulated other comprehensive income into pension expense over
the fiscal year are $0.4 million and $10.5 million, respectively.
The following tables provide a reconciliation of the changes in the United
States based pension and postretirement plans' benefit obligations, fair value
of assets and funded status for 2006 and 2005:
PENSION BENEFIT OTHER BENEFIT
--------------- ---------------
(in millions) 2006 2005 2006 2005
------ ------ ------ ------
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of period ... $423.1 $384.4 $194.5 $195.2
Service cost ............................. 10.2 9.1 3.9 4.9
Interest cost ............................ 22.5 21.8 10.3 10.6
Amendments ............................... -- 1.7 -- (32.2)
Actuarial (gain ) loss ................... (14.9) 19.0 (15.2) 27.0
Curtailment (gain) loss .................. (1.7) -- (8.2) --
Benefit payments ......................... (28.6) (27.7) (10.1) (11.1)
------ ------ ------ ------
Benefit obligation at measurement date ...... $410.6 $408.3 $175.2 $194.4
====== ====== ====== ======
CHANGE IN PLAN ASSETS
Fair value at beginning of period ........... $596.1 $589.6
Actual return on plan assets ............. 29.6 31.6
Employer contributions ................... 0.1 0.1
Benefit payments ......................... (27.4) (27.7)
------ ------
Fair value at measurement date .............. $598.4 $593.6
====== ======
The following table provides the funded status of the plans for 2006 and 2005:
PENSION BENEFITS OTHER BENEFITS
---------------- -----------------
(in millions) 2006 2005 2006 2005
------ ------ ------- -------
FUNDED STATUS
Funded status at measurement date .............. $186.5 $185.3 ($175.2) ($194.5)
Unrecognized transition asset ............... -- (0.1) -- --
Unrecognized prior service cost (benefit) ... -- 2.8 -- (39.9)
Unrecognized gain (loss) .................... -- (5.0) -- 14.9
------ ------ ------- -------
Net amount recognized ....................... $186.5 $183.0 ($175.2) ($219.5)
====== ====== ======= =======
67
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The accumulated benefit obligation for all defined benefit pension plans was
$378.1 million and $390.6 million at September 30, 2006 and 2005, respectively.
Information for pension plans with an accumulated benefit obligation in excess
of plan assets:
SEPTEMBER 30,
-------------
(in millions) 2006 2005
------ ----
Projected benefit obligation .... $17.8 $3.1
Accumulated benefit obligation .. 10.9 3.0
Fair value of plan assets ....... 3.0 0.5
Components of net periodic benefit (income) cost during the year:
PENSION BENEFITS OTHER BENEFITS
----------------- --------------
(in millions) 2006 2005 2006 2005
------- ------- ------ -----
Service cost ....................................... $ 10.2 $ 9.1 3.9 $ 4.9
Interest cost ...................................... 22.5 21.8 10.3 10.7
Expected return on plan assets ..................... (45.1) (41.9) -- --
Amortization of net gain ........................... (0.2) (2.5) (0.1) (2.8)
Amortization of actuarial transition obligation .... 0.1 -- -- --
Amortization of unrecognized prior service costs ... 1.0 0.4 (4.9) (1.9)
Additional income due to curtailments .............. (1.3) -- (7.5) --
------- ------- ----- -----
Net periodic benefit (income) cost.................. ($12.8) ($13.1) $ 1.7 $10.9
======= ======= ===== =====
ADDITIONAL INFORMATION
ASSUMPTIONS
Weighted-average assumptions used to determine benefit obligations at September
30,
PENSION BENEFITS OTHER BENEFITS
---------------- --------------
2006 2005 2006 2005
---- ---- ---- ----
Discount rate .................. 5.69% 5.50% 5.63% 5.50%
Rate of compensation increase .. 4.25% 4.25% N/A N/A
Weighted-average assumptions used to determine net periodic benefit costs for
the years ended December 31:
PENSION BENEFITS OTHER BENEFITS
---------------- --------------
2006 2005 2006 2005
---- ---- ---- ----
Discount rate .............................. 5.50% 5.85% 5.50% 5.85%
Expected long-term return on plan assets ... 7.50% 6.75% N/A N/A
Rate of compensation increase .............. 4.25% 4.50% N/A N/A
68
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The expected long-term return, variance, and correlation of return with other
asset classes are determined for each class of assets in which the plan is
invested. That information is combined with the target asset allocation to
create a distribution of expected returns. The selected assumption falls within
the best estimate range, which is the range in which it is reasonably
anticipated that the actual results are more likely to fall than not.
Assumed health care cost trend rates:
SEPTEMBER 30,
---------------------
2006 2005
--------- ---------
Health care cost trend rate assumed for next year .... 9.5-13.5% 7-14%
Rate to which the cost trend rate is assumed to
decline (the ultimate trend rate) ................. 5.0% 5.0%
Year that the rate reaches the ultimate trend rate ... 2015-2016 2013-2016
Assumed health care cost trend rates have a significant effect on the amounts
reported for the health care plans. The health care cost trend rates are based
on an evaluation of external market conditions and adjusted to reflect our
actual experience in relation to those market trends. The following table
provides the effects of a one-percentage-point change in assumed health care
cost trend rates:
1-PERCENTAGE- 1 - PERCENTAGE-
(in millions) POINT INCREASE POINT DECREASE
--------------- ---------------
Effect on total of service and interest cost .. $ 2.5 ($1.7)
Effect on postretirement benefit obligation ... 16.7 (14.9)
PLAN ASSETS
The following table provides pension plan asset allocations:
PLAN ASSETS
AT
SEPTEMBER 30,
-------------
2006 2005
---- ----
ASSET CATEGORY:
Debt securities ..... 49% 67%
Equity securities ... 51% 33%
Other ............... -- --
--- ---
Total ............ 100% 100%
=== ===
Our investment objective is to provide pension payments. This is accomplished by
investing the estimated payment obligations into fixed income portfolio where
maturities match the expended benefit payments. This portfolio consists of
investments rated "A" or better by Moody's or Standard & Poor's. Funds in excess
of the estimated ten-year payment obligations are invested in equal proportions
in a separate bond portfolio and an equity portfolio.
Equity securities include Tecumseh Products Company common stock in the amounts
of $3.5 million (0.6% of total plan assets) and $6.4 million (1.1% of total plan
assets) at September 30, 2006 and 2005, respectively.
We expect to make contributions of $0.1 million to our pension plans in 2007.
69
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The following benefit payments, which reflect expected future service, as
appropriate, are expected to be paid.
PROJECTED BENEFIT PAYMENTS
FROM POSTRETIREMENT MEDICAL
PROJECTED BENEFIT AND LIFE INSURANCE PLANS
(in millions) PAYMENTS FROM -------------------------------
YEAR PENSION PLANS GROSS CLAIMS EXPECTED SUBSIDY
- ---- ----------------- ------------ ----------------
2007 ..................... $ 26.3 $11.6 $0.6
2008 ..................... 26.6 11.7 0.4
2009 ..................... 27.1 12.2 0.5
2010 ..................... 27.5 13.0 0.5
2011 ..................... 28.1 13.6 0.5
Aggregate for 2012-2016 .. 148.9 64.9 3.1
FOREIGN PENSION PLANS
Our foreign subsidiaries provide for defined benefits that are generally based
on earnings at retirement date and years of credited service. The net pension
liability recorded in the consolidated balance sheet was $13.3 million and $12.5
million for 2006 and 2005, respectively. Our foreign subsidiaries also record
liabilities for certain retirement benefits that are not defined benefit plans.
The net liability for those other postretirement employee benefit plans recorded
in the consolidated balance sheet was $1.5 million and $0.4 million for 2006 and
2005, respectively. The combined expense for these plans was $1.5 million and
$1.6 million in 2006 and 2005, respectively.
DEFINED CONTRIBUTION PLANS
We have defined contribution retirement plans that cover substantially all
domestic employees. The combined expense for these plans was $2.4 million and
$3.1 million in 2006 and 2005, respectively.
NOTE 5. GOODWILL AND OTHER INTANGIBLE ASSETS
Our primary Goodwill and Other Intangibles relate to the assignment of purchase
price following the acquisition of certain of our subsidiaries, most
significantly the December 2002 acquisition of FASCO. We account for these
assets under SFAS 142, "Goodwill and Other Intangible Assets," subjecting the
recorded amounts to impairment testing on at least an annual basis. SFAS 142
requires that we estimate the fair value of the reporting unit as compared to
its recorded book value. If the estimated fair value is less than the book
value, then an impairment is deemed to have occurred. As required by SFAS 142,
we measure the amount of goodwill impairment by allocating the estimated fair
value to the tangible and intangible assets within this reporting unit.
We traditionally conduct our annual assessment of impairment in the fourth
quarter by comparing the carrying value of our reporting units to their
estimated fair value. Estimated fair value of our goodwill and other intangible
assets is estimated based upon a present value technique using discounted future
cash flows, forecasted over a five year period, with residual growth rates
forecasted at 3.0% thereafter. We use management business plans and projections
as the basis for expected
70
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
future cash flows. In evaluating such business plans for reasonableness in the
context of their use for predicting discounted cash flows in our valuation
model, we evaluate 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 utilize significant improvements in
growth rates in the first few years of forecast data, due to multiple factors
such as projected 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. We make 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) acceptance of the Company's pricing actions undertaken in response to
rapidly changing commodity prices and other product costs; ; (ii) product costs,
particularly commodities such as copper; (iii) currency exchange fluctuations;
(iv) successful implementation of our plan to increase or enhance productivity,
(v) fluctuations in sales volumes, which can be driven by multiple external
factors, including weather conditions affecting demand, (vi) interest rate
fluctuations, and (vii) the intention to continue to operate the reporting unit.
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 8.16% at December
31, 2006 and 9.25% at December 31, 2005 for all business units for which
goodwill is currently recorded.
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 1.0% Change in valuation with 1.0%
decrease in discount rate increase in discount rate
----------------------------- -----------------------------
Compressor Segment - Europe $ 4.7 ($4.4)
Compressor Segment - India 3.2 (3.0)
Electrical Components - Fasco 16.1 (15.1)
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 $15 million.
This rate increase would result in the carrying value of the business exceeding
its calculated fair value by $4.4 million, and the Company would complete a Step
2 analysis per SFAS 142. 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.
Operating Profit 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
71
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
forecasted operating profit percentages of 3.4% in 2007 and 3.3% thereafter. The
India reporting unit forecasted operating profit at 1.6% of sales in 2007 and
2.6% thereafter, and the reporting unit within the Electrical Components Group
with goodwill operating profit percentages of 0.0% in 2007, 3.0% in 2008, 6.4%
in 2009, and 5.0% thereafter.
