SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
ACT of 1934
For the quarterly period ended March 31, 2007
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT of 1934
For the transition period from ______to ______
COMMISSION FILE NUMBER: 0-452
TECUMSEH PRODUCTS COMPANY
(Exact name of registrant as specified in its charter)
MICHIGAN 38-1093240
(State of Incorporation) (IRS Employer Identification Number)
100 EAST PATTERSON STREET
TECUMSEH, MICHIGAN 49286
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code:
(517) 423-8411
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of accelerated
filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class of Stock Outstanding at March 31, 2007
-------------- -----------------------------
Class B Common Stock, $1.00 par value 5,077,746
Class A Common Stock, $1.00 par value 13,401,938
TABLE OF CONTENTS
Page
--------
Part I. Financial Information
Item 1. Financial Statements
Consolidated Condensed Balance Sheets.......................... 3
Consolidated Condensed Statements of Operations................ 4
Consolidated Condensed Statements of Cash Flows................ 5
Notes to Consolidated Condensed Financial Statements........... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... 19
Item 3. Quantitative and Qualitative Disclosures About Market
Risk................................................... 36
Item 4. Controls and Procedures................................... 38
Part II. Other Information........................................... 40
Signatures........................................................... 41
Certification of COO Pursuant to Section 302......................... Exh 31.1
Certification of CFO Pursuant to Section 302......................... Exh 31.2
Certification of COO Pursuant to Section 906......................... Exh 32.1
Certification of CFO Pursuant to Section 906......................... Exh 32.2
Page 2
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION - ITEM 1
CONSOLIDATED CONDENSED BALANCE SHEETS
(Unaudited)
MARCH 31, December 31,
(Dollars in millions, except share data) 2007 2006
--------- ------------
ASSETS
Current Assets:
Cash and cash equivalents $ 48.7 $ 81.9
Accounts receivable, trade, less allowance for doubtful
accounts of $8.5 in 2007 and $10.1 in 2006 257.6 219.5
Inventories 321.6 353.4
Deferred and recoverable income taxes 41.9 40.6
Other current assets 42.2 38.0
-------- --------
Total current assets 712.0 733.4
Property, plant, and equipment, net 487.8 552.4
Goodwill 127.5 127.0
Other intangibles 51.9 53.0
Prepaid pension expense 206.3 202.5
Other assets 120.7 114.4
-------- --------
Total assets $1,706.2 $1,782.7
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable, trade $ 221.7 $ 216.0
Short-term borrowings 78.5 163.2
Accrued liabilities 132.1 130.1
-------- --------
Total current liabilities 432.3 509.3
Long-term debt 228.0 217.3
Deferred income taxes 31.5 28.6
Other postretirement benefit liabilities 162.3 166.0
Product warranty and self-insured risks 14.4 13.6
Pension liabilities 15.0 14.9
Other non-current liabilities 32.9 34.6
-------- --------
Total liabilities 916.4 984.3
-------- --------
Stockholders' Equity
Class A common stock, $1 par value; authorized 75,000,000
shares; issued and outstanding 13,401,938 shares in 2007 and 2006 13.4 13.4
Class B common stock, $1 par value; authorized 25,000,000
shares; issued and outstanding 5,077,746 shares in 2007 and 2006 5.1 5.1
Paid in Capital 3.7 3.7
Retained earnings 709.1 726.3
Accumulated other comprehensive income 58.5 49.9
-------- --------
Total stockholders' equity 789.8 798.4
-------- --------
Total liabilities and stockholders' equity $1,706.2 $1,782.7
======== ========
The accompanying notes are an integral part of these Consolidated Condensed
Financial Statements.
Page 3
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION - ITEM 1
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
THREE MONTHS ENDED
MARCH 31,
------------------
(Dollars in millions, except per share data) 2007 2006
------- -------
Net sales $ 460.5 $ 446.1
Cost of sales 422.5 411.6
Selling and administrative expenses 44.1 45.2
Impairments, restructuring charges, and other items -- 0.6
------- -------
Operating loss (6.1) (11.3)
Interest expense (13.3) (8.4)
Interest income and other, net 1.7 5.0
------- -------
Loss from continuing operations before taxes (17.7) (14.7)
Tax benefit (0.9) (2.6)
------- -------
Loss from continuing operations (16.8) (12.1)
Loss from discontinued operations, net of tax -- (0.5)
------- -------
Net loss ($16.8) ($12.6)
======= =======
Basic and diluted loss per share
Loss from continuing operations ($0.91) ($0.65)
Loss from discontinued operations, net of tax -- (0.03)
------- -------
Net loss per share ($0.91) ($0.68)
======= =======
Weighted average shares (in thousands) 18,480 18,480
======= =======
Cash dividends declared per share $ 0.00 $ 0.00
======= =======
The accompanying notes are an integral part of these Consolidated Condensed
Financial Statements.
Page 4
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION - ITEM 1
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
THREE MONTHS ENDED
MARCH 31,
------------------
(Dollars in millions) 2007 2006
------- -------
Cash Flows from Operating Activities:
Cash used by operating activities* ($50.8) ($44.5)
Cash Flows from Investing Activities:
Cash effect of deconsolidation of TMT Motoco (0.3) --
Proceeds from sale of assets -- 9.0
Capital expenditures (1.9) (20.0)
Business acquisition -- (2.0)
------- -------
Cash used in investing activities (2.2) (13.0)
------- -------
Cash Flows from Financing Activities:
Repayment of Senior Guaranteed Notes -- (250.0)
Repayment of Industrial Development Revenue Bonds -- (10.5)
Proceeds from First Lien Credit Agreement, net 8.3 168.3
Proceeds from Second Lien Credit Agreement -- 100.0
Repayments of Second Lien Credit Agreement -- --
Other borrowings, net 8.8 16.2
------- -------
Cash provided by financing activities 17.1 24.0
------- -------
Effect of exchange rate changes on cash 2.7 (0.3)
------- -------
Decrease in cash and cash equivalents (33.2) (33.8)
Cash and Cash Equivalents:
Beginning of period 81.9 116.6
------- -------
End of period $ 48.7 $ 82.8
======= =======
*Depreciation and Amortization 18.4 20.2
Supplemental Schedule of Noncash Investing and Financing Activities:
Paid-in-Kind Interest 0.4
The accompanying notes are an integral part of these Consolidated Condensed
Financial Statements.
Page 5
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. The consolidated condensed financial statements of Tecumseh Products
Company and Subsidiaries (the "Company") are unaudited and reflect all
adjustments (including normal recurring adjustments) which are, in the
opinion of management, necessary for a fair statement of the financial
position and operating results for the interim periods. The December 31,
2006 consolidated condensed balance sheet data was derived from audited
financial statements, but does not include all disclosures required by
generally accepted accounting principles in the United States ("U.S.
GAAP"). The consolidated condensed financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
contained in our Annual Report for the fiscal year ended December 31, 2006.
Due to the seasonal nature of certain product lines, the results of
operations for the interim period are not necessarily indicative of the
results for the entire fiscal year.
