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 June 30, 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 June 30, 2007
- ------------------------------------- ----------------------------
Class B Common Stock, $1.00 par value 5,077,746
Class A Common Stock, $1.00 par value 13,401,938
Page 1
TABLE OF CONTENTS
Page
--------
Part I. Financial Information (unaudited)
Item 1. Financial Statements (unaudited)
Consolidated Condensed Balance Sheets (unaudited)......... 3
Consolidated Condensed Statements of Operations
(unaudited)............................................ 4
Consolidated Condensed Statements of Cash Flows
(unaudited)............................................ 5
Notes to Consolidated Condensed Financial Statements...... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 23
Item 3. Quantitative and Qualitative Disclosures About Market
Risk...................................................... 45
Item 4. Controls and Procedures.................................... 46
Part II. Other Information........................................... 48
Signatures........................................................... 49
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)
JUNE 30, 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 $7.1 in 2007 and $10.1 in 2006 172.3 219.5
Inventories 213.6 353.4
Deferred and recoverable income taxes 42.3 40.6
Assets held for sale 148.6 --
Other current assets 59.5 38.0
-------- --------
Total current assets 685.0 733.4
Property, plant, and equipment, net 405.8 552.4
Goodwill 19.1 127.0
Other intangibles -- 53.0
Prepaid pension expense 204.6 202.5
Assets held for sale 180.1 --
Other assets 142.3 114.4
-------- --------
Total assets $1,636.9 $1,782.7
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable, trade $ 188.9 $ 216.0
Short-term borrowings 70.3 163.2
Liabilities held for sale 63.8 --
Accrued liabilities 113.2 130.1
-------- --------
Total current liabilities 436.2 509.3
Long-term debt 220.3 217.3
Deferred income taxes 29.7 28.6
Other postretirement benefit liabilities 154.4 166.0
Product warranty and self-insured risks 15.3 13.6
Pension liabilities 15.2 14.9
Liabilities held for sale 2.7 --
Other non-current liabilities 32.8 34.6
-------- --------
Total liabilities 906.6 984.3
-------- --------
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 11.0 3.7
Retained earnings 621.0 726.3
Accumulated other comprehensive income 79.8 49.9
-------- --------
Total stockholders' equity 730.3 798.4
-------- --------
Total liabilities and stockholders' equity $1,636.9 $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 SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------- ------------------
(Dollars in millions, except per share data) 2007 2006 2007 2006
------- ------- -------- -------
Net sales $ 350.7 $ 349.4 $ 707.9 $ 686.4
Cost of sales 323.3 333.7 651.9 649.4
Selling and administrative expenses 34.7 34.3 70.4 71.2
Impairments, restructuring charges, and other items 0.9 2.7 (0.5) 3.2
------- ------- -------- -------
Operating loss (8.2) (21.3) (14.0) (37.4)
Interest expense (10.3) (7.0) (18.9) (11.1)
Interest income and other, net 1.8 3.1 3.7 8.3
------- ------- -------- -------
Loss from continuing operations before taxes (16.7) (25.2) (29.2) (40.2)
Tax expense (benefit) (2.2) (6.9) (3.2) (9.6)
------- ------- -------- -------
Loss from continuing operations (14.5) (18.3) (26.0) (30.6)
Income (loss) from discontinued operations, net of tax (73.7) 52.2 (79.0) 51.9
------- ------- -------- -------
Net income (loss) ($88.2) $ 33.9 ($105.0) $ 21.3
======= ======= ======== =======
Basic and diluted earnings (loss) per share*
Loss from continuing operations ($0.78) ($0.99) ($1.40) ($1.66)
Income (loss) from discontinued operations, net of tax ($3.99) $ 2.82 ($4.28) $ 2.81
------- ------- -------- -------
Net income (loss) per share ($4.77) $ 1.83 ($5.68) $ 1.15
======= ======= ======== =======
Weighted average shares (in thousands) 18,480 18,480 18,480 18,480
======= ======= ======== =======
Cash dividends declared per share $ 0.00 $ 0.00 $ 0.00 $ 0.00
======= ======= ======== =======
* On April 9, 2007, we issued a warrant to our Second Lien lender to purchase
1,390,944 shares of our Class A Common Stock, which is equivalent to 7% of
our fully diluted common stock. This warrant is not included in diluted
earnings per share for the three and six month periods ended June 30, 2007,
as the effect would be antidilutive.