On April 21, 2006, we completed the sale of our 100% ownership in Little Giant
Pump Company, for which we had recorded $5.1 million in goodwill. The only other
change in goodwill during 2006 was due to foreign currency fluctuations.
During the second quarter of 2005, we recorded an impairment charge of $108.0
million related to the goodwill associated with the 2002 acquisition of FASCO
(which is included in the Electrical Components segment). The failure to achieve
the business plan, coupled with expected market conditions, caused us to perform
a mid-year assessment of the assumptions utilized to determine FASCO's estimated
fair value in the impairment assessment performed at December 31, 2004. The
deterioration of volumes and our inability to recover higher commodity and
transportation costs through price increases resulted in revised expected cash
flows for FASCO. Based on the revised estimates of cash flow, FASCO's estimated
fair value has deteriorated from the previous assessment and, as a result, a
goodwill impairment of $108.0 million was recognized.
During our 2005 annual fourth quarter assessment, the expected cash flows were
lower than had previously been estimated for both the Engine & Power Train's
Czech Republic operations and Manufacturing Data Systems, Inc., a technology
business not associated with any of our three main segments, both representing
the entire carrying value recorded. The issues with the Czech Republic operation
were indicative of what we are experiencing throughout the Engine and Power
Train segment, but reflect decisions made in the fourth quarter of 2005
regarding as to where certain products will be produced in future years and
uncertainty as to our ability to bring costs down enough to meet previous cash
flow forecasts. The decline in expected cash flows resulted in a goodwill
impairment of $2.7 million or the entire carrying value. The decreased
expectations related to MDSI reflected the fact that the operation had failed to
meet key development targets and had been unsuccessful in developing a market
for certain products introduced in 2005. A $2.7 million impairment charge
related to the intangible assets, representing the remaining unamortized
balance, was recorded.
The changes in the carrying amount of goodwill by reporting unit follow:
ENGINE &
COMPRESSOR COMPRESSOR ELECTRICAL POWER
(in millions) EUROPE INDIA COMP. 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
===== ===== ======= ===== ===== =======
72
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Other intangible assets as of December 31, 2006 consisted of the following:
Gross
Carrying Accumulated Amortizable
(in millions) Amount Amortization Net Life
-------- ------------ ----- -----------
Intangible assets subject to amortization:
Customer relationships and contracts ...... $39.9 $11.2 $28.7 6-15 years
Technology ................................ 12.0 4.6 7.4 3-10 years
----- ----- -----
Total ..................................... 51.9 15.8 36.1
----- ----- -----
Intangible assets not subject to amortization:
Trade-name ................................ 16.9 16.9
----- ----- -----
Total other intangible assets ................ $68.8 $15.8 $53.0
===== ===== =====
Other intangible assets as of December 31, 2005 consisted of the following:
Gross
Carrying Accumulated Amortizable
(in millions) Amount Amortization Impairment Net Life
-------- ------------ ---------- ----- -----------
Intangible assets subject to amortization:
Customer relationships and contracts ...... $39.3 $ 8.1 $ -- $31.2 6-15 years
Technology ................................ 15.4 6.4 (2.3) 6.7 3-10 years
Trade-name and trademarks ................. 0.9 0.5 (0.4) -- 3-8 years
----- ----- ------ -----
Total .................................. 55.6 15.0 (2.7) 37.9
----- ----- ------ -----
Intangible assets not subject to amortization:
Trade-name ................................ 16.9 -- -- 16.9
----- ----- ------ -----
Total other intangible assets ................ $72.5 $15.0 ($2.7) $54.8
===== ===== ====== =====
The aggregate amortization expense for the years ended December 31, 2006, 2005
and 2004 was $4.1 million, $5.0 million, and $12.5 million, respectively. The
estimated amortization expense is approximately $3.9 million for 2007, $3.7
million for 2008, $3.5 million in 2009 and 2010, and $3.3 million thereafter.
73
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 6. INCOME TAXES
Consolidated income (loss) from continuing operations before taxes consists of
the following:
(in millions) 2006 2005 2004
------- ------- -------
U.S. ........ ($90.7) ($157.8) ($32.4)
Foreign ..... (61.8) (41.7) 32.9
------- ------- -------
($152.5) ($199.5) $ 0.5
======= ======= =======
Provision for (benefit from) income taxes from continuing operations consists of
the following:
(in millions) 2006 2005 2004
------- ------ ------
Current:
U.S. federal .......................... $ 1.0 ($14.9) ($7.7)
State and local ....................... 0.1 (0.3) (1.9)
Foreign income and withholding taxes .. 2.6 8.6 18.0
------- ------ ------
3.7 (6.6) 8.4
------- ------ ------
Deferred:
U.S. federal and state ................ (32.7) 32.4 (6.2)
Foreign ............................... 6.5 1.1 (2.4)
------- ------ ------
(26.2) 33.5 (8.6)
------- ------ ------
Provision for (benefit from) income taxes
from continuing operations ............ ($22.5) $ 26.9 ($0.2)
Income taxes paid, net ................... $ 1.6 ($7.7) $ 18.9
======= ====== ======
A reconciliation between the actual income tax expense (benefit) provided and
the income tax expense (benefit) computed by applying the statutory federal
income tax rate of 35% to income before tax is as follows:
(in millions) 2006 2005 2004
------ ------- ------
Income taxes (benefit) at U.S. statutory rate ... ($53.2) ($69.8) $ 0.2
Foreign tax differential (and withholding tax) .. 0.8 6.4 0.9
Change in valuation allowance ................... 29.2 71.5 5.8
State and local income taxes .................... (0.5) (0.1) (1.4)
Extraterritorial income exclusion ............... (0.1) (0.5) (1.5)
Medicare reimbursement .......................... -- (0.8) (0.8)
Federal credits ................................. -- (0.8) (1.0)
Goodwill impairment ............................. -- 37.8 --
Worthless stock of subsidiary ................... -- (17.0) --
Settlements of U.S. taxes ....................... -- -- (2.6)
Other ........................................... 1.4 0.2 0.2
------ ------- ------
($22.4) $ 26.9 ($0.2)
====== ======= ======
74
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
We calculate deferred taxes from temporary differences between the tax basis of
an asset or liability and its reported amount in the financial statements.
Furthermore, we provide United States taxes on unremitted foreign earnings.
Income taxes are recorded pursuant to SFAS No. 109, "Accounting for Income
Taxes," which 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 or discontinued operations), tax expense is
first allocated to the other sources of income with a related benefit recorded
in continuing operations. The full year results of 2006 reflected a tax benefit
in continuing operations and tax expense in other comprehensive income and
discontinued operations.
Significant components of our deferred tax assets and liabilities as of December
31 were as follows:
(in millions) 2006 2005
------- ------
Deferred tax assets:
Other postretirement liabilities ......................................... $ 65.6 $ 80.4
Product warranty and self-insured risks .................................. 14.5 17.2
Net operating loss carryforwards ......................................... 88.6 61.7
Provision for environmental matters ...................................... 1.2 1.2
Translation adjustments .................................................. (13.3) 18.2
Tax credit carryovers .................................................... 47.1 39.8
Other accruals and miscellaneous ......................................... 72.3 43.5
------ ------
276.0 262.0
Valuation allowance ...................................................... (119.4) (90.3)
------ ------
Total deferred tax assets ................................................ 156.6 171.7
------ ------
Deferred tax liabilities:
Tax over book depreciation ............................................... 32.1 24.4
Pension .................................................................. 73.3 68.2
Unremitted foreign earnings .............................................. 36.1 50.2
Intangibles .............................................................. 16.9 17.4
Other .................................................................... -- 8.1
------ ------
Total deferred tax liabilities ........................................... 158.4 168.3
------ ------
Net deferred tax (liabilities) assets .................................... ($ 1.8) $ 3.4
====== ======
Deferred tax detail is included in the consolidated balance sheet as follows:
Current tax assets (including refundable of $13.8 and $14.9) ............. $ 40.6 $ 43.4
Non-current deferred tax liabilities ..................................... 28.6 25.0
------ ------
Total .................................................................... $ 12.0 $ 18.4
====== ======
At December 31, 2006, we had federal net operating loss carryforwards of
approximately $96.6 million, of which $56.0 million will expire in 2025 and the
remainder will expire in 2026. We also had state net operating loss
carryforwards of $181.9 million, which will expire at various dates.
Additionally, we had foreign net operating loss carryforwards of $131.5 million,
of which $6.0
75
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
million will expire in 2008 through 2011. The remainder of the foreign net
operating loss carryforwards have an unlimited carryforward period. Foreign tax
credit and research credit carryforwards of approximately $47.4 million will
expire from 2012 through 2016. Furthermore, we also had various state tax credit
carryovers of $2.4 million, which expire at various dates from 2007 to 2020.
The valuation allowance for deferred tax assets relates to all net federal
deferred tax assets, state deferred tax assets and certain tax assets arising in
foreign tax jurisdictions, and in the judgment of management, these tax assets
are not likely to be realized in the foreseeable future. The valuation allowance
increased $29.2 million and $70.0 million in 2006 and 2005 respectively. The
2006 change is the result of a valuation allowance of $5.9 million established
against remaining tax assets in Brazil and $25.7 million for current year losses
and credits which are reflected in the provision and a net decrease of $2.4
million in the balance of other deferred tax assets, primarily from foreign
currency translations. The 2005 change results from initial recognition of a
federal valuation allowance of $18.2 million, initial recognition of a foreign
valuation allowance of $7.1 million, federal losses and credits of $27.9 million
and foreign items of $18.3 million, all of which are reflected in the provision,
and a net decrease of $1.5 million in the balance of other deferred tax assets,
primarily from foreign currency translation, the write-off of foreign losses,
the expiration of state tax credits, and the state tax credits generated in the
current year for which a valuation allowance was provided.
Tax returns are subject to audit by various taxing authorities. In 2004, we
recorded a benefit to income of $2.6 million from settlements of U.S. tax issues
primarily related to prior years. Although we believe that adequate accruals
have been made for unsettled issues, additional gains or losses could occur in
future years from resolution of outstanding matters.