On March 28, 2007, our Brazilian engine subsidiary, TMT Motoco, was granted
permission by the Brazilian court to pursue a judicial restructuring, which
is similar to U.S. Chapter 11 bankruptcy protection. TMT Motoco has sixty
days from the date the judicial restructuring was granted to submit its
restructuring plan, although that deadline may, under certain
circumstances, be extended. The facility suspended operations on the date
it filed for the judicial restructuring, and it has not been determined
whether or when it will re-open in the future.
The assets and liabilities of TMT Motoco at March 31, 2007 have been
removed from our consolidated balance sheets. The following is a summary
of the assets, liabilities and equity of TMT Motoco at March 31, 2007:
March 31,
(Dollars in millions) 2007
---------
Accounts receivable, net $ 0.6
Inventories 24.6
Other current assets 8.5
Property, plant and equipment, net 63.6
------
Total Assets $ 97.3
======
Accounts payable, trade $ 8.0
Other current liabilities 25.7
Noncurrent Liabilities 67.7
------
Total Liabilities 101.4
Shareholders' Deficit (4.1)
------
Total Liabilities and Shareholders' Deficit $ 97.3
======
Losses associated with TMT Motoco of $3.5 million and $4.1 million,
including interest expense, were included in our consolidated net loss for
the periods ended March 31, 2007 and 2006, respectively.
2. Liquidity and Management Plans
Management has implemented a financial plan for 2007 which reflects
improvements in operating income approximating $94 million over that
reported for the year ended December 31, 2006. For the period ended
March 31, 2007, our operating loss was favorable to this plan
by $5.6 million.
Page 6
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
Attainment of the 2007 budget would result in exceeding the Adjusted EBITDA
covenants in our domestic credit agreements by approximately $35 million.
While we expect to meet our plan during 2007 and thereby maintain
compliance with the Adjusted EBITDA covenants and our other covenants for
remainder of the year, 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.
In addition to the factors described above, we consider it necessary that
our Brazilian compressor subsidiary, Tecumseh do Brasil ("TdB"), secures
normal credit terms, including long term committed credit lines. While we
have been successful to date in obtaining sufficient lending arrangements
to meet the operational needs of TdB, the majority of its credit lines are
not committed lines with lives beyond one year. We consider the restoration
of normal credit terms for TdB to be essential to ensuring that it
continues to maintain adequate liquidity. Refer to the Executive Summary in
Part 1, Item 2 of this report for further discussion of the issues related
to TdB's credit agreements.
Non-compliance with our 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.
Refer to Note 2, "Liquidity and Management Plans," in our Annual Report on
Form 10-K for the year ended December 31, 2006, for further information
regarding our 2007 plan and a discussion of the risks associated with
shortfalls to our plan and our covenant targets.
3. Comprehensive Income
THREE MONTHS
ENDED
MARCH 31,
---------------
(Dollars in millions) 2007 2006
------ ------
Net loss ($16.8) ($12.6)
Other comprehensive income (loss):
Foreign currency translation adjustments 6.5 23.2
Gain (Loss) on derivatives 2.1 (0.9)
Unrealized gain (loss) on investment holdings -- (3.9)
------ ------
Total comprehensive income (loss) ($8.2) $ 5.8
====== ======
Page 7
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
4. Inventories
MARCH 31, December 31,
(Dollars in millions) 2007 2006
--------- ------------
Raw material $143.7 $159.0
Work in progress 59.1 60.1
Finished goods 107.0 121.5
Supplies 11.8 12.8
------ ------
Total inventories $321.6 $353.4
====== ======
Page 8
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
5. Business Segments
We have three reportable segments based on the criteria set forth in SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related
Information": Compressor Products, Electrical Component Products, and
Engine & Power Train Products. Net sales and operating income (loss) by
segment for the periods indicated are as follows:
THREE MONTHS
ENDED
MARCH 31,
BUSINESS SEGMENT DATA ---------------
(Dollars in millions) 2007 2006
------ ------
Net sales:
Compressor Products $289.3 $251.5
Electrical Component Products 103.3 109.1
Engine & Power Train Products 63.0 80.9
Other (a) 4.9 4.6
------ ------
Total Net Sales $460.5 $446.1
====== ======
Operating income (loss):
Compressor Products $ 10.5 $ 6.6
Electrical Component Products 1.1 4.9
Engine & Power Train Products (8.0) (18.5)
Other (a) 0.3 0.3
Corporate expenses (10.0) (4.0)
Impairments, restructuring charges, and other items -- (0.6)
------ ------
Total operating loss from continuing operations (6.1) (11.3)
Interest expense (13.3) (8.4)
Interest income and other, net 1.7 5.0
------ ------
Loss from continuing operations before taxes ($17.7) ($14.7)
====== ======
(a) "Other" consists of non-reportable business segments.
The Electrical Component Products segment had inter-segment sales of $10.7
million and $11.9 million in the first quarter of 2007 and 2006, respectively.
Page 9
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
6. Goodwill and Other Intangible Assets
At March 31, 2007, goodwill by segment consisted of the following:
COMPRESSOR COMPRESSOR ELECTRICAL
EUROPE INDIA COMPONENTS TOTAL
---------- ---------- ---------- ------
Balance at 1/1/2007 $11.2 $7.0 $108.8 $127.0
Foreign Currency Translation 0.1 0.1 0.3 0.5
----- ---- ------ ------
Balance at 3/31/2007 $11.3 $7.1 $109.1 $127.5
===== ==== ====== ======
At March 31, 2006, goodwill by segment consisted of the following:
COMPRESSOR COMPRESSOR ELECTRICAL
EUROPE INDIA COMPONENTS OTHER TOTAL
---------- ---------- ---------- ----- ------
Balance at 1/1/2006 $10.0 $6.9 $108.9 $ 5.1 $130.9
Sale of Little Giant Pump
Company -- -- -- (5.1) (5.1)
Foreign Currency Translation 0.3 -- -- -- 0.3
----- ---- ------ ----- ------
Balance at 3/31/2006 $10.3 $6.9 $108.9 $ 0.0 $126.1
On April 21, 2006, the Company completed the sale of its 100% ownership in
Little Giant Pump Company. Its assets were classified as held for sale as
of March 31, 2006. The only other changes in goodwill during the first
three months of 2007 and 2006 were due to foreign currency fluctuations.
Other intangible assets (all included in the Electrical Components Group)
as of March 31, 2007 consisted of the following:
Gross
Carrying Accumulated Amortizable
Amount Amortization Net Life
-------- ------------ ----- -----------
Intangible assets subject to amortization:
Customer relationships and contracts $39.9 $12.0 $27.9 6-15 years
Technology 12.0 4.9 7.1 5-10 years
----- ----- -----
Total 51.9 16.9 35.0
Intangible assets not subject to amortization:
Trade name 16.9 -- 16.9
----- ----- -----
Total intangible assets $68.8 $16.9 $51.9
===== ===== =====
The estimated amortization expense over the next five years is $4.1 million
for 2007, $3.9 million for 2008, approximately $3.7 million annually for
2009 and 2010, and $3.5 million thereafter. Amortization expense for the
three months ended March 31 was $1.1 million and $0.9 million for 2007 and
2006, respectively.
As a result of the acquisition of In Motion Technologies Pty. Ltd. (IMT),
in the first quarter 2006, the Company recorded an additional technology
intangible asset of $2.0 million.