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)
SIX MONTHS
ENDED
JUNE 30,
----------------
(Dollars in millions) 2007 2006
------- ------
Cash Flows from Operating Activities:
Cash used by operating activities ($24.0) ($93.8)
Cash Flows from Investing Activities:
Proceeds from sale of assets 2.0 130.9
Capital expenditures (5.4) (32.8)
Business acquisition -- (2.0)
------- -------
Cash provided by (used in) investing activities (3.4) 96.1
------- -------
Cash Flows from Financing Activities:
Debt amendment costs (2.5) --
Repayment of Senior Guaranteed Notes -- (250.0)
Repayment of Industrial Development Revenue Bonds -- (10.5)
Proceeds from First Lien Credit Agreement, net 1.9 133.1
Proceeds from Second Lien Credit Agreement -- 100.0
Repayments of Second Lien Credit Agreement -- (45.1)
Other borrowings (repayments), net (0.9) 57.2
------- -------
Cash used in financing activities (1.5) (15.3)
------- -------
Effect of exchange rate changes on cash (4.3) 0.9
------- -------
Decrease in cash and cash equivalents (33.2) (12.1)
Cash and Cash Equivalents:
Beginning of period 81.9 116.6
------- -------
End of period $ 48.7 $ 104.5
======= =======
*Depreciation and Amortization 35.3 42.0
Supplemental Schedule of Noncash Investing and Financing
Activities:
Warrants issued in conjunction with debt
financing 7.3
Paid-in-Kind Interest 0.8
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 filed its
restructuring plan with the court on May 28, and the court is currently
evaluating this plan. 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.
TMT Motoco at June 30, 2007 was removed from our consolidated balance sheets at
March 28, 2007, and TMT Motoco is now being accounted for under the equity
method. The following is a summary of the assets, liabilities and equity of TMT
Motoco at June 30, 2007:
June 30,
(Dollars in millions) 2007
--------
Accounts receivable, net $ 0.2
Inventories 25.6
Other current assets 8.6
Property, plant and equipment, net 67.7
------
Total Assets $102.1
======
Accounts payable, trade $ 9.7
Other current liabilities 94.3
------
Total Liabilities 104.0
Shareholders' Deficit (1.9)
------
Total Liabilities and Shareholders' Deficit $102.1
======
While TMT Motoco had no impact on our consolidated net loss for the three months
ended June 30, 2007, losses associated with TMT Motoco of $3.1 million,
including interest expense, were included in our consolidated net loss for the
three month period ended June 30, 2006. Losses of $3.5 million and $7.2 million,
including interest expense, were included in our consolidated net loss for the
six months ended June 30, 2007 and 2006, respectively.
Page 6
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
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. Attainment of the 2007 budget would result in exceeding
the Adjusted EBITDA covenants in our domestic credit agreements by $17.6 million
at June 30 and $29.8 million at December 31, 2007 (before considering the impact
of the sale of portions of our Electrical Components business segment to Regal
Beloit Corporation, as discussed further in Note 3, or any other potential sales
transactions). For the period ended June 30, 2007, we fell short against our
Adjusted EBITDA projections by $11.0 million. This variance was attributable to
volume shortfalls in our Engine and Electrical Components Groups, unfavorable
currency exchange rates, and professional fees that were not eligible for
add-back as part of our Adjusted EBITDA calculation.
During the second quarter of 2007, our board of directors approved a plan to
sell our Electrical Components business segment. On July 3, 2007, we signed an
agreement with Regal Beloit Corporation to sell the Residential & Commercial and
Asia Pacific divisions of this business segment to Regal Beloit for $220 million
in cash, subject to adjustments for working capital changes and a hold back of
certain proceeds in escrow for up to eighteen months to cover any potential
claims that may arise from any breach of representations and warranties as well
as the resolution of certain contingencies. Net proceeds of this sale
transaction at closing are estimated to be approximately $195 million. The
proceeds will be utilized to repay our Second Lien lender in full, including
principal, prepayment penalties and fees, and both cash and PIK interest. The
remainder of the proceeds, or approximately $90 million, will be utilized to
reduce the outstanding balance on our First Lien debt.