NOTE 7. INVENTORIES
The components of inventories at December 31 were:
(in millions) 2006 2005
------ ------
Raw materials ..... $159.0 $128.5
Work in progress .. 60.1 73.3
Finished goods .... 121.5 136.7
Supplies .......... 12.8 8.3
------ ------
$353.4 $346.8
====== ======
76
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 8. PROPERTY, PLANT AND EQUIPMENT, NET
The components of property, plant and equipment, net are as follows:
DECEMBER 31,
-------------------
(Dollars in millions, except share data) 2006 2005
-------- --------
Land and land improvements .......... $ 31.9 $ 30.1
Buildings ........................... 204.4 219.1
Machinery and equipment ............. 1,239.1 1,127.6
Assets in process ................... 22.2 78.2
-------- --------
1,497.6 1,455.0
Less, accumulated depreciation ... 945.2 876.4
-------- --------
Property, plant and equipment, net .. $ 552.4 $ 578.6
-------- --------
NOTE 9. BUSINESS SEGMENTS
In accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information," we have identified three reportable operating
segments. Operating segments are defined as components of an enterprise for
which separate financial information is available that is evaluated regularly by
the chief operating decision maker(s) in deciding how to allocate resources and
in assessing performance. Our segments share similar economic characteristics
and are similar in terms of products offered, production processes, types of
customers served and methods of distribution.
Our three reportable operating segments are defined as follows:
Compressor Products - Manufacturing and marketing of a full line of hermetic
compressors for residential and commercial air conditioning and refrigeration
products.
Electrical Component Products - Manufacturing and marketing of AC and DC
electric motors, blowers, gear motors and linear actuators for a broad and
diverse set of applications across many industries.
Engine & Power Train Products - Manufacturing and marketing of gasoline engines
and power train components for lawn and garden and utility applications.
Previously, we also reported a Pump Products business segment; however, as a
result of the decision, during the first quarter of 2006, to sell 100% of our
ownership in Little Giant Pump Company, such operations are no longer reported
in income (loss) from continuing operations before tax. Little Giant operations
represented approximately 90% of that previously reported segment. Since our
remaining pump business does not meet the definition of a reporting segment as
defined by SFAS 131, we no longer report a Pump Products segment, and operating
results of the remaining pump business are included in Other for segment
reporting purposes.
The accounting policies of the reportable segments are the same as those
described in Note 1 of Notes to the Consolidated Financial Statements.
77
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
External customer sales by geographic area are based upon the destination of
products sold. We have no single customer that accounts for 10% or more of
consolidated net sales. Long-lived assets by geographic area are based upon the
physical location of the assets.
78
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
BUSINESS SEGMENT INFORMATION (in millions)
2006 2005 2004
-------- -------- --------
External customer sales:
Compressor Products .................................................... $1,002.7 $ 910.9 $ 880.2
Electrical Component Products .......................................... 429.9 410.1 422.6
Engine & Power Train Products .......................................... 319.0 404.1 480.9
Other .................................................................. 17.5 15.6 13.7
-------- -------- --------
Total external customer sales ....................................... $1,769.1 $1,740.7 $1,797.4
======== ======== ========
Operating income (loss):
Compressor Products .................................................... ($4.5) $ 18.8 $ 60.5
Electrical Component Products .......................................... (4.7) 7.5 11.3
Engine & Power Train Products .......................................... (53.8) (75.1) (21.2)
Other .................................................................. 0.5 0.1 (4.9)
Corporate and consolidating items ...................................... (22.9) (14.6) (15.0)
Impairments, restructuring charges, and other items (see Note 15) ...... (32.3) (121.0) (21.5)
-------- -------- --------
Total operating (loss) income ....................................... ($117.7) ($184.3) $ 9.2
======== ======== ========
Reconciliation to income (loss) from continuing operations before taxes:
Operating income (loss) ................................................ ($117.7) ($184.3) $ 9.2
Interest (expense) income and other, net ............................... (34.8) (15.2) (8.7)
-------- -------- --------
Income (loss) from continuing operations before taxes ............... ($152.5) ($199.5) $ 0.5
======== ======== ========
Assets:
Compressor Products .................................................... $ 738.6 $ 678.7 $ 649.2
Electrical Component Products .......................................... 412.4 389.9 544.9
Engine & Power Train Products .......................................... 237.3 294.8 326.2
Corporate and consolidating items ...................................... 387.1 374.2 480.7
Other .................................................................. 7.3 62.9 61.8
-------- -------- --------
Total assets ........................................................ $1,782.7 $1,800.5 $2,062.8
======== ======== ========
Capital expenditures:
Compressor Products .................................................... $ 37.9 $ 68.4 $ 35.2
Electrical Component Products .......................................... 4.7 7.7 3.6
Engine & Power Train Products .......................................... 7.7 18.9 27.6
Other .................................................................. 0.1 0.5 1.0
Corporate and consolidating items ...................................... 11.7 17.8 16.6
-------- -------- --------
Total capital expenditures .......................................... $ 62.1 $ 113.3 $ 84.0
======== ======== ========
Depreciation and amortization:
Compressor Products .................................................... $ 33.4 $ 48.5 $ 49.6
Electrical Component Products .......................................... 19.4 21.0 27.8
Engine & Power Train Products .......................................... 18.3 18.8 21.3
Corporate and consolidating items ...................................... 8.6 2.2 1.7
Other .................................................................. 0.4 1.8 2.5
-------- -------- --------
Total depreciation and amortization ................................. $ 80.1 $ 92.3 $ 102.9
======== ======== ========
79
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
GEOGRAPHIC SEGMENT INFORMATION (in millions)
2006 2005 2004
-------- -------- --------
Customer Sales by Destination
North America
United States ............ $ 849.7 $ 891.2 $ 965.9
Other North America ...... 85.7 87.6 79.4
-------- -------- --------
Total North America ......... 935.4 978.8 1,045.3
-------- -------- --------
Brazil ................... 144.2 129.8 151.5
Other South America ...... 93.2 81.5 37.9
-------- -------- --------
Total South America ......... 237.4 211.3 189.4
Europe ...................... 361.0 331.2 317.4
Middle East and Asia ........ 235.3 219.4 245.3
-------- -------- --------
$1,769.1 $1,740.7 $1,797.4
======== ======== ========
2006 2005 2004
------ ------ ------
Net Fixed Assets
United States ............... $165.1 $211.1 $215.4
Brazil ...................... 248.2 234.2 182.2
Rest of world ............... 139.1 133.3 157.2
------ ------ ------
$552.4 $578.6 $554.8
====== ====== ======
The Electrical Component Products had intersegment sales of $52.6 million, $52.5
million and $65.9 million in 2006, 2005 and 2004 respectively.
NOTE 10. DEBT
(in millions) 2006 2005
------ ------
Short-term borrowings consist of the following:
Borrowings by foreign subsidiaries under revolving credit
agreements, advances on export receivables and overdraft
arrangements with banks used in the normal course of
business; interest rate at December 31 of 8.2% in 2006
and 7.7% in 2005 ............................................. 80.6 68.3
Current maturities of long-term debt ............................... 82.6 14.2
------ ------
Total short-term borrowings ..................................... $163.2 $ 82.5
====== ======
Long-term debt consists of the following:
Unsecured borrowings, primarily with banks, by foreign
subsidiaries with interest rate at December 31 of 9.2%
in 2006 and 12.8% in 2005 and maturing in 2006 through 2012 .. 85.6 35.8
First Lien Credit Agreement, 7.4% interest rate as of
December 31, 2006, maturing November, 2009 .................. 113.1
Second Lien Credit Agreement, 13.5% interest rate as of
December 31, 2006, maturing November, 2009 ................... 100.0
Senior Guaranteed Notes, 6.6% fixed rate in 2005, maturing
on March 5, 2008 through 2011 (*) ............................ 250.0
Variable Rate Industrial Development Revenue Bonds
payable in quarterly installments from 2005 to 2021,
interest rate of 4.4% as of December 31, 2005 (*) ............ 10.5
------ ------
298.7 296.3
Plus: Unamortized net premiums (*) .............................. 1.2 0.9
Less: Current maturities of long-term debt ...................... (82.6) (14.2)
------ ------
Total long-term debt ...................................... $217.3 $283.0
====== ======
80
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(*) We successfully refinanced these obligations on February 6, 2006. The
Senior Guaranteed Notes, Revolving Credit Facility, and Industrial
Development Revenue Bonds were replaced by a new financing package that
included a $275 million First Lien Credit Agreement (amended to $250
million in the fourth quarter of 2006) and a $100 million Second Lien
Credit Agreement (replaced in the fourth quarter by a different Second Lien
Credit Agreement). The agreements provided for security interests in
certain of our assets and specific financial covenants related to EBITDA,
capital expenditures and fixed charge coverage. Additionally under the
terms of the agreements (prior to later amendments), no dividends could be
paid prior to December 31, 2006 and minimum amounts of credit availability
were required thereafter. The First Lien Credit Agreement as originally
structured was available for five years and bore interest at LIBOR plus a
margin tied to excess availability. The Second Lien Credit Agreement as
originally structured had a seven year term and bore interest at LIBOR plus
7.5%. The weighed average interest rate at funding was 9%.
The repayment of the Senior Guaranteed Notes, Revolving Credit Facility and
Industrial Revenue Bonds was accounted for as an extinguishment of debt and $0.9
million of unamortized debt issuance costs net of unamortized gains from related
swap agreements were written off to interest expense. Costs of $7.0 million
associated with the origination of our new lending arrangements were capitalized
and will be amortized as interest expense over the terms of the agreements.
The First and Second Lien Credit Agreements provided for security interests in
substantially all of our assets and specific quarterly financial covenants
related to EBITDA (as defined under the agreement, which provides adjustments
for certain items, and hereafter referred to as "Adjusted EBITDA"), capital
expenditures, and fixed charge coverage. The Adjusted EBITDA covenant applies
through September 30, 2007, and a fixed charge coverage covenant applied
thereafter.
As more fully described in Note 17, on April 21, 2006, we sold Little Giant Pump
Company and proceeds from the sale were used to repay debt.
During the second quarter, we entered into interest rate swap agreements,
effectively converting $90 million (or 24% of our total debt as of December 31,
2006) of variable rate debt to fixed rate debt.
At December 31, 2006, we had outstanding letters of credit of $6.2 million and
total borrowing availability of $37.6 million under our $250 million First Lien
Credit Agreement.
In addition, the Company has various borrowing arrangements at its foreign
subsidiaries to support working capital needs and governmental sponsored
lendings that provide advantageous lending rates. During 2006, the Company had
net proceeds from these arrangements totaling $52.6 million.
During 2006 our results from operations continued to be impacted by unfavorable
events that caused actual Adjusted EBITDA for the twelve-month period ended
September 30, 2006, calculated to be $5.1 million, to fall short of the $21.0
million required under the credit agreements before the amendments and
replacement second lien agreement described below. As a result, we sought, and
on November 3, 2006 signed, amendments to our lending arrangements with our
first and second lien lenders. The principal terms of the November 3 amendments
were described in a Current Report on Form 8-K we filed on November 8, 2006.