Page 10
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
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
===== ===== =====
Page 11
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
7. Pension and Other Postretirement Benefit Plans
Components of net periodic benefit (income) cost are as follows:
PENSION OTHER
BENEFITS BENEFITS
------------- -------------
THREE MONTHS THREE MONTHS
ENDED ENDED
MARCH 31, MARCH 31,
------------- -------------
2007 2006 2007 2006
----- ----- ----- -----
Service Cost $ 2.2 $ 2.4 $ 1.0 $ 0.8
Interest Cost 5.6 5.3 2.1 2.4
Expected return on plan assets (11.3) (11.1) (0.1) --
Amortization of prior service costs (0.1) 0.1 (2.6) (1.2)
----- ----- ----- -----
Net periodic benefit (income) cost ($3.6) ($3.3) $ 0.4 $ 2.0
===== ===== ===== =====
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.
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 in overfunding
for all our pension plans that have plan assets in excess of obligations.
On May 1, 2007, we initiated 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, without additional annual contributions, for approximately six to
eight years.
We expect to contribute $0.1 million to our pension plans in 2007.
8. Guarantees and Warranties
A portion of accounts receivable at our Brazilian compressor subsidiary are
sold with recourse. Brazilian receivables sold at March 31, 2007 and
December 31, 2006 were $60.8 million and $46.5 million, respectively. We
estimate the fair value of the contingent liability related to these
receivables to be $0.5 million, which is included in operating profit
(loss) and allowance for doubtful accounts.
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.
Page 12
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
Changes in the carrying amount and accrued product warranty costs for the three
months ended March 31, 2007 and 2006 are summarized as follows:
Three Months Three Months
Ended Ended
(Dollars in millions) March 31, 2007 March 31, 2006
-------------- --------------
Balance at January 1 $26.2 $29.4
Settlements made (in cash or in kind) (4.1) (4.4)
Current year accrual 2.3 2.8
Adjustments to preexisting warranties (1.3) 1.5
Effect of foreign currency translation 0.1 0.2
Reclassification* -- (2.7)
Other* (0.4) --
----- -----
Balance at March 31 $22.8 $26.8
===== =====
* At March 31, 2007, balances for TMT Motoco were removed from our
consolidated balance sheet. At March 31, 2006, balances for Little Giant
Pump Company were removed from our consolidated balance sheet and
reclassified as held for sale.
At March 31, 2007, $16.6 million was included in current liabilities and
$6.2 million was included in noncurrent liabilities.
9. Debt
Our domestic credit facilities consist of a financing package that includes
a $250 million First Lien Credit Agreement and a $100 million Second Lien
Credit Agreement. The First and Second Lien Credit Agreements provide for
security interests in substantially all of our assets and specific
quarterly financial covenants related to EBITDA (as defined under the
agreements, which provide adjustments for certain items, and are hereafter
referred to as "Adjusted EBITDA"), capital expenditures, and fixed charge
coverage. The Adjusted EBITDA covenant applies through December 31, 2007,
and a four-quarter fixed charge coverage ratio covenant applies beginning
on December 31, 2007. Both our First Lien Credit Agreement and our Second
Lien Credit Agreement expire in November 2009.
During the second quarter of 2006, we entered into interest rate swap
agreements, effectively converting $90 million (or 29% of our total debt as
of March 31, 2007) of variable rate debt to fixed rate debt. Including the
effect of these swap agreements, the effective weighted average interest
rate of our outstanding borrowings under the First and Second Lien Credit
Agreements was 10.1% at March 31, 2007.
At March 31, 2007, we had outstanding letters of credit of $6.4 million and
total borrowing availability of $32.1 million under our $250 million First
Lien Credit Agreement, and availability of $43.4 million under foreign
credit agreements. Our weighted average interest rate for all borrowings is
9.6%.
In addition, we have various borrowing arrangements at our foreign
subsidiaries to support working capital needs and governmental sponsored
borrowings that provide advantageous lending rates.
Page 13
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
During the quarter, we had net proceeds from these arrangements totaling
$8.8 million.
Interest on the 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.
Other interest rate related terms of the 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.
The Second Lien Credit Agreement 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 independent 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.
In March of 2007, our Brazilian engine subsidiary, TMT Motoco, was granted
permission by the Brazilian courts to pursue a judicial restructuring,
similar to a U.S. filing for Chapter 11 bankruptcy protection. The TMT
Motoco filing in Brazil constituted an event of default with our domestic
lenders. On April 9, 2007 we obtained 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 2007
Page 14
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
quarterly periods (in millions) were set at:
Quarterly Period Ending First Lien Agreement Second Lien Agreement
- ----------------------- -------------------- ---------------------
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 product 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 was not hired by May 1, 2007, the
amendment to our Second Lien credit agreement also provided for a 2.5% per
annum step-up in cash interest rate from that day forward until such time
as a permanent CEO was hired. However, the agreement also provided that the
additional interest would not be assessed beginning May 1 if the CEO
candidate had not assumed his or her duties due either to a personal
emergency or inability to reach agreement on terms of employment. Since
this condition has been met, the additional interest is not being assessed
and will not be assessed as long as we continue to apply our best efforts
to engage a permanent CEO as soon as possible.
We paid $625,000 in fees, plus expenses, to the First Lien lender on April
9, 2007 upon execution of the agreement. In addition to fees paid of
$750,000, plus expenses, to the Second Lien lender, on April 9 we also
granted the Second Lien lender a warrant 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. The sum of
these costs 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. While we are currently
moving forward with these actions, there can be no assurance that any of
these initiatives will be sufficient.
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 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.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
As a result of its judicial restructuring in Brazil, the TMT Motoco balance
sheet, including $89.5 million in debt, has been deconsolidated from our
Consolidated Balance Sheet at March 31, 2007. See Note 1 for further
details on TMT Motoco's assets and liabilities.
Also refer to Part I, Item 1A, "Risk Factors," in our Annual Report on Form
10-K for the year ended December 31, 2006 for a summary of some of the most
significant risks posed by our current liquidity issues.
10. Environmental Matters
We are involved in a number of environmental sites where we are either
responsible for or participating in a cleanup effort. We had accrued $3.3
million at both March 31, 2007 and December 31, 2006 for environmental
remediation. 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. For additional information on our
potential environmental liabilities, including the Sheboygan River and
Harbor Superfund and Hayton Area Remediation Project sites, see Note 11 to
the Financial Statements in our Annual Report on Form 10-K for the year
ended December 31, 2006.
11. Income Taxes
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.
For the three month period ended March 31, 2007, we reported other U.S.
income in the form of other comprehensive income that is related to the
U.S. tax jurisdiction. Pursuant to SFAS No. 109, Paragraph 35, we allocated
income tax expense or benefit between continuing operations and OCI. The
consolidated condensed statement of operations reflects a $0.9 million
income tax benefit for the three months ended March 31, 2007 and a $2.6
million income tax benefit for the three months ended March 31, 2006. Both
periods reflect tax benefit in the statement of operations and tax expense
in other comprehensive income.
At March 31, 2007 and December 31, 2006, full valuation allowances were
recorded for net operating loss carryovers for those tax jurisdictions in
which we are in a cumulative year loss position.