Due to the continued strengthening of the Brazilian Real, declines in sales
volumes at the Engine & Power Train business segment, and continued increases in
the cost of commodities such as copper, we no longer expect to achieve our
original financial plan, nor can we provide assurance that the business would
meet our EBITDA covenants after adjustment for the sale to Regal Beloit
Corporation or other potential asset sales, due to our inability to project when
such sales may close. In order to close the sale transaction with Regal Beloit,
we will be entering into amendments to modify the credit agreements with our
First and Second Lien lenders to permit actions necessary to prepare the sold
asset for sale, in accordance with the terms of the purchase agreement. As part
of this process, we will also seek additional amendments that will re-define our
EBITDA covenants, to align those requirements with businesses that can
reasonably be expected to remain part of our continuing operations. As defined
by the credit agreements, as of June 30, 2007 our cumulative Adjusted EBITDA was
$23.6 million or $6.6 million in excess of the covenant levels.
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.
Page 7
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
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. Discontinued Operations and Sale of Businesses
During the second quarter of 2007, our board of directors approved a plan to
sell our Electrical Components business segment. On July 3, 2007, we signed an
agreement with Regal Beloit Corporation to sell the Residential & Commercial and
Asia Pacific divisions of this business segment to Regal Beloit for $220 million
in cash, subject to adjustments for working capital changes and a hold back of
certain proceeds in escrow for up to eighteen months to cover any potential
claims that may arise from any breach of representations and warranties as well
as the resolution of certain contingencies. A copy of the purchase agreement is
filed with this report as Exhibit 10.1. We continue to pursue the sale of the
remaining businesses within the Electrical Components segment, including the
Automotive & Specialty divisions.
Accordingly, the assets of the entire Electrical Components business segment
have been classified as held for sale as of June 30, 2007. The segment's results
for the three and six months ended June 30, 2007 and 2006 are included in income
(loss) from discontinued operations. Interest expense of $4.7 million and $4.0
million was allocated to discontinued operations for the three months ended June
30, 2007 and 2006, and interest expense of $9.4 million and $8.2 million was
allocated to the six months ended June 30, 2007 and 2006, as our First and
Second Lien credit agreements require the proceeds from the sale to be utilized
to repay our second lien credit agreement, as well as a substantial portion of
our outstanding first lien debt.
Following is a summary of loss from discontinued operations related to the
Electrical Components segment for the three months ended June 30, 2007 and 2006:
Three Months Three Months
Ended Ended
(Dollars in millions) June 30, 2007 June 30, 2006
------------- -------------
Net sales $ 101.7 $106.9
Cost of sales 93.9 98.6
Selling and administrative expenses 8.4 10.0
Impairments * 68.8 2.3
------- ------
Operating loss (69.4) (4.0)
Interest expense, including allocated interest 4.8 4.2
------- ------
Loss from discontinued operations before income taxes (74.2) (8.2)
Tax provision (benefit) (0.5) (2.3)
------- ------
Loss from discontinued operations, net of tax ($73.7) ($5.9)
------- ------
Page 8
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
Following is a summary of income (loss) from discontinued operations related to
the Electrical components segment for the six months ended June 30, 2007 and
2006:
Six Months Six Months
Ended Ended
(Dollars in millions) June 30, 2007 June 30, 2006
------------- -------------
Net sales $ 205.0 $216.0
Cost of sales 187.8 194.5
Selling and administrative expenses 16.8 18.3
Impairments * 70.1 2.4
------- ------
Operating income (loss) (69.7) 0.8
Interest expense, including allocated interest 9.7 8.7
------- ------
Loss from discontinued operations before income taxes (79.4) (7.9)
Tax provision (benefit) (0.4) (2.2)
------- ------
Loss from discontinued operations, net of tax ($79.0) ($5.7)
------- ------
* We recorded impairment charges as part of our loss from discontinued
operations in the three and six months ended June 30, 2007. These
impairments included $39.3 million of the goodwill balance associated with
the Electrical Components business segment, as well as $25.8 million in
long-lived assets and $3.4 million in intangible assets associated with the
Automotive & Specialty division of that business segment. Refer to Note 7,
"Goodwill and Other Intangible Assets," for further details on these
impairment charges.