81
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
On November 13, 2006 we signed a new $100 million Second Lien Credit Agreement
with Tricap Partners LLC and another amendment to our February 6, 2006 First
Lien Credit Agreement. The new second lien facility provided us with additional
liquidity and more lenient financial covenants. We borrowed $100 million under
the new Second Lien Credit Agreement and used the proceeds to repay in full the
outstanding balance of $54.6 million under the old Second Lien Credit agreement,
plus a 2.0% prepayment premium, and to repay $40.0 million of borrowings under
the First Lien Credit Agreement. Both the First Lien Credit Agreement as amended
and the new Second Lien Credit Agreement have three year terms. The Adjusted
EBITDA covenant requirement as of September 30, 2006 in the First Lien Credit
Agreement was removed as a result of the amendments.
Interest on the new Second Lien Agreement is equal to LIBOR plus 6.75% plus paid
in kind ("PIK") interest of 1.5%. PIK interest accrues monthly on the
outstanding debt balance and is paid when the associated principal is repaid.
This compares to the previous second lien arrangement, as amended, of interest
of LIBOR plus 7.5% plus PIK interest of 2.0%.
While the new Second Lien Agreement has more favorable interest terms than its
predecessor, our weighted average cost of borrowing under the current agreements
is higher than it was before the November 13 refinancing. This is attributable
to a greater proportion of our total debt being borrowed under the Second Lien
Agreement ($100 million versus $54.6 million) and less under the First Lien
Agreement. Giving effect to our new and amended arrangements, our weighted
average interest rate for all long-term borrowings as of December 31, 2006 is
10.0% compared to an average interest rate of 9.2% for the full year 2006.
Other interest rate related terms of the new Second Lien Credit Agreement
provide for additional PIK interest at the rate of 5.0% if outstanding debt
balances are not reduced by certain specified dates. This additional PIK
interest would apply to the difference between a target amount of aggregate
reduction in debt and the actual amount of first and second lien debt reduction
according to the following milestones:
Milestone Date Aggregate Reduction
- -------------- -------------------
June 30, 2007 $20.0 million
September 30, 2007 $40.0 million
December 31, 2007 $60.0 million
The Second Lien Credit Agreement also provides for an additional 2.5% in PIK
interest if certain assets are not sold by December 31, 2007. Sources of funds
to make the principal reductions could include, but are not limited to, cash
from operations, reductions in working capital, or asset sales.
In addition, the Second Lien Credit Agreement includes a commitment to create an
advisory committee to assist our board of directors in working with a nationally
recognized executive recruiting firm and to recommend to the board qualified
candidates for various executive management positions, including the Chief
Executive Officer position. The committee, consisting of Mr. Risley and Mr.
Banks of our board of directors, as well as a representative from our second
lien lender, has engaged a search firm and is currently in the process of
interviewing candidates for this position.
On January 19, 2007, a special committee of our board of directors appointed
James J. Bonsall interim President and Chief Operating Officer, a new position.
Mr. Bonsall will function as our
82
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
principal executive officer until a new Chief Executive Officer is appointed.
Todd W. Herrick, our former Chief Executive Officer, stepped aside from that
position in January. He has also subsequently agreed to step down from the Board
of Directors and to serve in an honorary role as Chairman Emeritus.
Some of our major shareholders (Herrick Foundation, of which Todd W. Herrick and
Kent B. Herrick are members of the Board of Trustees, and two Herrick family
trusts, of which Todd W. Herrick is one of the trustees) entered into option
agreements with Tricap to induce Tricap to make the new second lien financing
available to us. We have recorded the value of these option agreements as part
of the loan origination fees, with a credit to paid in capital, associated with
the new Second Lien credit agreement with Tricap. The costs are being amortized
as interest expense over the remaining term of the debt.
In our November 15, 2006 Form 8-K, we disclosed that we were in negotiations
with our lenders in Brazil to reschedule maturities of our current lending
arrangements for our Brazilian engine manufacturing subsidiary, TMT Motoco. TMT
Motoco has its own financing arrangements with Brazilian banks under which it is
required to pay principal installments of various amounts throughout the
remainder of 2006 through 2009. Historically, the subsidiary has experienced
negative cash flows from operations indicating that it may not have sufficient
liquidity on its own to make all required debt repayments as originally
scheduled.
On November 21, 2006, lenders representing greater than 60% of the outstanding
amounts borrowed, executed a restructuring agreement whereby scheduled
maturities were deferred for eighteen months, with subsequent amortization over
the following eighteen months. Other provisions of the agreement included a
pledge of certain of the assets of TMT Motoco, and a parent guarantee of the
obligation, which would only become effective after full repayment of the Second
Lien debt.
Two banks representing less than 40% of the outstanding balances did not
participate in the restructuring agreement. We ceased further payments to those
banks effective November 15, 2006 and began seeking remedies available to us
under Brazilian law that would require those banks to abide by the terms of the
restructuring agreement. While the non-payments constituted a default under the
debt agreements, the lenders under the First and Second Lien Credit Agreements
waived, for a time, any cross-default that otherwise would have resulted from
our failing to make a required payment on these Brazilian loans.
The agreement with the Brazilian banks was subject to the approval of our First
and Second Lien credit holders. This approval was obtained through amendments to
our existing agreements, which were effective on December 11, 2006. The
principal terms of the December 11 amendments were described on a Current Report
on Form 8-K we filed on December 15, 2006. Terms of the amendments included fees
paid to the Brazilian banks of $1.5 million. In addition, the availability
reserve of $10.0 million instituted under a previous amendment to the First Lien
Credit Agreement became permanent.
On March 15, 2007, the Brazilian court denied TMT Motoco's request to impose the
terms of its restructuring agreement on the dissenting banks. In conjunction
with its ruling, the Brazilian court also lifted a stay that had previously
prevented one of the dissenting banks from pursuing collection proceedings. The
court also implemented sweep procedures for TMT Motoco's bank accounts. These
actions had the effect of accelerating TMT Motoco's debt to that dissenting
bank, making it all due and payable and enabling the bank to pursue its remedies
for collection under Brazilian law.
83
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
As a result of these rulings, on March 22, 2007 TMT Motoco filed a request in
Brazil for court permission to pursue a judicial restructuring, similar to a
U.S. filing for Chapter 11 bankruptcy protection. The court granted its
permission for the restructuring request on March 28.
Selected financial data for TMT Motoco as of December 31, 2006 and 2005, and for
the three years ended December 31, 2006 is as follows:
2006 2005
------ ------
Current assets $ 33.5 $ 25.5
Noncurrent assets 62.3 71.7
Current liabilities (97.3) (70.0)
Noncurrent liabilities -- (22.1)
Stockholders' Deficit (Equity) / Intercompany 1.5 (5.1)
Year Ended Year Ended Year Ended
Dec. 31, 2006 Dec 31, 2005 Dec 31, 2004
------------- ------------ ------------
Net sales* $ 59.6 $ 52.4 $ 19.8
Cost of sales* 63.7 67.1 23.6
Net loss ($13.2) ($21.8) ($11.3)
* Net sales and cost of sales includes intercompany transactions of $58.8
million, $52.1 million, and $18.9 million in 2006, 2005, and 2004
respectively.
The TMT Motoco filing in Brazil constituted an event of default with our
domestic lenders. On April 9, 2007 we obtained further amendments to our First
and Second Lien Credit Agreements that cured the cross-default provisions
triggered by the filing in Brazil.
As part of the April 9, 2007 amendments to our First and Second Lien Credit
Agreements, the minimum cumulative Adjusted EBITDA levels (measured from October
1, 2006) for the fourth quarter 2006 and 2007 quarterly periods (in millions)
were set at:
Quarterly Period Ending First Lien Agreement Second Lien Agreement
- ----------------------- -------------------- ---------------------
December 31, 2006 ($14.9) ($16.9)
March 31, 2007 ($8.0) ($10.0)
June 30, 2007 $17.0 $ 15.0
September 30, 2007 $42.0 $ 40.0
December 31, 2007 $62.0 $ 60.0
These levels of Adjusted EBITDA are subject to further adjustment if certain
business units or products lines are sold during the period. In addition, other
terms of the amendments included limitations on the amounts of capital
expenditures and professional fees during the term of the agreements. If a
permanent Chief Executive Officer has not been hired by May 1, 2007, the
amendment to our Second Lien credit agreement also includes a 2.5% per annum
step-up in cash interest rate from that day forward until such time as a
permanent CEO is hired. However, the
84
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
additional interest is not assessed if the CEO candidate has not assumed his or
her duties due either to a personal emergency or inability to reach agreement on
terms of employment.
We paid $625,000 in fees, plus expenses, to the First Lien lender upon execution
of the agreement. In addition to fees paid of $750,000, plus expenses, to the
Second Lien lender, we also granted warrants to purchase a number of shares of
Class A Common Stock equal to 7% of our fully diluted common stock. These
warrants, valued at $7.7 million, expire five years from the date of the
execution of this amendment to the Second Lien credit agreement. This cost will
be recorded as interest expense in the second quarter of 2007.
After giving effect to the refinancing, waivers and amendments discussed above,
we are currently in compliance with the covenants of our domestic debt
agreements. Achieving the level of future financial performance required by our
lending arrangements will depend on a variety of factors, including customer
price increases to cover increases in commodity costs, further employee
headcount reductions, consolidation of productive capacity and rationalization
of various product platforms.
In the event that we fail to improve performance through these measures, our
ability to raise additional funds through debt financing will be limited. We are
also concerned about the amount of debt we are carrying in this challenging
operating environment and as we seek to improve our company's financial
performance. As a result, we are evaluating the feasibility of asset sales as a
means to reduce our total indebtedness and to increase liquidity.
As a result of the requested judicial restructuring in Brazil, all of the TMT
Motoco debt ($88.7 million) has been classified on our Consolidated Balance
Sheet at December 31, 2006 as current.
Scheduled maturities of debt for each of the five years subsequent to December
31, 2006, based upon the refinancing on December 11, 2006 and the classification
of the TMT Motoco debt, are as follows:
(in millions)
2007 ......... $163.2
2008 ......... 1.2
2009 ......... 215.5
2010 ......... 0.6
2011 ......... --
Thereafter ... --
------
$380.5
======
These scheduled maturities do not consider any of the targeted debt reductions
that are incorporated, but not mandated, in our credit agreements.
Interest paid was $47.2 million in 2006, $35.9 million in 2005, and $25.6
million in 2004.
NOTE 11. ENVIRONMENTAL MATTERS
We have 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 our Sheboygan Falls plant site and the upper river
constituting the first phase ("Phase I") and the middle and lower
85
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
river and harbor being the second phase ("Phase II"). In May 2003, we 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 our 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, we have 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. We believe 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, we completed the
transfer of title to the Sheboygan Falls, Wisconsin property to PRS.