We adopted FASB Interpretation No. 48, "Accounting for Uncertainty in
Income Taxes - an Interpretation of FASB Statement No. 109" (FIN 48) on
January 1, 2007. FIN 48 clarifies the accounting and reporting for
uncertainties in income tax positions. This interpretation prescribes a
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
comprehensive model for the financial statement recognition, measurement,
presentation and disclosure of uncertain tax positions taken or expected to
be taken in income tax returns.
The effect of adopting FIN 48 was an increase in tax reserves and a
decrease of retained earnings of $0.4 million. Upon adoption, the liability
for income taxes associated with uncertain tax positions at January 1, 2007
was $3.0 million. In addition, consistent with the provisions of FIN 48, we
reclassified $1.8 million of income tax liabilities from current to
deferred income taxes, because payment of cash is not anticipated within
one year of the balance sheet date. The total amount of $3.0 million, if
ultimately recognized, would impact our effective tax rate.
Interest and penalties related to income tax liabilities are included in
income tax expense. The balance of accrued interest and penalties recorded
in the Consolidated Balance Sheet at January 1, 2007 was $1.1 million; of
this amount, $0.7 million was also reclassified from current to non-current
liabilities upon adoption of FIN 48.
With limited exceptions, we are no longer subject to U.S. federal, state
and local or non-U.S. income tax audits by taxing authorities for year
through 2002. We anticipate a decrease in the total amount of unrecognized
tax benefits within the next twelve months of approximately $1.2 million.
12. Commitments and Contingencies
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 and asbestos-related claims, incidental to our 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.
13. Discontinued Operations
During the first quarter of 2006, we approved a plan to proceed with a
transaction to sell 100% of our ownership in our Little Giant Pump Company
subsidiary. Its results for the quarter ended March 31, 2006 are included
in loss from discontinued operations. Interest expense of $2.3 million was
allocated to discontinued operations for the period because our financing
agreements required that the proceeds from the sale be utilized to repay
portions of our debt.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
Following is a summary of loss from discontinued operations for Little
Giant Pump Company for the quarter ended March 31, 2006:
(Dollars in millions) March 31, 2006
--------------
Net sales $26.8
Cost of sales 19.2
Selling and administrative expenses 5.6
-----
Operating income 2.0
Interest expense allocated 2.3
-----
Loss from discontinued operations before income taxes ($0.3)
Tax provision 0.2
-----
Loss from discontinued operations, net of tax ($0.5)
=====
14. Impairments, Restructuring Charges, and Other Items
We recorded no impairments, restructuring charges, or other items in the three
months ended March 31, 2007. We recognized asset impairment charges of $0.6
million for the three months ended March 31, 2006.
15. Recently Issued Accounting Pronouncements
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 requires (or permits) 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. We are currently
evaluating the impact of this pronouncement on our consolidated financial
statements.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Executive Summary
We are one of the largest independent producers of hermetically sealed
compressors in the world, one of the world's leading manufacturers of small
gasoline engines and power train products used in lawn and garden applications,
and one of the leading manufacturers of fractional horsepower motors for the
United States market. 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 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 refrigeration 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. 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
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 deflationary pricing in many of the
market segments in which we operate. Like many of our customers and competitors,
we have restructured older operations to remain cost competitive, including the
movement of productive capacities to low-cost locations or nearer to customer
facilities. These restructurings involve significant costs, in both financial
and human terms. In addition, many of our markets are subject to macroeconomics
trends, which expand and contract, and many overall trends which affect demand,
such as weather.
The foreign manufacturing operations we have developed are subject to many
risks, including governmental expropriation, governmental regulations that may
be disadvantageous to businesses owned by foreign nationals, and instabilities
in the workforce due to changing political and social conditions.
These considerations are especially significant in the context of our Brazilian
operations. Until recently, our Curitiba, Brazil facility, TMT Motoco, provided
full engine assemblies to supply worldwide demand for lawn and garden engines.
Due to pressure from one of its lenders, however, in March 2007 TMT Motoco was
forced to file for judicial restructuring, similar to a U.S. Chapter 11
bankruptcy filing, and has suspended operations, including releasing the
majority of its employees. While TMT Motoco will
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
remain in possession of its assets during the restructuring process, certain
decisions regarding those assets are subject to court approval. As result, TMT
Motoco has been deconsolidated from our Consolidated Balance Sheet at March 31,
2007. See "Significant Accounting Policies and Critical Accounting Estimates" in
Item 2 for further details on TMT Motoco's assets and liabilities.
TMT Motoco's restructuring plan is due to be filed in Brazilian court by May 28,
although under certain circumstances that deadline may be extended. In the
interim, we are continuing to meet the needs of our customers for lawn and
garden engines. We are currently evaluating several alternatives for the future
of TMT Motoco and products that have been manufactured at that facility. The
range of potential outcomes includes resuming full scale production, minimal
production and/or rental of the facility, or a controlled liquidation.
The filing in Brazil constituted an event of default with our domestic lenders.
On April 9, 2007 we obtained amendments to our First and Second Lien Credit
Agreements that cured the default, though at significant cost. The details of
these agreements are discussed below in "Adequacy of Liquidity Sources" and in
Note 9, "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 ("TdB"), maintains its credit facilities and continues to
successfully meet its obligations to its suppliers and customers. TdB provided a
significant portion of total Compressor Products segment production during 2006
and is continuing to do so in 2007. During the period subsequent to the
unfavorable judicial rulings received by TMT Motoco and the related cross
defaults with our U.S. lending agreements, certain Brazilian lenders to TdB,
including lenders that were also lenders to TMT Motoco, curtailed or did not
renew maturing credit facilities, pending the outcome of the uncertainties
created by these events. Now that we have obtained the necessary amendments to
bring our U.S. credit agreements into compliance, we have been negotiating with
TdB's group of lenders in Brazil to reestablish normal credit terms for the
compressor operation. To date, we have been able to obtain sufficient lending
arrangements to meet the needs of TdB. However, the majority of its credit lines
are not committed lines with lives beyond one year. Accordingly, we consider it
necessary to restore normal credit terms, including obtaining long term
committed credit lines, if TdB is to be certain to have continued adequacy of
liquidity. We believe that we have good relationships with many of our lenders
in Brazil and that progress is being made in securing these committed credit
lines during the second quarter. However, there can be no assurance that we will
ultimately be successful in this endeavor. In addition, it is possible that the
cost of such lines may be considerable, given that some of the lenders are also
lenders to our Brazilian engine operations, and that terms included in any
resulting credit agreements may require the approval of the first and second
lien lenders in the United States.
As a global manufacturer with production in 11 countries and sales in over 110
countries throughout the world, results are sensitive to changes in foreign
currency exchange rates. In total, those movements have not been favorable to us
during 2006 and the first three months of 2007, and have had significant adverse
effect on our results over these periods. 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.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Dollars and Euros. 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 2005, 2006 and into 2007.