On April 21, 2006, we completed the sale of our 100% ownership interest in
Little Giant Pump Company for $120.7 million. Its results for the three and six
months ended June 30, 2006 are included in loss from discontinued operations.
Interest expense of $2.9 million was allocated to discontinued operations for
the six months ended June 30, 2006 because our financing agreements required
that the proceeds from the sale be utilized to repay portions of our debt.
Following is a summary of income (loss) from discontinued operations related to
Little Giant Pump Company for the twenty-one days ended April 21, 2006:
Twenty-one Days
Ended
(Dollars in millions) April 21, 2006
---------------
Net sales $ 6.1
Cost of sales 4.7
Selling and administrative expenses 1.3
-----
Operating income 0.1
Interest expense allocated 0.6
-----
Loss from discontinued operations (0.5)
-----
Gain on disposal 69.5
Tax provision on gain 10.9
-----
Gain on disposal, net 58.6
-----
Income from discontinued operations $58.1
=====
Page 9
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
Following is a summary of income (loss) from discontinued operations related to
Little Giant Pump Company for the six months ended June 30, 2006:
Six Months Ended
(Dollars in millions) June 30, 2006
----------------
Net sales $ 32.9
Cost of sales 23.9
Selling and administrative expenses 6.9
------
Operating income 2.1
Interest expense allocated 2.9
------
Loss from discontinued operations before income taxes (0.8)
Tax provision 0.2
------
Loss from discontinued operations, net of tax ($1.0)
------
Gain on disposal 69.5
Tax provision on gain 10.9
------
Gain on disposal, net 58.6
------
Income from discontinued operations $ 57.6
======
Page 10
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
The following summary balance sheet information is derived from the businesses
that are classified as held for sale, which management believes is
representative of the net assets of the business held for disposal:
JUNE 30,
(Dollars in millions) 2007
--------
ASSETS:
Current Assets:
Accounts receivable, net 62.6
Inventories 82.9
Other current assets 3.1
------
Total current assets held for sale $148.6
Property, plant, and equipment, net 60.5
Goodwill 72.1
Other intangibles 47.5
Other assets --
------
Total assets held for sale $328.7
======
LIABILITIES:
Current Liabilities:
Accounts payable, trade $ 49.4
Short-term borrowings --
Accrued liabilities 14.4
------
Total current liabilities held for sale 63.8
Long-term debt --
Deferred income taxes 2.0
Product warranty and self-insured risks --
Other non-current liabilities 0.7
------
Total liabilities held for sale 66.5
------
Net assets held for sale $262.2
Page 11
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
4. Comprehensive Income
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
----------------- ------------------
(Dollars in millions) 2007 2006 2007 2006
------- ------- -------- -------
Net income (loss) ($88.2) $33.9 ($105.0) $21.3
Other comprehensive income (loss):
Foreign currency translation adjustments 23.4 5.7 29.9 28.8
Gain (Loss) on derivatives 1.5 (1.7) 3.6 (2.6)
Curtailment (Note 8) (3.5) -- (3.5) --
Unrealized gain (loss) on investment holdings -- -- -- (0.2)
Less: Reclassification adjustment for gains realized in net income -- -- -- (3.6)
------ ----- ------ -----
Total comprehensive income (loss) ($66.9) $37.9 ($75.0) $43.7
====== ===== ====== =====
5. Inventories
JUNE 30, December 31,
(Dollars in millions) 2007 2006
-------- ------------
Raw material $ 90.2 $159.0
Work in progress 39.2 60.1
Finished goods 79.1 121.5
Supplies 5.1 12.8
------ ------
Total inventories $213.6 $353.4
====== ======
Page 12
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
6. Business Segments