The total cost of the Liability Transfer Agreement, including the cost of the
insurance policies, was $39.2 million. We 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. We continue 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 we 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, we have removed the asset and
$39.2 million of the liability from the balance sheet. While we believe the
arrangements with PRS are sufficient to satisfy substantially all of our
environmental responsibilities with respect to the Site, these arrangements do
not constitute a legal discharge or release of our 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 Wisconsin
Department of Natural Resources (the "WDNR"), and may be greater or lower than
the amount accrued.
With respect to other environmental matters, we have 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 our 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 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.
Concurrently, on December 29, 2004, the Company and two of its subsidiaries and
TRC entered into an Exit Strategy Agreement (the "Agreement"), whereby we
transferred to TRC substantially all of our obligations to complete the HARP
remediation pursuant to the Consent Order and in accordance
86
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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
us.
As required by the Agreement, we 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 us 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. We believe that the Policy provides
additional assurance that the responsibilities, obligations, and liabilities
transferred and assigned by us 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 our liabilities, we believe 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 our
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 we had voluntarily agreed.
In cooperation with the WDNR, we also conducted an investigation of soil and
groundwater contamination at our 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. We 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 December 31, 2006, we
had accrued $2.2 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, we are 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 December 31, 2006 and 2005, we had accrued a total of $3.3
million and $3.5 million, respectively, for environmental remediation, including
$0.5 million in each period relating to the Sheboygan River and Harbor Superfund
Site and $2.2 million and $2.3 million in 2006 and 2005 respectively relating to
the Grafton site. As these matters continue toward final resolution, amounts in
excess of those already provided may be necessary to discharge us from 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
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.
NOTE 12. COMMITMENTS AND CONTINGENCIES
We are 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
and asbestos-related claims, incidental to its business.
87
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
A lawsuit filed against us 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. On March 30, 2007, the Court entered an
order dismissing Plaintiffs' complaint subject to the ability to re-plead
certain claims, pursuant to a detailed written order to follow. While we believe
we have meritorious defenses and intend to assert them vigorously, there can be
no assurance that we will prevail. We also may pursue settlement discussions. It
is not possible to reasonably estimate the amount of our ultimate liability, if
any, or the amount of any future settlement, but the amount could be material to
our financial position, consolidated results of operations and cash flows.
We are 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 us,
management does not believe that the disposition of these other matters will
have a material adverse effect on our consolidated financial position or results
of operations.
On March 6, 2007, the Company and three members of its board of directors were
named as subjects of a lawsuit filed by Todd W. Herrick, our former Chief
Executive Officer, and Herrick Foundation (a Michigan non-profit corporation) in
the Circuit Court for the County of Lenawee, Michigan. The lawsuit sought to
overturn actions taken by our board of directors at their February 28, 2007
meeting. On March 15, 2007, the Company filed a separate lawsuit in the United
States District Court for the Eastern District of Michigan against Todd W.
Herrick, Herrick Foundation and its Board of Trustees (consisting of Todd
Herrick, Kent Herrick and Michael Indenbaum), and Toni Herrick (a trustee along
with Todd Herrick of various Herrick trusts) (collectively, "Herrick entities")
seeking the suspension of the Herrick entities' stock voting rights.
On April 2, 2007, a settlement agreement was signed by the Company, the three
members of the board of directors named in the suit, and the Herrick entities,
fully settling both lawsuits. The terms of the settlement agreement were
disclosed in a Current Report on Form 8-K that we filed on April 10, 2007.
NOTE 13. FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and the estimated fair values
of financial instruments at December 31, 2006 and 2005:
2006 2005
----------------- -----------------
CARRYING FAIR CARRYING FAIR
(in millions) AMOUNT VALUE AMOUNT VALUE
-------- ------ -------- ------
Cash and cash equivalents ... $ 81.9 $ 81.9 $116.6 $116.6
Short-term borrowings ....... 163.2 163.2 82.5 82.5
Long-term debt .............. 217.3 217.3 283.0 283.0
Foreign currency contracts .. 5.5 5.5 13.0 13.0
Commodity contracts ......... -- (1.1) -- 25.1
88
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The carrying amount of cash equivalents approximates fair value due to their
liquidity and short-term maturities. The fair value of our fixed interest rate
debt reflects the difference between the contract rate and the prevailing rates
as of the balance sheet date. The carrying value of our variable interest rate
debt approximates fair value. The fair values of foreign currency and commodity
contracts reflect the differences between the contract prices and the forward
prices available at the balance sheet date.
We do not utilize financial instruments for trading or other speculative
purposes. We generally do not hedge the net investment in our subsidiaries. All
derivative financial instruments held at December 31, 2006 will mature within
twelve months. All such instruments held at December 31, 2005 matured in 2006.
Our derivative financial instruments consist of foreign currency forward
exchange contracts. These contracts are recognized on the balance sheet at their
fair value, which is the estimated amount at which they could be settled based
on forward market exchange rates. Our foreign subsidiaries use forward exchange
contracts to hedge foreign currency receivables, payables, and other known and
forecasted transactional exposures for periods consistent with the expected cash
flow of the underlying transactions. The contracts generally mature within one
year and are designed to limit exposure to exchange rate fluctuations. On the
date a forward exchange contract is entered into, it is designated as a foreign
currency cash flow hedge. Subsequent changes in the fair value of the contract
that is highly effective and qualifies as a foreign currency cash flow hedge are
recorded in other comprehensive income. Our European subsidiaries had contracts
for the sale of $13.5 million and $14.0 million at December 31, 2006 and 2005,
respectively. Our India subsidiary had contracts for the sale of $2.1 million
and $0 at 2006 and 2005, respectively. Finally, the Brazilian subsidiaries had
contracts for the sale of $114.8 million and $159.0 million at December 31, 2006
and 2005, respectively.
We formally document all relationships between hedging instruments and hedged
items, as well as our risk management objective and strategy for undertaking
various hedge transactions. This process includes linking all derivatives that
are designated as foreign currency hedges to specific forecasted transactions.
We formally assess, both at the hedge's inception and on an ongoing basis,
whether the derivatives that are used in hedging transactions are highly
effective in offsetting changes in cash flows of hedged items. When it is
determined that a derivative is not highly effective as a hedge or that it has
ceased to be a highly effective hedge, we discontinue hedge accounting
prospectively, as discussed below.
We discontinue hedge accounting prospectively when the derivative is (1)
determined to be no longer effective in offsetting the fair value of the cash
flows of a hedged item; (2) sold, terminated, or exercised; (3) undesignated as
a hedge instrument, because it is unlikely that a forecasted transaction will
occur. When hedge accounting is discontinued, the derivative will be carried at
its fair value on the balance sheet, with changes in its fair value recognized
in current period earnings. Any related gains or losses that were accumulated in
other comprehensive income will be recognized immediately in cost of sales.
We use commodity forward purchasing contracts to help control the cost of
commodities (primarily copper and aluminum) used in the production of compressor
motors and components and engines. Company policy allows managers to contract
commodity forwards for a limited percentage of raw material requirements up to
fifteen months in advance. These contracts are not recorded in the balance sheet
as they do not require an initial cash outlay and do not represent a liability
until
89
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
delivery of the commodity. Commodity forwards outstanding at December 31, 2006
and 2005 were $62.1 million and $61.8 million, respectively.
A portion of accounts receivable at our Brazilian subsidiary are sold with
recourse at a discount. Sold Brazilian receivable balances at December 31, 2006
and 2005 were $46.5 million and $32.1 million, respectively, and the discount
rate was 7.45% in 2006 and 8.56% in 2005. We estimate 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.
90
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 14. GUARANTEES AND WARRANTIES
Reserves are recorded on the Consolidated Balance Sheet to reflect our
contractual liabilities relating to warranty commitments to customers. Warranty
coverage is provided for a period of twenty months to two years from date of
manufacture for compressors; ninety days to three years from date of purchase
for electrical components; one year from date of delivery for engines and one
year from date of sale for pumps. An estimate for warranty expense is recorded
at the time of sale, based on historical warranty return rates and repair costs.
Changes in the carrying amount and accrued product warranty costs for the years
ended December 31, 2006 and 2005 are summarized as follows:
(in millions)
Balance at January 1, 2005 ........................... $ 35.6
Current year accruals for warranties ................. 16.4
Adjustments to preexisting warranties ................ 3.1
Settlements of warranty claims (in cash or in kind) .. (25.4)
Closure of Tecumseh Europa ........................... (2.5)
Effect of foreign currency translation ............... (0.5)
------
Balance at December 31, 2005 ......................... 26.7
Current year accruals for warranties ................. 16.5
Adjustments to preexisting warranties ................ (0.8)
Settlements of warranty claims (in cash or in kind) .. (16.5)
Effect of foreign currency translation ............... 0.3
------
Balance at December 31, 2006 ......................... $ 26.2
======
NOTE 15. STOCKHOLDERS' EQUITY
The shares of Class A common stock and Class B common stock are substantially
identical except as to voting rights. Class A common stock has no voting rights
except the right to i) vote on any amendments that could adversely affect the
Class A Protection Provision in the articles of incorporation and ii) vote in
other limited circumstances, primarily involving mergers and acquisitions, as
required by law.
A Shareholders' Rights Plan is in effect for each class of stock. These plans
protect shareholders against unsolicited attempts to acquire control of the
Company that do not offer an adequate price to all shareholders. The rights are
not currently exercisable, but would become exercisable at an exercise price of
$180 per share, subject to adjustment, if certain events occurred relating to a
person or group acquiring or attempting to acquire 10% or more of the
outstanding shares of Class B common stock. The rights have no voting or
dividend privileges and are attached to, and do not trade separately from, the
Class A and Class B common stock. The rights expire on August 25, 2009. As of
December 31, 2006, 13,401,938 shares of authorized but unissued Class A common
stock and 5,077,746 shares of authorized but unissued Class B common stock were
reserved for future exercise under the plans.
91
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Under the terms of our First and Second Lien credit agreements, no dividends
could be paid after February 6, 2006 and prior to December 31, 2006, and after
that date minimum amounts of credit availability were required. We have no
near-term expectation to resume dividend payments.
In April of 2007, as part of the amendment to our Second Lien credit agreements,
we granted warrants to purchase a number of shares of Class A Common Stock equal
to 7% of our fully diluted common stock. These warrants, valued at $7.7 million,
expire five years from the date of the execution of the amendment to the Second
Lien credit agreement.