Due to competitive markets, we were not able to fully recover these cost
increases through price increases and other cost savings. Increases in raw
material, energy and certain commodity costs have had a material adverse impact
on our operating results during these periods. For example, from January 1, 2006
through April 30, 2007, the prices of copper and aluminum have increased
approximately 63.8% and 21.8%, 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
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 have 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 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 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 affect on our results of operations both in the near
and long term. Any such increases in cost that could not be recovered through
increases 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, but our continued compliance will be 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 further 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. 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 management structure. Our
Second Lien Credit Agreement, established in November of 2006, included a
commitment to create an advisory committee
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 sued by Todd W. Herrick and a charitable foundation
he and his family control that holds more than 43% of our voting shares, and we
filed a separate lawsuit against them and related parties. Both lawsuits have
been settled, as described 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 "Adequacy of Liquidity," "Outlook," and "Cautionary
Statements Relating To Forward-Looking Statements" below.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations
A summary of our operating results as a percentage of net sales is shown below
(dollar amounts in millions):
Three Months Ended March 31,
(dollars in millions) 2007 % 2006 %
------ ----- ------ -----
Net sales $460.5 100.0% $446.1 100.0%
Cost of sales 422.5 91.7% 411.6 92.3%
Selling and administrative expenses 44.1 9.6% 45.2 10.1%
Impairments, restructuring charges, and
other items -- -- 0.6 0.1%
------ ------
Operating loss (6.1) (1.3%) (11.3) (2.5%)
Interest expense (13.3) (2.9%) (8.4) (1.9%)
Interest income and other, net 1.7 0.4% 5.0 1.1%
------ ------
Loss from continuing operations before taxes (17.7) (3.8%) (14.7) (3.3%)
Tax benefit (0.9) (0.2%) (2.6) (0.6%)
------ ------
Loss from continuing operations ($16.8) (3.6%) ($12.1) (2.7%)
====== ======
Three Months Ended March 31, 2007 vs. Three Months Ended March 31, 2006
Consolidated net sales from continuing operations in the first quarter of 2007
increased to $460.5 million from $446.1 million in 2006. $13.2 million of the
$14.4 million increase in sales was due to the effects of currency translation.
Sales increases attributable to the Compressor segment ($37.8 million) were
offset by a slight decline in the Electrical Components segment ($5.8 million)
and a substantial decline ($17.9 million) in sales in the Engine & Power Train
segment. The remainder of the changes are attributable to businesses not
associated with any of our three major business segments.
Cost of sales was $422.5 million in the three months ended March 31, 2007, as
compared to $411.6 million in the three months ended March 31, 2006. As a
percentage of net sales, cost of sales was 91.7% and 92.3% in the first quarters
of 2007 and 2006, respectively. Unfavorable foreign currency exchange rates and
higher commodity costs were offset by efficiency improvements and overhead
reductions, particularly at the Engine & Power Train segment.
Selling, general and administrative expenses were $44.1 million in the three
months ended March 31, 2007, as compared to $45.2 million in the three months
ended March 31, 2006. As a percentage of net sales, selling, general and
administrative expenses were 9.6% and 10.1% in the first quarters of 2007 and
2006, respectively. Reductions in SG & A were attributable to overhead cost
improvements that resulted from our restructuring efforts over the past year,
particularly at the Engine & Power Train group, although these advances were
somewhat offset by costs associated with professional fees. Fees paid to
AlixPartners were reduced over the prior year; $4.0 million was incurred in the
first quarter of 2007 for AlixPartners services, including the services of James
Bonsall, while $9.0 million was incurred in the first quarter of 2006 for their
consulting services provided to our Engine & Power Train business. However,
professional fees for the business as a whole were $10.4 million in the first
quarter of 2007, which included $4.6 million in fees in excess of those incurred
in the ordinary course of business. These costs were associated with the
amendments to our First and Second Lien credit
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
agreements, the legal proceedings relating to governance issues, and our efforts
to market portions of the business.
There were no impairments, restructuring charges or other items in the three
months ended March 31, 2007, compared to $0.6 million in the three months ended
March 31, 2006.
Interest expense amounted to $13.3 million in the first quarter of 2007 compared
to $8.4 million in the first quarter of 2006. The increase was primarily related
to the higher average interest rates associated with our current borrowing
arrangements.
Interest income and other, net was $1.7 million in the first quarter of 2007
compared to $5.0 million in the first quarter of 2006. In 2006, we recorded 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. 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 condensed statement of operations reflects a $0.9 million
income tax benefit for the first quarter 2007 and a $2.6 million income tax
benefit for the first quarter 2006. Income taxes are recorded pursuant to SFAS
No. 109, "Accounting for Income Taxes," and are applied on a jurisdiction by
jurisdiction basis.
At March 31, 2007 and 2006, full valuation allowances were recorded for net
operating loss carryovers for those tax jurisdictions in which we are in a
cumulative three year loss position. Although we reported a 0% U.S. federal tax
provision in total, paragraph 140 of SFAS 109 requires that we allocate taxes
across all categories of income or loss, including continuing operations,
discontinued operations, and Other Comprehensive Income (OCI). In the three
months ended March 31, 2007 and 2006, we reported losses from continuing
operations, but income in OCI, and in the period ended March 31, 2006 we also
reported a loss from discontinued operations. In accordance with paragraph 140,
we recorded federal tax benefits for continuing and discontinued operations, and
federal tax expense in OCI. The net result was an effective rate in the U.S.
federal jurisdiction of 0%. Since we pay taxes in various states there is also
an expense recorded in the U.S. that is related to separate company state tax
liabilities, including state tax expense that is recorded in discontinued
operations.
Net loss from continuing operations in the first quarter of 2007 was $16.8
million ($0.91 per share) as compared to net loss of $12.1 million ($0.65 per
share) in the first quarter of 2006. The decline was the result of the factors
described above.
Reportable Operating Segments
The financial information presented below is for our three reportable operating
segments for the periods presented: Compressor, Electrical Components, and
Engine & Power Train. Financial measures regarding each segment's income (loss)
before interest, other expense, income taxes, and impairments, restructuring
charges, and other items ("operating income") and income (loss) before interest,
other expense and income taxes and impairments, restructuring charges, and other
items divided by net sales ("operating margin") are not measures of performance
under accounting principles generally accepted in the United States (GAAP). Such
measures are presented because we evaluate the performance of our reportable
operating segments, in part, based on income (loss) before interest, other
expense, income taxes, and impairments, restructuring charges, and other items.
These measures should not be considered in isolation or as a substitute for net
income, net cash provided by
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
operating activities or other income statement or cash flow statement data
prepared in accordance with GAAP or as measures of profitability or liquidity.
In addition, these measures, as we determine them, may not be comparable to
related or similarly titled measures reported by other companies. For a
reconciliation of consolidated income (loss) before interest, other expense and
income taxes, impairments, restructuring charges, and other items to income
before provision for income taxes, see Note 5, Business Segments.
Compressor Products
First quarter 2007 sales in the Compressor segment increased to $289.3 million
from $251.5 million in the prior year. $12.0 million of the $37.8 million
increase in sales was due to the effects of foreign currency translation. Sales
increases in this segment were led by the refrigeration and freezer product
lines (up $21.4 million), an increase of 24.7%. Consistent with the trends we
experienced in 2006, the sales increase in refrigeration and freezer compressors
was led by growth in new markets in India. Sales were also higher for the
commercial compressor product lines (up $11.8 million). This sales increase was
attributable to pricing advances rather than unit volumes.