We have two reportable segments based on the criteria set forth in SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information":
Compressor Products and Engine & Power Train Products. Previously, we also
reported an Electrical Component Products segment; however, as a result of the
decision made by our board of directors to sell all of the businesses associated
with that segment, its operations are no longer reported in continuing
operations before tax. Net sales and operating income (loss) by segment for the
periods indicated are as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
BUSINESS SEGMENT DATA ------------------ -----------------
(Dollars in millions) 2007 2006 2007 2006
------- ------- ------- -------
Net sales:
Compressor Products $ 297.0 $ 273.3 $ 586.3 $ 524.8
Engine & Power Train Products 49.1 71.5 112.1 152.4
Other (a) 4.6 4.6 9.5 9.2
------- ------- ------- -------
Total Net Sales $ 350.7 $ 349.4 $ 707.9 $ 686.4
======= ======= ======= =======
Operating income (loss):
Compressor Products $ 10.8 ($3.8) $ 21.3 $ 2.8
Engine & Power Train Products (8.5) (11.2) (16.5) (29.7)
Other (a) 0.4 0.4 0.7 0.7
Corporate expenses (10.0) (4.0) (20.0) (8.0)
Impairments, restructuring charges, and other
items (0.9) (2.7) 0.5 (3.2)
------- ------- ------- -------
Total operating loss from continuing
operations (8.2) (21.3) (14.0) (37.4)
Interest expense (10.3) (7.0) (18.9) (11.3)
Interest income and other, net 1.8 3.1 3.7 8.3
------- ------- ------- -------
Loss from continuing operations before taxes ($16.7) ($25.2) ($29.2) ($40.2)
======= ======= ======= =======
(a) "Other" consists of non-reportable business segments.
Page 13
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
7. Goodwill and Other Intangible Assets
At June 30, 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 0.3 0.6 2.6 3.5
Impairment (39.3) (39.3)
Reclassified as held for sale (72.1) (72.1)
----- ---- ------ ------
Balance at 6/30/2007 $11.5 $7.6 -- $ 19.1
===== ==== ====== ======
On July 3, 2007, we announced that we had signed an agreement with Regal Beloit
Corporation to sell to Regal Beloit the majority of Tecumseh's Electrical
Components business operations for $220 million in cash, subject to adjustments
for working capital changes and a hold back of certain proceeds in escrow for up
to eighteen months to cover any potential claims that may arise from any breach
of representations and warranties as well as the resolution of certain
contingencies. We performed an interim analysis of the fair value of the
Electrical Components business unit, utilizing the final purchase price agreed
upon with Regal Beloit as an indication of fair market valuation of the
Residential & Commercial and Asia Pacific divisions of the Electrical Components
business. With respect to the remaining divisions of the Electrical Components
business, we considered initial indications of interest from potential acquirers
of those businesses to evaluate the overall marketplace value of the business
unit. Based on the outcome of this analysis, we determined that $39.3 million of
the goodwill balance associated with the Electrical Components business had
become impaired. The remainder of the goodwill balance associated with the
Electrical Components business has been reclassified as held for sale.
We also performed a fair value analysis of the other long-lived assets of the
Electrical Components business segment, and determined that $3.4 million of the
intangible assets associated with the Automotive & Specialty division of the
Electrical Components business had become impaired. All of the other intangible
assets of the Company were included in the Electrical Components Group, and as
of June 30, 2007 they have been reclassified as assets held for sale.