NOTE 16. IMPAIRMENTS, RESTRUCTURING CHARGES, AND OTHER ITEMS
2006
2006 net loss included $32.3 million ($1.75 per share) of restructuring,
impairment and other charges. $27.1 million of this amount was recorded by the
Engine Group as part of its ongoing restructuring programs, for impairment
charges for long-lived assets ($24.1 million) and other restructuring charges
($3.0 million). $2.8 million in asset impairments were recorded by the
Electrical Components Group for various plant consolidation initiatives.
Finally, the Compressor Group recorded $2.4 million in restructuring charges,
for impairment of long-lived assets ($2.2 million) and related charges ($0.2
million) at two of its facilities in Mississippi.
2005
2005 results were adversely impacted by a total of $121.0 million ($6.55 per
share) of restructuring, impairment and other charges. Charges include goodwill
and other intangible impairments as projected cash flows in several businesses
did not support these carrying values. We also initiated actions to further
reduce our manufacturing footprint, including closure of the Italian Engine and
Power Train manufacturing facility and a North American Engine and Power Train
manufacturing facility, and took steps to complete several actions previously
announced in other businesses.
We recorded an impairment charge of $108.0 million related to the goodwill
associated with the 2002 acquisition of FASCO (which is included in the
Electrical Components segment). The failure to achieve the business plan,
coupled with expected market conditions, caused us to perform a mid-year
assessment of the assumptions utilized to determine FASCO's estimated fair value
in the impairment assessment performed at December 31, 2004. The deterioration
of volumes and our inability to recover higher commodity and transportation
costs through price increases resulted in revised expected cash flows for FASCO.
Based on the revised estimates of cash flow, FASCO's estimated fair value has
deteriorated from the previous assessment and, as a result, a goodwill
impairment of $108.0 million was recognized.
During our annual fourth quarter assessment, the expected cash flows were lower
than had previously been estimated resulting in goodwill impairment of $2.7
million related to the 2001 acquisition of the Engine & Power Train's Czech
Republic operations and a $2.7 million impairment charge related to the
intangible assets associated with the 2001 acquisition of Manufacturing Data
Systems, Inc., a technology business not associated with any of our three main
segments, both representing the entire carrying value recorded. The issues with
the Czech Republic operation are indicative of what we are experiencing
throughout the Engine and Power Train segment, but reflects decisions made in
the fourth quarter regarding as to where certain products will be produced in
future years and uncertainty as to our ability to bring costs down enough to
meet previous cash flow forecasts. The decreased
92
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
expectations related to MDSI reflect the fact that the operation has failed to
meet key development targets and been recently unsuccessful in developing a
market for certain products introduced in 2005.
In addition to these impairments, we incurred $7.6 million in asset impairment
and restructuring charges during the fiscal year ended December 31, 2005. The
Italian Engine & Power Train operations recorded $1.4 million of termination
costs during the third quarter related to previously announced intent to reduce
its workforce by 115 persons. We then recorded a $3.0 million write down of the
net investment in this operation upon the closure of this operation at the end
of December reflecting our entire remaining carrying value.
The remaining charges include $0.9 million recorded by the North American
Compressor operations related to additional moving costs for previously
announced actions and $1.6 million, $0.5 million and $0.2 million of asset
impairment charges at Electrical Components, North American Compressor and
Engine & Power Train, respectively, for manufacturing equipment idled through
facility consolidations and the reduction of carrying value of closed plants to
fair value.
2004
2004 results were adversely impacted by a total of $21.5 million ($14.0 million
net of tax or $0.77 per share) of restructuring, impairment and other charges.
During the second quarter, we began consolidation actions affecting several of
our facilities in its North American Compressor and Electrical Components
businesses.
Actions within the Compressor business included moving compressor machining and
assembly operations from our Tecumseh, Michigan facility to its existing
compressor facility located in Tupelo, Mississippi. In conjunction, aftermarket
distribution operations located in Clinton, Michigan were relocated to the
Tecumseh, Michigan facility. The facility consolidation was necessitated by the
relocation of significant customer-base to overseas locations, which left our
North American Compressor operations with excess compressor manufacturing
capacity.
Approximately 300 layoffs were involved at the Tecumseh and Clinton facilities
while employment increases in Tupelo were approximately one-half of those lost
in Tecumseh. Charges related to the Compressor group actions for 2004 totaled
$3.0 million, including $2.4 million in asset impairment charges and $0.6
million in equipment relocation costs.
Actions in the Electrical Components business included the closure of our
manufacturing facility in St. Clair, Missouri with gear machining operations
being consolidated into our Salem, Indiana facility and motor assembly
operations being consolidated into our Piedras Negras and Juarez, Mexico
facilities. While approximately 250 employees were affected by the shutdown at
the St. Clair facility, this action resulted in a net reduction of approximately
20 employees. Charges related to the Electrical Components group actions for
2004 totaled $4.5 million, including $2.7 million in asset impairment charges,
$0.8 million of equipment relocation costs and $1.0 million in accrued employee
related severance costs.
During the third and fourth quarters of 2004, we executed a program to reduce
employment levels at one of our Indian compressor facilities. The action
affected approximately 100 employees at a cost of $1.2 million. All of these
costs were paid in 2004.
93
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
During the fourth quarter, we recognized a charge of $14.6 million related to
environmental costs involving the Engine & Power Train Group's New Holstein,
Wisconsin facility (see Note 10).
2004 results also reflected a fourth quarter curtailment gain of $1.8 million
associated with the cessation of medical benefits to hourly employees who were
affected by the closing in 2003 of the Engine & Power Train Group's facility in
Sheboygan Falls, Wisconsin.
NOTE 17. DISCONTINUED OPERATIONS
On April 21, 2006, we completed the sale of our 100% ownership interest in
Little Giant Pump Company for $120.7 million. Its results for the twelve months
ended December 31, 2006, 2005, and 2004 are included in income from discontinued
operations. Interest expense of $2.9 and $6.3 million was allocated to
discontinued operations for the twelve months ended December, 2006 and 2005
respectively because our new financing package required that the proceeds from
the sale be utilized to repay portions of our debt. Our debt agreements prior to
2005 had no such requirement. We recognized a pre-tax gain on the sale of $78.0
million. The gain on the sale, including losses incurred during our period of
ownership, net of taxes and interest, is presented in income from discontinued
operations and amounted to $49.7 million net of tax ($2.69 per share). Pretax
gains of $8.4 million associated with curtailment of employee benefits formerly
provided to Little Giant employees are reflected in the net gain.
Our 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 income from discontinued operations for the years
ended December 31, 2006, 2005 and 2004:
Year Ended Year Ended Year Ended
(Dollars in millions) Dec. 31, 2006 Dec 31, 2005 Dec 31, 2004
------------- ------------ ------------
Net sales $ 32.9 $106.3 $114.3
Cost of sales 23.9 77.6 80.7
Selling and administrative expenses 6.9 19.2 18.7
------ ------ ------
Operating income 2.1 9.5 14.9
Interest expense allocated 2.9 6.3 --
------ ------ ------
Income (loss) from discontinued operations before income taxes ($0.8) $ 3.2 $ 14.9
Tax provision 0.2 0.3 5.5
------ ------ ------
Income (loss) from discontinued operations, net of tax ($1.0) $ 2.9 $ 9.4
------ ------ ------
Gain on disposal 78.0 -- --
Tax provision on gain 27.3 -- --
------ ------ ------
Gain on disposal, net 50.7 -- --
------ ------ ------
Income from discontinued operations $ 49.7 $ 2.9 $ 9.4
====== ====== ======
94
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 18. NEW ACCOUNTING STANDARDS
Accounting for Uncertainty in Income Taxes
In June 2006, the FASB issued Financial Interpretation No. 48 ("FIN 48"),
"Accounting for Uncertainty in Income Taxes," an interpretation of FASB
Statement of Financial Accounting Standards No. 109 ("SFAS 109"), "Accounting
for Income Taxes." This interpretation clarifies the accounting for income taxes
recognized in accordance with SFAS 109 with respect to recognition and
measurement for tax positions that are taken or expected to be taken in a tax
return. FIN 48 is effective on January 1, 2007. The impact of this pronouncement
on our consolidated financial statements is not expected to be material.
Fair Value Measurements
In September 2006, the FASB issued Statement No. 157, "Fair Value Measurements"
("SFAS 157), to provide enhanced guidance for using fair value to measure assets
and liabilities. The Standard also expands disclosure requirements for assets
and liabilities measured at fair value, how fair value is determined, and the
effect of fair value measurements on earnings. The Standard applies whenever
other authoritative literature require (or permit) certain assets or liabilities
to be measured at fair value, but does not expand the use of fair value. SFAS
157 is effective beginning January 1, 2008, and we are currently evaluating the
impact of this pronouncement on our consolidated financial statements.
95
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 19. QUARTERLY FINANCIAL DATA - UNAUDITED
QUARTER
-------------------------------------
(in millions, except per share data) FIRST SECOND THIRD FOURTH TOTAL
------- ------- ------- ------- --------
2006
Net sales .................................... $ 446.1 $ 456.3 $ 429.4 $ 437.3 $1,769.1
Gross profit ................................. 34.5 24.0 21.5 15.1 95.1
Net income (loss) ............................ (12.6) 33.9 (37.8) (63.8) (80.3)
======= ======= ======= ======= ========
Basic and diluted earnings (loss) per share .. ($0.68) $ 1.83 ($2.05) ($3.44) ($4.34)
======= ======= ======= ======= ========
2005 (A)
Net sales .................................... $ 440.2 $ 432.8 $ 449.9 $ 417.8 $1,740.7
Gross profit ................................. 27.5 30.6 40.1 7.2 105.4
Net income (loss) ............................ (16.0) (118.4) (37.2) (51.9) (223.5)
======= ======= ======= ======= ========
Basic and diluted earnings (loss) per share .. ($0.87) ($6.40) ($2.01) ($2.81) ($12.09)
======= ======= ======= ======= ========
(a) Restated to show Little Giant Pump Company as discontinued operations.
96
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in the reports that we file or submit 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 our management,
including our President and Chief Operating 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 year covered by this report, we carried out an
evaluation, under the supervision and with the participation of our Disclosure
Committee and management, including the President and Chief Operating Officer
and our 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, and
as of December 31, 2006, our President and Chief Operating Officer along with
our Vice President, Treasurer and Chief Financial Officer concluded that our
disclosure controls and procedures were not effective at the reasonable
assurance level as of December 31, 2006 because of the material weakness
discussed below; however, management believes that the financial statements
included in this report fairly present in all material respects our financial
condition, results of operations and cash flows for the periods presented.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate internal
control over financial reporting. Our internal control over financial reporting
is a process designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles.