Compressor business operating results for the first quarter of 2007 were income
of $10.5 million compared to income of $6.6 million in the first quarter of
2006. The higher operating income was attributable to pricing adjustments and
greater sales volumes ($23.3 million) and productivity and other improvements
($6.8 million). These year-on-year improvements were partially offset by
unfavorable foreign currency exchange rates ($16.2 million) For the first
quarter, the Brazilian Real was on average 4.9% stronger against the U.S. Dollar
in 2007 versus 2006. The price of copper and other commodities also contributed
unfavorably to results in the first quarter of 2007. Including the effects of
hedging activities, the Company estimates that the continued escalation in
commodity pricing decreased operating income by approximately $10.8 million
compared to the first quarter of 2006.
Electrical Component Products
Electrical Components business sales were $103.3 million for the first quarter
of 2007, a decrease of 5.3% compared to sales of $109.1 million in the same
quarter last year. Sales increases of $2.4 million in the automotive product
lines reflected the implementation of new programs with our customers and their
respective OEM's. Increases of $2.3 million were reported in the Asia Pacific
markets as well. Sales increases in the Asia Pacific markets were primarily due
to favorable impacts of currency exchange, but also reflected the addition of
new product in Thailand. These advances were offset by declines of $9.5 million
in residential & commercial motors; these declines were primarily due to the
mild winter, which reduced sales of components for gas furnaces and other
heating products.
Electrical Components operating results for the first quarter of 2007 were
income of $1.1 million compared to income of $4.9 million in the first quarter
of 2006. The differences were primarily related to volume declines and a less
favorable product mix ($10.1 million), as automotive product lines carry
substantially lower margins than residential & commercial motors. On the other
hand, productivity and other improvements increased operating income by $3.5
million. In addition, due to better hedging positions on our copper needs in the
first quarter of 2007, and pricing adjustments implemented to offset the
escalation in commodity pricing, commodity cost impacts improved results by $3.1
million compared to the first quarter of 2006.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Engine & Power Train Products
Engine & Power Train business sales were $63.0 million in the first quarter of
2007 compared to $80.9 million for the same period a year ago. Declines were led
by engines for walk behind mowers (down $5.2 million), a decline of 14.6%.
Engines for generators were also down by $4.7 million, declining by 68.1%,
consistent with an overall market trend due to the lack of significant hurricane
or other storm activity in recent months. Engines for riding mowers were also
down by $2.6 million or 21.2%. Reductions in both walk behind and riding mower
engines were a result of lower sales volumes with certain key customers. To a
lesser extent, the declines also reflected timing of purchases, as customers
delayed purchases into the second quarter of 2007. The remaining decreases in
the Engine & Power Train Group were spread across multiple product lines.
Engine & Power Train business operating loss for the first quarter of 2007 was
$8.0 million compared to a loss of $18.5 million during the same period a year
ago. Included in the results were AlixPartners' fees of $1.3 million in 2007 and
$9.0 million in 2006. Operating loss in the first quarter of 2006 was reduced
due to a gain of $3.5 million in 2006 from the sale of the segment's Douglas,
Georgia facility. The improvement in the first quarter results reflected lower
fixed costs, primarily associated with the segment's restructuring efforts ($5.9
million), and price increases ($2.8 million), offset by lost margins from
reductions in sales volume ($1.7 million).
OTHER MATTERS
Environmental Matters
We are subject to various federal, state and local laws relating to the
protection of the environment and are actively involved in various stages of
investigation or remediation for sites where contamination has been alleged.
(See Note 10 to the financial statements.) Liabilities relating to probable
remediation activities are recorded when the costs of such activities can be
reasonably estimated based on the facts and circumstances currently known.
Difficulties exist estimating the future timing and ultimate costs to be
incurred due to uncertainties regarding the status of laws, regulations, levels
of required remediation, changes in remediation technology and information
available.
We had accrued $3.3 million at both March 31, 2007 and December 31, 2006 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 and included eliminating significant
duplicate capacity, among other cost reduction efforts. We believe participation
by AlixPartners has allowed us to progress in effecting these changes in a
shorter time frame than it otherwise could have achieved. During the first
quarter of 2007 and the full year of 2006, the Company recognized fees of $4.0
million and $21.1 million, respectively, related to the AlixPartners engagement.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
On December 9, 2006, we entered into a new letter agreement with AlixPartners
and its affiliate, AP Services, LLC. This agreement provided for AlixPartners to
continue to provide interim management, financial advisory, and consulting
services for our Engine and Power Train Group, but altered the amounts and
timing of payments that would be due to AlixPartners over subsequent next nine
months. The new agreement replaced 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 above
in our Executive Summary, 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.
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
For the first three months of 2007, cash used by operations amounted to $50.8
million, reflecting both an operating loss and net investments in working
capital. Accounts receivable increased by $42.4 million from the beginning of
the year. This increase was the result of several factors. First, the
seasonality of the Company's sales patterns resulted in higher sales in the
first quarter of the year when compared to the fourth quarter of 2006. More
specifically, sales in the last two months of the respective quarters - which is
the primary driver of the accounts receivable balance - increased by $31.9
million in the February 1 to March 31, 2007 period when compared to November and
December of 2006. Finally, receivables, on average, required an additional four
days to collect as of March 31, 2007 as compared to the end of 2006. This
increase was driven by the Engine & Power Train segment, whose days sales
outstanding increased from 54 at the end of the year to 60 as of March 31. The
Compressor segment also saw an increase in days sales outstanding, from 61 at
the end of the year to 67 at March 31 (before consideration for discounted
accounts receivable at the segment's Brazilian subsidiary). In contrast,
inventories have decreased by $9.9 million since the beginning of the year,
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
reflecting improvements in days inventory on hand at the Compressor and Engine &
Power Train business segments.
In evaluating its balance sheet metrics, the Company considers the days sales
outstanding and days inventory on hand metrics to be more relevant when
comparing year-over-year periods than when comparing the current period to
year-end, as it removes any seasonality of the Company's sales patterns from the
comparison. Average days sales outstanding were 63 days at March 31, 2007 versus
56 days at March 31, 2006, before giving effect to receivables sold. Days
inventory on hand were 64 days at March 31, 2007, down from 76 days at March 31,
2006, due to improving management of inventory balances.
Cash used by investing activities was $2.2 million in the first three months of
2007 versus a use of $13.0 million for the same period of 2006. Of the overall
change of $10.8 million, $18.1 million was related to lower capital expenditures
in 2007. In contrast, $9.0 million in proceeds were received from the sale of
assets during 2006, while no such sales occurred in the first quarter of 2007.
Included in the 2006 sales was the Company's 7% interest in Kulthorn Kirby
Public Company Limited stock for $4.7 million and the sale of the Company's
former Douglas, Georgia manufacturing facility for $3.5 million. In addition,
the Company acquired a small Australian-based company, which owned patents
related to the manufacturing of certain types of electric motors, which are
applicable to both our Electrical Components and Compressor segments. The entire
purchase price was allocated to amortizable intangible assets.