At June 30, 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 0.8 (0.1) (1.0) -- (0.3)
----- ---- ------ ----- ------
Balance at 6/30/2006 $10.8 $6.8 $107.9 $ 0.0 $125.5
On April 21, 2006, the Company completed the sale of its 100% ownership in
Little Giant Pump Company. The only other changes in goodwill during the first
six months of 2006 were due to foreign currency fluctuations.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
8. Pension and Other Postretirement Benefit Plans
Components of net periodic benefit (income) cost are as follows:
PENSION BENEFITS OTHER BENEFITS
------------------ ------------------
THREE MONTHS ENDED THREE MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ------------------
2007 2006 2007 2006
------ ------ ------- -----
Service Cost $ 2.2 $ 2.4 $ 0.9 $ 0.8
Interest Cost 5.6 5.3 2.1 2.4
Expected return on plan assets (11.3) (11.1) -- --
Amortization of prior service costs (0.1) 0.1 (2.7) (1.2)
Curtailment (income) cost 3.8 -- (10.7) --
------ ------ ------- -----
Net periodic benefit (income) cost $ 0.2 ($3.3) ($10.4) $ 2.0
====== ====== ======= =====
PENSION BENEFITS OTHER BENEFITS
---------------- ----------------
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------- ----------------
2007 2006 2007 2006
------ ------- ------- ------
Service Cost $ 4.4 $ 4.8 $ 1.9 $ 1.6
Interest Cost 11.2 10.6 4.2 4.8
Expected return on plan assets (22.6) (22.2) (0.1) --
Amortization of prior service costs (0.2) 0.2 (5.3) (2.4)
Curtailment (income) cost 3.8 -- (10.7) --
------ ------ ------- -----
Net periodic benefit (income) cost ($3.4) ($6.6) ($10.0) $ 4.0
====== ====== ======= =====
As a result of the previously announced closure of our Engine & Power Train
facility in New Holstein, Wisconsin and the associated curtailment of pension
and retiree benefits of its employees, we recognized a net gain of $6.9 million
in the second quarter of 2007. The curtailment gain of $10.7 million realized
for other postretirement employee benefits consists of an $7.2 million reduction
in pension liabilities and a reduction of $3.5 million in prior service costs,
which was recognized in accumulated other comprehensive income upon the adoption
of SFAS 158 in 2006. Additional curtailment gains of $2.0 million and $4.9
million related to these plans will be recognized in the third and fourth
quarters of 2007, respectively. In addition to this net curtailment gain, future
pension and retiree health care expense will decrease by $0.9 million per
quarter. As we complete the divestitures of the business units within our
Electrical Components business segment, we expect that further curtailment gains
will also be recognized.
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,
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
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.
9. Guarantees and Warranties
A portion of accounts receivable at our Brazilian, European, and Indian
compressor subsidiaries are sold without recourse. The amount of these
receivables sold at June 30, 2007 and December 31, 2006 were $90.3 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.
Changes in the carrying amount and accrued product warranty costs for the six
months ended June 30, 2007 and 2006 are summarized as follows:
Six Months Six Months
Ended Ended
(Dollars in millions) June 30, 2007 June 30, 2006
------------- -------------
Balance at January 1 $ 26.2 $ 29.4
Settlements made (in cash or in kind) (6.8) (7.6)
Current year accrual 5.4 5.4
Adjustments to preexisting warranties (1.7) 2.8
Effect of foreign currency translation 0.5 0.2
Reclassification to held for sale* (2.6) --
Sale of Little Giant Pump Company -- (2.7)
Other** (0.4) --
------ ------
Balance at June 30 $ 20.6 $ 27.5
====== ======
* At June 30, 2007, balances for the Electrical Components business segment
were removed from our consolidated balance sheet and reclassified as held
for sale.
** At March 31, 2007, balances for TMT Motoco were removed from our
consolidated balance sheet.
At June 30, 2007, $14.5 million was included in current liabilities and $6.1
million was included in noncurrent liabilities.
10. 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
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
adjustments for certain items, and are hereafter referred to as "Adjusted
EBITDA"), capital expenditures, fixed charge coverage, and limits on additional
foreign borrowings and fees paid for professional services. 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.
On July 3, 2007, we signed an agreement with Regal Beloit Corporation to sell
the Residential & Commercial and Asia Pacific divisions of the Electrical
Components business segment to Regal Beloit for $220 million in cash, subject to
adjustments for working capital changes and a hold back of certain proceeds in
escrow for up to eighteen months to cover any potential claims that may arise
from any breach of representations and warranties as well as the resolution of
certain contingencies. Net proceeds of this sale transaction at closing are
estimated to be approximately $195 million. The proceeds will be utilized to
repay our Second Lien lender in full, including principal, prepayment penalties
and fees, and both cash and PIK interest. The remainder of the proceeds, or
approximately $90 million, will be utilized to reduce the outstanding balance on
our First Lien debt.
The principal terms of our purchase agreement with Regal Beloit were disclosed
in a Current Report on Form 8-K that we filed on July 10, 2007, and the purchase
agreement is filed with this report as Exhibit 10.1.