Management has assessed the effectiveness of its internal control over financial
reporting as of December 31, 2006. In making its assessment, management used the
criteria described in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO).
A material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected.
We did not maintain effective controls over the completeness and accuracy of
interim income taxes. Specifically, we 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
97
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 our 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 our interim and annual consolidated financial statements that
would not be prevented or detected. Accordingly, management has determined that
this control deficiency represents a material weakness.
Because of the material weakness referred to above, management has concluded
that the Company did not maintain effective internal control over financial
reporting as of December 31, 2006, based on criteria in the Internal
Control-Integrated Framework issued by the COSO.
Management's assessment of the effectiveness of the Company's internal control
over financial reporting as of December 31, 2006 has been audited by
PricewaterhouseCoopers LLP, an independent registered public accounting firm, as
stated in their report which is included in Item 8 of this report on Form 10-K.
MATERIAL WEAKNESS REMEDIATION PLANS
With respect to the completeness and accuracy of the calculation of interim
income taxes, we have enhanced our methodologies to comply with generally
accepted accounting principles. We have also instituted additional review
procedures relating to these processes that include additional management
reviews and review by 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
cannot perform an assessment of these controls until 2007 due to the timing of
operation of such controls. Therefore, management cannot conclude at this time
that the material weakness has been remediated.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There have been no changes in our internal control over financial reporting that
occurred during the fourth quarter of 2006 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS AND PROCEDURES
Management of the Company, including the chief operating officer and chief
financial officer, does not expect that our 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
98
changes in condition, or that the degree of compliance with policies and
procedures included in such controls may deteriorate.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
EXECUTIVE OFFICERS OF THE COMPANY
The following are our executive officers:
PERIOD OF SERVICE
NAME AND AGE OFFICE OR POSITION HELD AS AN OFFICER
- ------------ ----------------------------------------- ---------------------
James J. Bonsall, 54 President and Chief Operating Officer (1) Since March 29, 2006
James S. Nicholson, 45 Vice President, Treasurer, and Chief
Financial Officer (2) Since 2003
Michael R. Forman, 60 Vice President of Global Human Resources Since 2001
Ronald E. Pratt, 54 President of Electrical Components
Business Unit (3) Since January 1, 2006
(1) Last five years of business experience - Present position since January 19,
2007. President, Engine and Power Train Group, Tecumseh Products Company
2005 - March 1, 2007. Managing Director, AlixPartners LLP, 1996 - present.
Principal assignments at AlixPartners clients during the past five years as
follows: President and Chief Executive Officer of Peregrine, Inc. (an
automotive parts supplier until it ceased operations in 2001) since 1999.
Chief Restructuring Officer for LTV Steel Company, Inc. from February 2001
to March 2002. Chief Financial Officer for ish GmbH & Co. KG (a German
supplier of cable analogue and digital television, telephone, and internet
service) from May 2002 to December 2002. Chief Executive Officer of ish
GmbH & Co. KG from December 2002 to June 2005.
(2) Last five years of business experience - Present position since 2004.
Corporate Controller, Tecumseh Products Company 2002 - 2004. Partner,
PricewaterhouseCoopers, 1996 - 2001.
(3) Last five years of business experience - Present position since 2004. Vice
President, Collins & Aikman - Specialty Products Division, 2002 - 2004.
Director, TRW, 2000 - 2002.
On January 19, 2007, our board of directors named James Bonsall as our President
and Chief Operating Officer, a new position, and removed Todd W. Herrick from
the positions of President and Chief Executive Officer. Under the previously
announced succession planning process that is currently under way, our Board of
Directors, assisted by an advisory committee formed pursuant to
99
the terms of our new Second Lien Credit Agreement, has engaged an executive
recruiting firm to help it identify and evaluate candidates for the position of
Chief Executive Officer. Mr. Bonsall is functioning as our principal executive
officer until a new Chief Executive Officer is appointed.
Mr. Bonsall served as the President of our Engine and Power Train Group from
July of 2005 until March of 2007 and, in that position, became an executive
officer effective March 29, 2006. He is not an employee of our company. Mr.
Bonsall is a Managing Director of AlixPartners, LLP and an employee of its
affiliate, AP Services LLC, which provides his services to us under contract.
The information pertaining to directors required by Item 401 of Regulation S-K
will be set forth under the captions "Proposal 1: Election of Directors" and
"Audit Committee" in our definitive Proxy Statement relating to our 2007 Annual
Meeting of Shareholders and is incorporated herein by reference. The information
required to be reported pursuant to Item 405 of Regulation S-K will be set forth
under the caption "Appendix A - Share Ownership - Section 16(a) Beneficial
Ownership Reporting Compliance" in our definitive Proxy Statement relating to
our 2007 Annual Meeting of Shareholders and is incorporated herein by reference.
We have adopted a Code of Ethics for Financial Managers, which applies to our
Chief Executive Officer, Chief Operating Officer, Chief Financial Officer,
Corporate Controller, and Director of Financial Reporting, and the controller or
principal accounting manager of each business unit, as well as a Code of Conduct
for All Directors, Officers, and Employees and an Ethics Reporting Policy.
Current copies of both codes and the reporting policy are posted at the Investor
Relations section of our website at www.tecumseh.com.
The information required to be reported pursuant to paragraphs (d)(4) and (d)(5)
of Item 407 of Regulation S-K will be set forth under the caption "Audit
Committee" in our definitive Proxy Statement relating to our 2007 Annual Meeting
of Shareholders and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information under the captions "Appendix B - Executive Compensation," and
the information under the sub-captions "Compensation Committee Interlocks and
Insider Participation" and "Compensation Committee Report" under the caption
"Governance, Compensation, and Nominating Committee" in our definitive Proxy
Statement relating to our 2007 Annual Meeting of Shareholders is incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information under the caption "Appendix A - Share Ownership" in our
definitive Proxy Statement relating to our 2007 Annual Meeting of Shareholders
is incorporated herein by reference. No information is required to be reported
pursuant to Item 201(d) of Regulation S-K.
100
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
The information under the sub-captions "Director Independence" and "Related
Party Transactions" under the caption "Corporate Governance" in our definitive
Proxy Statement relating to our 2007 Annual Meeting of Shareholders is
incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information under the caption "Appendix C--Audit and Non-Audit Fees" in our
definitive Proxy Statement relating to our 2007 Annual Meeting of Shareholders
is incorporated herein by reference.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) (1) and (2) Financial Statements
See "Financial Statements"
(3) See Index to Exhibits (See Item 15 (b), below)
(b) Exhibits
EXHIBIT NO. DESCRIPTION
- ----------- -----------
2 Not applicable
3.1 Restated Articles of Incorporation of Tecumseh Products Company
(incorporated by reference to Exhibit (3) to registrant's Annual
Report on Form 10-K for the year ended December 31, 1991, File No.
0-452)
3.2 Certificate of Amendment to the Restated Articles of Incorporation
of Tecumseh Products Company (incorporated by reference to Exhibit
B-5 to registrant's Form 8 Amendment No. 1 dated April 22, 1992 to
Form 10 Registration Statement dated April 24, 1965, File No.
0-452)
3.3 Certificate of Amendment to the Restated Articles of Incorporation
of Tecumseh Products Company (incorporated by reference to Exhibit
(4)(c) to registrant's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1994, File No. 0-452)
3.4 Amended and Restated Bylaws of Tecumseh Products Company as
amended through February 28, 2007 (incorporated by reference to
Exhibit 3.1 to registrant's Form 8-K, filed March 1, 2007, File
No. 0-452)
101
4.1 First Lien Credit Agreement dated February 6, 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 Current Report on Form 8-K filed February 9, 2006,
File No. 0-452)
4.2 Amendment No. 1 dated May 5, 2006 to First Lien Credit Agreement
(incorporated by reference to Exhibit 4.1 to registrant's Current
Report on Form 8-K filed March 31, 2006, File No. 0-452)
4.3 Amendment No. 2 dated November 3, 2006 to First Lien Credit
Agreement (incorporated by reference to Exhibit 4.1 to
registrant's Current Report on Form 8-K filed November 8, 2006,
File No. 0-452)
4.4 Amendment No. 3 dated November 13, 2006 to First Lien Credit
Agreement (incorporated by reference to Exhibit 4.1 to
registrant's Current Report on Form 8-K filed November 15, 2006,
File No. 0-452)
4.5 Amendment No. 4 dated December 7, 2006 to First Lien Credit
Agreement (incorporated by reference to Exhibit 4.1 to
registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2006, File No. 0-452)
4.6 Amendment No. 5 dated April 9, 2007 to First Lien Credit Agreement
(incorporated by reference to Exhibit 4.1 to registrant's Current
Report on Form 8-K filed April 10, 2007, File No. 0-452)
4.7 Amended and Restated Second Lien Credit Agreement dated November
13, 2006 among Tecumseh Products Company, Tricap Partners LLC and
Citicorp USA, Inc. (incorporated by reference to Exhibit 4.2 to
registrant's Current Report on Form 8-K filed November 15, 2006,
File No. 0-452).
4.8 Amendment No. 1 dated December 7, 2006 to Amended and Restated
Second Lien Credit Agreement (incorporated by reference to Exhibit
4.2 to registrant's Quarterly Report on Form 10-Q for the quarter
ended September 30, 2006, File No. 0-452).
4.9 Amendment No. 2 dated April 9, 2007 to Amended and Restated Second
Lien Credit Agreement (incorporated by reference to Exhibit 4.2 to
registrant's Current Report on Form 8-K filed April 10, 2007, File
No. 0-452)
Note: Other instruments defining the rights of holders of
long-term debt are not filed because the total amount authorized
thereunder does not exceed 10% of the total assets of the
registrant and its subsidiaries on a consolidated basis. The
registrant hereby agrees to furnish a copy of any such agreement
to the Commission upon request.