Cash flows from financing activities provided cash of $17.1 million in the first
three months of 2007 as compared to providing cash of $24.0 million in the same
period of 2006. 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 (later revised to $250 million) and a
$100 million Second Lien Credit Agreement.
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 three months ended March 31, 2007 and December 31, 2006, our average
outstanding debt balance was $299.2 million (excluding debt for TMT Motoco) and
$373.0 million, respectively. The weighted average long-term interest rate,
including the effect of hedging activities, was 10.1% and 9.2% for the
respective periods.
Accounts Receivable Sales
Certain of our Brazilian, Asian, and European subsidiaries periodically sell
their accounts receivable to financial institutions. Such receivables are
factored with recourse to us and, in the case of Brazil and Europe, are excluded
from accounts receivable in our consolidated balance sheets. The amount of sold
receivables excluded from our balance sheet was $60.8 million and $46.5 million
as of March 31, 2007 and December 31, 2006, respectively. We cannot provide any
assurances that these facilities will be available or utilized in the future.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 and the first quarter of 2007 cash flows from operations were
negative and we have had to rely on existing cash balances, proceeds from credit
facilities and asset sales to fund its needs.
Throughout the first quarter, our main domestic credit facilities were provided
under a $250 million First Lien Credit Agreement and a $100 million Second Lien
Credit Agreement. Both agreements provide for security interests in
substantially all of the Company's assets and specific financial covenants
related to EBITDA (as defined under the agreements and hereafter referred to as
our "Adjusted EBITDA"), capital expenditures, fixed charge coverage, and limits
on additional foreign borrowings. During the first quarter, the weighted average
annual interest rate on our borrowings under these agreements was 10.1%.
Under the terms of the First Lien Credit Agreement, as of March 31, 2007 we had
the capacity for additional borrowings under the borrowing base formula of $32.1
million in the U.S. and $43.4 million in foreign jurisdictions. Both the First
Lien Credit Agreement and the Second Lien Credit Agreement have terms expiring
in November, 2009.
In March of 2007, our Brazilian engine subsidiary, TMT Motoco, was granted
permission by the Brazilian courts to pursue a judicial restructuring, similar
to a U.S. filing for Chapter 11 bankruptcy protection. The TMT Motoco filing in
Brazil constituted an event of default with our domestic lenders. On April 9,
2007 we obtained amendments to our First and Second Lien Credit Agreements that
cured the cross-defaults 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 2007 quarterly periods (in millions) were set at:
Quarterly Period Ending First Lien Agreement Second Lien Agreement
- ----------------------- -------------------- ---------------------
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
As defined in the credit agreements, as of March 31, 2007 our cumulative
Adjusted EBITDA was $13.3 million or $21.3 million in excess of the covenant
levels.
These levels of Adjusted EBITDA are subject to further adjustment if certain
business units or product 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 was not hired by May 1, 2007, the
amendment to our Second Lien credit agreement also included a 2.5% per annum
step-up in cash interest rate from that day forward until such time as a
permanent CEO was hired. However, the agreement provided that the
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
additional interest would not be assessed beginning May 1 if the CEO candidate
had not assumed his or her duties due either to a personal emergency or
inability to reach agreement on terms of employment. Since this condition was
met, the additional interest is not being assessed and will not be assessed
as long as we continue to apply our best efforts to engage a permanent CEO
as soon as possible.
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. The sum of
these costs will be recorded as interest expense in the second quarter of 2007.
Interest on the 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.
The 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 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.
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. While we are currently moving forward with these
actions, there can be no assurance that any of these initiatives will be
sufficient.
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 judicial restructuring, all the debt associated with TMT
Motoco ($89.5 million) has been removed from our Consolidated Balance Sheet at
March 31, 2007. After giving effect to this reclassification, as well as the
amendments to the First and Second Lien agreements, our payments by period as of
March 31, 2007 for our long-term contractual obligations are as follows:
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Payments by Period (in millions)
-------------------------------------
Total Less than 1 Year 1-3 Years
------ ---------------- ---------
Debt Obligations $307.5 $78.5 $228.0
Interest Payments on Debt * 88.5 29.5 59.0
* Debt levels are assumed to remain constant. Interest rate debt obligations
are assumed to remain constant at the current weighted average rate of
9.6%.
These scheduled maturities do not consider any of the targeted debt reductions
that are incorporated, but not mandated, in our credit agreements.
See Part II, Item 1A, "Risk Factors," in our Annual Report on Form 10-K for the
year ended December 31, 2006 for a summary of some of the most significant risks
posed by our current liquidity issues.
SIGNIFICANT ACCOUNTING POLICIES AND CRITICAL ACCOUNTING ESTIMATES
Some of our accounting policies require management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. These estimates and
assumptions are subject to an inherent degree of uncertainty. They are based on
our historical experience, the terms of existing contracts, our evaluation of
trends in the industry, information provided by our customers and suppliers, and
information available from other outside sources, as appropriate. Actual results
in these areas could differ from our estimates. For a discussion of our
significant accounting policies and critical accounting estimates, see Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Significant Accounting Policies and Critical Accounting
Estimates," and Note 1, "Accounting Policies," to the consolidated financial
statements included in our Annual Report on Form 10-K for the year ended
December 31, 2006.
In addition to the significant accounting policies described in our Annual
Report on Form 10-K for the period ended December 31, 2006, we adopted FASB
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an
Interpretation of FASB Statement No. 109" (FIN 48) on January 1, 2007. FIN 48
clarifies the accounting and reporting for uncertainties in income tax law. This
interpretation prescribes a comprehensive model for the financial statement
recognition, measurement, presentation and disclosure of uncertain tax positions
taken or expected to be taken in income tax returns.
The effect of adopting FIN 48 was an increase in tax reserves and a decrease of
retained earnings of $0.4 million. Upon adoption, the liability for income taxes
associated with uncertain tax positions at January 1, 2007 was $3.0 million. In
addition, consistent with the provisions of FIN 48, we reclassified $1.8 million
of income tax liabilities from current to deferred income taxes, because payment
of cash is not anticipated within one year of the balance sheet date. The total
amount of $3.0 million, if ultimately recognized, would impact our effective tax
rate.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Interest and penalties related to income tax liabilities are included in income
tax expense. The balance of accrued interest and penalties recorded in the
Consolidated Balance Sheet at January 1, 2007 was $1.1 million; of this amount,
$0.7 million was also reclassified from current to non-current liabilities upon
adoption of FIN 48.
With limited exceptions, we are no longer subject to U.S. federal, state and
local or non-U.S. income tax audits by taxing authorities for years through
2002. We anticipate a decrease in the total amount of unrecognized tax benefits
within the next twelve months of approximately $1.2 million.
Recently Issued Accounting Pronouncements
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 requires (or permits) 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 language and discussion of risks included below.
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 April 30, 2007, the price of
aluminum increased approximately 22%, and the price of copper increased over 64%
in the same time frame. In the first quarter of 2007 alone, copper prices
escalated by over 10%. However, due to copper forward purchase contracts
obtained prior to the cost increase, we were able to maintain costs consistent
with, or slightly better than, our 2007 business plan. We currently hold
approximately 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, and continued escalation of copper prices
through 2007 and into 2008 and beyond could have a long-term unfavorable impact
on our results of operations, if adequate pricing increases cannot be obtained
from our customers. Lack of storm activity has significantly reduced sales of
engines used for generators and snowthrowers, and has left us and the industry
with above normal inventory levels.