9 Not applicable
102
10.1 Amended and Restated Class B Rights Agreement (incorporated by
reference to Exhibit 4 to Form 8 Amendment No. 1 dated April 22,
1992 to Form 8-A registering Common Stock Purchase Rights dated
January 23, 1991, File No. 0-452)
10.2 Amendment No. 1 to Amended and Restated Class B Rights Agreement
(incorporated by reference to Exhibit 4 to Form 8 Amendment No. 2
dated October 2, 1992 to Form 8-A registering Common Stock
Purchase Rights dated January 23, 1991, File No. 0-452)
10.3 Amendment No. 2 to Amended and Restated Class B Rights Agreement
(incorporated by reference to Exhibit 4 to Form 8-A/A Amendment
No. 3 dated June 22, 1993 to Form 8-A registering Common Stock
Purchase Rights dated January 23, 1991, File No. 0-452)
10.4 Amendment No. 3 to Amended and Restated Class B Rights Agreement
(incorporated by reference to Exhibit 4.2 to registrant's Current
Report on Form 8-K as filed August 26, 1999, File No. 0-452)
10.5 Amendment No. 4 to Amended and Restated Class B Rights Agreement,
dated as of August 22, 2001, between Tecumseh Products Company and
State Street Bank and Trust Company, N.A., as successor Class B
Rights Agent (incorporated by reference to Exhibit 4.4 to Form
8-A/A Amendment No. 5 dated September 19, 2001 to Form 8-A
registering Common Stock Purchase Rights dated January 23, 1991,
File No. 0-452)
10.6 Amendment No. 5 to Amended and Restated Class B Rights Agreement,
dated as of July 15, 2002, between Tecumseh products Company,
State Street Bank and Trust Company, N.A. as the existing agent,
and Equiserve Trust Company, N.A. as successor Class B Rights
Agent (incorporated by reference to Exhibit 10.6 to registrant's
Annual Report on Form 10-K for the year ended December 31, 2002,
File No. 0-452)
10.7 Class A Rights Agreement (incorporated by reference to Exhibit 4
to Form 8-A registering Class A Common Stock Purchase Rights dated
April 22, 1992, File No. 0-452)
10.8 Amendment No. 1 to Class A Rights Agreement (incorporated by
reference to Exhibit 4 to Form 8 Amendment No. 1 dated October 2,
1992 to Form 8-A registering Class A Common Stock Purchase Rights
dated April 22, 1992, File No. 0-452)
10.9 Amendment No. 2 to Class A Rights Agreement (incorporated by
reference to Exhibit 4 to Form 8-A/A Amendment No. 2 dated June
22, 1993 to Form 8-A registering Class A Common Stock Purchase
Rights dated April 22, 1992, File No. 0-452)
103
10.10 Amendment No. 3 to Class A Rights Agreement (incorporated by
reference to Exhibit 4.1 to registrant's Current Report on Form
8-K filed August 26, 1999, File No. 0-452)
10.11 Amendment No. 4 to Class A Rights Agreement dated as of August 22,
2001, between Tecumseh Products Company and State Street Bank and
Trust Company, N.A., as successor Class A Rights Agent
(incorporated by reference to Exhibit 4.4 to Form 8-A/A Amendment
No. 4 dated September 19, 2001 to Form 8-A registering Class A
Common Stock Purchase Rights dated April 22, 1992, File No. 0-452)
10.12 Amendment No. 5 to Class A Rights Agreement, dated as of July 15,
2002, between Tecumseh Products Company, State Street Bank and
Trust Company, N.A. as the existing agent, and Equiserve Trust
Company, N.A. as successor Class A Rights Agent (incorporated by
reference to Exhibit 10.12 to registrant's Annual Report on Form
10-K for the year ended December 31, 2002, File No. 0-452)
10.13 Description of Death Benefit Plan (management contract or
compensatory plan or arrangement) (incorporated by reference to
Exhibit (10)(f) to registrant's Annual Report on Form 10-K for the
year ended December 31, 1992, File No. 0-452)
10.14 Management Incentive Plan, as amended and restated on March 29,
2006, effective as January 1, 2005 in part and as of January 1,
2006 in part (management contract or compensatory plan or
arrangement) (incorporated by reference to Exhibit 10.1 to
registrant's Quarterly Report on Form 10-Q for the quarter ended
March 31, 2006, File No. 0-452)
10.18 Amended and Restated Supplemental Executive Retirement Plan
effective June 27, 2001 (management contract or compensatory plan
or arrangement) (incorporated by reference to Exhibit 10.16 to
registrant's Annual Report on Form 10-K for the year ended
December 31, 2001, File No. 0-452)
10.19 Amendment No. 1 to the Supplemental Executive Retirement Plan
adopted September 26, 2001 (management contract or compensatory
plan or arrangement) (incorporated by reference to Exhibit 10.17
to registrant's Annual Report on Form 10-K for the year ended
December 31, 2001, File No. 0-452)
10.20 Outside Directors' Voluntary Deferred Compensation Plan adopted
November 25, 1998 (management contract or compensatory plan or
arrangement) (incorporated by reference to Exhibit (10)(k) to
registrant's Annual Report on Form 10-K for the year ended
December 31, 1998, File No. 0-452)
10.21 Amendment No. 1 to Outside Directors' Voluntary Deferred
Compensation Plan adopted August 28, 2002 (management contract or
compensatory plan or arrangement) (incorporated by reference to
Exhibit 10.21 to registrant's Annual Report on Form 10-K for the
year ended December 31, 2002, File No. 0-452)
104
10.22 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 Quarterly Report on Form 10-Q for the
quarter ended March 31, 2006, File No. 0-452)
10.23 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 Quarterly Report on Form
10-Q for the quarter ended March 31, 2006, File No. 0-452)
10.24 Employment letter to Eric L. Stolzenberg dated November 16, 2005
(management contract or compensatory plan or arrangement)
(incorporated by reference to Exhibit 10.1 to registrant's Current
Report on Form 8-K filed January 9, 2006, File No. 0-452)
10.25 Form of Tecumseh Products Company Change in Control Agreement
(management contract or compensatory plan or arrangement)
(incorporated by reference to Exhibit 10.1 to registrant's Current
Report on Form 8-K filed January 10, 2006, File No. 0-452)
10.26* List of executive officers with Change in Control Agreements
(management contract or compensatory plan or arrangement)
10.27 Liability Transfer and Assumption Agreement for Sheboygan River
and Harbor Superfund Site dated March 25, 2003, by and between
Tecumseh Products Company and Pollution Risk Services, LLC
(incorporated by reference to Exhibit 10.1 to registrant's Current
Report on Form 8-K filed April 9, 2003, File No. 0-452)
10.28 Consent Order entered into on December 9, 2004 with Wisconsin
Department of Natural Resources and TRC Companies, Inc.
(incorporated by reference to Exhibit 10.26 to registrant's Annual
Report on Form 10-K for the year ended December 31, 2004, File No.
0-452)
10.29 Exit Strategy Agreement dated December 29, 2004 with TRC
Companies, Inc. (incorporated by reference to Exhibit 10.27 to
registrant's Annual Report on Form 10-K for the year ended
December 31, 2004, File No. 0-452)
10.30 Stock Purchase Agreement dated as of March 17, 2006 between
Tecumseh Products Company and Franklin Electric Co, Inc. relating
to Little Giant Pump Company (schedules and exhibits omitted)
(incorporated by reference to Exhibit 10-1 to registrant's Current
Report on Form 8-K filed March 21, 2006, File No. 0-452)
10.31 Out-of-Court Restructuring Agreement dated November 21, 2006 among
Tecumseh Products Company, Tecumseh Power Company, TMT Motoco do
Brasil, Ltda., and the banks named therein (incorporated by
reference to Exhibit 10.1 to registrant's Quarterly Report on Form
10-Q for the quarter ended September 30, 2006, File No. 0-452)
105
10.32 Agreement with AP Services, LLC and AlixPartners, LLP dated
December 7, 2006 (incorporated by reference to Exhibit 10.1 to
registrant's Current Report on Form 8-K filed December 14, 2006,
File No. 0-452)
10.33 First Addendum dated January 19, 2007 to agreement with AP
Services, LLC dated December 7, 2006 (incorporated by reference to
Exhibit 10.2 to registrant's Current Report on Form 8-K filed
January 25, 2007, File No. 0-452)
10.33 Settlement and Release Agreement dated as of April 2, 2007 among
Tecumseh Products Company; Herrick Foundation; Todd W. Herrick and
Toni Herrick, each in their capacity as trustee for specified
Herrick family trusts; Todd W. Herrick, Kent B. Herrick, and
Michael Indenbaum, each in their capacity as members of the Board
of Trustees of Herrick Foundation; Todd W. Herrick, Kent B.
Herrick, Michael Indenbaum, and Toni Herrick, each in their
individual capacities; and Albert A. Koch, Peter Banks, and David
M. Risley, each in their capacity as directors of Tecumseh
Products Company (incorporated by reference to Exhibit 10.3 to
registrant's Current Report on Form 8-K filed April 10, 2007, File
No. 0-452)
10.34 Warrant to Purchase Class A Common Stock of Tecumseh Products
Company issued to Tricap Partners II L.P. on April 9, 2007
(incorporated by reference to Exhibit 10.1 to registrant's Current
Report on Form 8-K filed April 10, 2007, File No. 0-452)
10.35 Registration Rights Agreement dated as of April 9, 2007 between
Tecumseh Products Company and Tricap Partners II L.P.
(incorporated by reference to Exhibit 10.2 to registrant's Current
Report on Form 8-K filed April 10, 2007, File No. 0-452)
11 Not applicable
12 Not applicable
13 Not applicable
14 Not applicable
16 Not applicable
18 Not applicable
21* Subsidiaries of the Company
22 Not applicable
23 Not applicable
24* Power of Attorney
31.1* Certification of President and Chief Operating Officer pursuant to
Rule 13a-14(a).
106
31.2* Certification of Chief Financial Officer pursuant to Rule
13a-14(a).
32.1* Certification of President and Chief Operating Officer pursuant to
Rule 13a-14(b) and Section 1350 of Chapter 63 of Title 18 of the
United States Code.
32.2* Certification of Chief Financial Officer pursuant to Rule
13a-14(b) and Section 1350 of Chapter 63 of Title 18 of the United
States Code.
33. Not applicable
34 Not applicable
35 Not applicable
99 Not applicable
100 Not applicable
* Filed herewith
(c) Financial Statement Schedules
None.
107
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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
Date: April 9, 2007 By /s/ James J. Bonsall
-------------------------------------
James J. Bonsall
President and Chief Operating Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
SIGNATURE OFFICE DATE OF SIGNING
--------- ------ ---------------
/s/ JAMES J. BONSALL President and Chief Operating Officer April 9, 2007
- -------------------------------- (Acting Principal Executive Officer)
James J. Bonsall
/s/ JAMES S. NICHOLSON Vice President, Treasurer and April 9, 2007
- -------------------------------- Chief Financial Officer
James S. Nicholson (Principal Accounting and Principal
Financial Officer)
* Director April 9, 2007
- --------------------------------
Peter M. Banks
* Director April 9, 2007
- --------------------------------
Albert A. Koch
* Director April 9, 2007
- --------------------------------
Todd W. Herrick
* Director April 9, 2007
- --------------------------------
David M. Risley
* Director April 9, 2007
- --------------------------------
Kevin E. Sheehan
*By: /s/ JAMES S. NICHOLSON
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James S. Nicholson
Attorney-in-Fact