The Brazilian Real continues to strengthen against the dollar, and strengthened
13.1% from January 1, 2006 to April 30, 2007. From January 1 through March 31,
2007, the Real strengthened by 4.1%. Net
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
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FINANCIAL CONDITION AND RESULTS OF OPERATIONS
of currency hedging activities, this continued strengthening of the Real
affected our operating results unfavorably by approximately $2.4 million when
compared to our 2007 plan.
Nonetheless, we expect the operating results of all three of our business
segments to improve in the second quarter of 2007 when compared to the results
of the comparable 2006 period. Pricing adjustments in the Compressor group,
implemented to offset the escalating price of copper, are the most significant
improvement expected in that segment when compared to the prior year. In
addition, for both the Compressor group and the Electrical Components group,
operational efficiencies and productivity improvements are expected to improve
operational margins when compared to the second quarter of 2006.
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 second quarter of 2006 excluding restructuring
charges. The improvement continues to be 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
currently being developed. It is uncertain at this point whether or when the
facility will re-open. In the interim, we are continuing to meet the needs of
our customers for lawn and garden engines, as a substantial portion of 2007
summer season requirements had already been produced prior to suspension of
operations. We will consider multiple factors in determining the future
viability of TMT Motoco, including (i) customer requirements, (ii) the
willingness of Brazilian lenders to support continued manufacturing operations
in that country, (iii) the impact to profitability from any further
strengthening of the Brazilian Real, and (iv) the cost to retool operations to
address upcoming changes in environmental regulations. The range of potential
outcomes of the restructuring plan includes resuming full scale production,
minimal production and/or rental of the facility, or a controlled liquidation.
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.
As part of our efforts to improve profitability and reduce the 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. As part of these efforts, we announced certain operational
actions and staff reductions on April 27, 2007 at the Compressor and Engine &
Power Train business units. While no specific further 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.
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FINANCIAL CONDITION AND 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 at March 31, 2007 was approximately 1.3% higher
than the same period a year ago, resulting in higher interest expense on
approximately similar levels of debt. As well, the 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 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 2007 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 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, without additional annual
contributions, for six to eight future years.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAUTIONARY STATEMENTS RELATING TO FORWARD-LOOKING STATEMENTS
This discussion contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act that are subject to the safe harbor
provisions created by that Act. In addition, forward-looking statements may be
made orally in the future by or on behalf of us. Forward-looking statements can
be identified by the use of terms such as "expects," "should," "may,"
"believes," "anticipates," "will," and other future tense and forward-looking
terminology, or by the fact that they appear under the caption "Outlook."
Readers are cautioned that actual results may differ materially from those
projected as a result of certain risks and uncertainties, including, but not
limited to i) 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.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to risk during the normal course of business from credit risk
associated with accounts receivable and from changes in interest rates,
commodity prices, and foreign currency exchange rates. The exposure to these
risks is managed through a combination of normal operating and financing
activities which include the use of derivative financial instruments in the form
of foreign currency forward exchange contracts and commodity forward purchasing
contracts. Fluctuations in commodity prices and foreign currency exchange rates
can be volatile, and our risk management activities do not totally eliminate
these risks. Consequently, these fluctuations can have a significant effect on
results. A discussion of our policies and procedures regarding the management of
market risk and the use of derivative financial instruments was provided in our
Annual Report on Form 10-K in Item 7A and in Notes 1 and 14 of the Notes to
Consolidated Financial Statements. We do not utilize financial instruments for
trading or other speculative purposes. There have been no changes in these
policies or procedures during the first three months of 2007.
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 its 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 March 31, 2007 and December 31, 2006, we held foreign currency
forward contracts with a total notional value of $104.7 million and $130.4
million, respectively. We have a particularly concentrated exposure to the
Brazilian Real. Based on our current level of activity, and excluding any
mitigation as the result of hedging activities, we believe that a strengthening
in the value of the Real of 0.10 per U.S. Dollar negatively impacts our
operating profit by approximately $10 million on an annual basis.
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 forwards for a limited percentage of projected raw
material requirements up to fifteen months in advance. Commodity contracts at
most of the Company's divisions and subsidiaries are essentially purchase
contracts designed to fix the price of the commodities during the operating
cycle. Our practice has been to accept delivery of the commodities and consume
them in manufacturing activities. At March 31, 2007 and December 31, 2006, the
Company held a total notional value of $72.0 million and $62.1 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.
We are subject to interest rate risk, primarily associated with our borrowings
of $306.5 million at March 31, 2007. 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. In 2006, we entered into variable to fixed interest rate swaps
with notional amounts totaling $90 million. This resulted in 29.3% of our total
debt at March 31, 2007 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
Page 36
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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 $2.2 million.
Page 37
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 4
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 its 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 quarter 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, our
President and Chief Operating Officer along with our Vice President, Treasurer
and Chief Financial Officer have concluded that our disclosure controls and
procedures were effective at the reasonable assurance level as of March 31,
2007.
As outlined in management's annual report 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
determined that as of December 31, 2006, this control deficiency represented a
material weakness.
Management believes that this material weakness has been remediated as of March
31, 2007. We have corrected our methodologies to comply with generally accepted
accounting principles. We have also instituted additional review procedures
relating to these processes that includes additional management reviews and
review by our outside tax advisors prior to the finalization of the income tax
provision for the period. However, management has not yet completed testing of
its updated procedures.
Changes In Internal Control Over Financial Reporting
As noted above, management believes that the material weakness that existed as
of December 31, 2006 related to the calculation of interim period income taxes
has been remediated. During the three months ended March 31, 2007, there have
been no other significant changes that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
Page 38
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 4
CONTROLS AND PROCEDURES
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 changes in condition, or that the
degree of compliance with policies and procedures included in such controls may
deteriorate.
Page 39
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Shareholders of Tecumseh Products Company was held on May
2, 2007. Proxies for the meeting were solicited pursuant to Section 14(a) of the
Securities Exchange Act of 1934, and there was no solicitation in opposition to
management's solicitation. A total of 4,724,422 shares were represented in
person or by proxy, representing 93.04% of the 5,077,746 shares of Class B
Common stock outstanding and entitled to vote.
All of management's nominees for directors as listed in the proxy statement were
elected with the following votes:
Votes Votes
Director For Withheld
- -------- --------- --------
Peter M. Banks 4,449,325 275,097
Kent B. Herrick 4,385,600 338,822
Albert A. Koch 4,200,317 524,105
David M. Risley 4,237,479 486,943
Kevin E. Sheehan 4,440,647 283,775
ITEM 6. EXHIBITS
Exhibit
(a) Number Description
------- -----------
31.1 Certification of the President and Chief Operating Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the President and Chief Operating Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
Page 40
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
TECUMSEH PRODUCTS COMPANY
(Registrant)
Dated: May 15, 2007 BY: /s/ James S. Nicholson
------------------------------------
James S. Nicholson
Vice President, Treasurer and
Chief Financial Officer (on behalf
of the Registrant and as principal
financial officer)
Page 41