During the second quarter of 2006, we entered into interest rate swap
agreements, effectively converting $90 million of variable rate debt to fixed
rate debt. These interest rate swap agreements were terminated in the second
quarter of 2007, at a cost of $1.0 million. The effective weighted average
interest rate of our outstanding borrowings under the First and Second Lien
Credit Agreements was 9.3% at June 30, 2007.
At June 30, 2007, we had outstanding letters of credit of $7.1 million and the
capacity for additional borrowings under the borrowing base formula of $30.7
million in the U.S. and $24.9 million in foreign jurisdictions under our $250
million First Lien Credit Agreement. Our weighted average interest rate for all
borrowings is 9.1%.
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. During the quarter, we had net repayments on
these arrangements totaling $0.9 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:
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
Milestone Date Aggregate Reduction
- -------------- -------------------
June 30, 2007 $20.0 million
September 30, 2007 $40.0 million
December 31, 2007 $60.0 million
As of June 30, 2007, there had been no reduction in the balance of the Second
Lien Credit Agreement. Therefore, the additional PIK interest will apply
effective beginning July 1, 2007 until such time as those debt balances are
reduced by $20 million. We expect this reduction to occur upon the closing of
the sale transaction of the Residential & Commercial and Asia Pacific portions
of our Electrical Components business to Regal Beloit Corporation as referenced
above.
The Second Lien Credit Agreement also provides for an additional 2.5% in PIK
interest if certain assets are not sold by December 31, 2007. Sources of funds
to make the principal reductions could include, but are not limited to, cash
from operations, reductions in working capital, or asset sales.
In 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 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 by the credit agreements, as of June 30, 2007 our cumulative Adjusted
EBITDA was $23.6 million or $6.6 million in excess of the covenant levels.
Upon the closing of the sale transaction of the Residential & Commercial and
Asia Pacific portions of our Electrical Components business, we expect our
minimum cumulative Adjusted EBITDA levels to be modified to reflect the removal
of a pro-rata share of a percentage of the 2007 planned financial results of
those business units, as follows (in millions):
Quarterly Period Ending First Lien Agreement
- ----------------------- --------------------
September 30, 2007 $41.1
December 31, 2007 $57.3
These levels of Adjusted EBITDA are subject to further adjustment if certain
additional business units or product lines are sold during the period.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
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 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, or if the Company continued
to apply its best efforts to engage the new CEO. On August 1, 2007, we announced
that we had appointed a permanent Chief Executive Officer. Since the conditions
of the credit agreement were met through the date of the CEO's appointment, the
additional interest was not assessed.
We paid $625,000 in fees, plus expenses, to the First Lien lender on April 9,
2007 upon execution of the April 9 amendment. 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 1,390,944 shares of Class A Common
Stock, which is equivalent to 7% of our fully diluted common stock. This
warrant, valued at $7.3 million or $5.29 per share, expires five years from the
date of the execution of this amendment to the Second Lien credit agreements.
These costs are being accounted for as additional interest expense over the
remaining terms of the credit agreements, subject to acceleration upon full
repayment of the debt, which we expect to occur in the third 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.
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 June 30, 2007, and is now being accounted for
under the equity method. 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 the most significant risks
posed by our current liquidity issues.
11. 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 $3.1
million and $3.3 million at June 30, 2007 and December 31, 2006 respectively 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
Page 19
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
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.
12. Income Taxes
Under Accounting Principles Board Opinion No. 28, "Interim Financial Reporting,"
we are required to adjust our effective tax rate for each quarter to be
consistent with the estimated annual effective tax rate. We are also required to
record the tax impact of certain discrete items (unusual or infrequently
occurring), including changes in judgment about valuation allowances and effects
of changes in tax laws or rates in the interim period in which they occur.
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
of income (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 June 30, 2007, we reported other U.S. and
foreign income in the form of other comprehensive income. 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 $3.2 million income tax benefit for the six months ended June 30, 2007 and a
$9.6 million income tax benefit for the six months ended June 30, 2006. Both
periods reflect tax benefit in the statement of operations and tax expense in
other comprehensive income.
At June 30, 2007 and December 31, 2006, full valuation allowances were recorded
for net operating loss carryovers for those tax jurisdictions in which we
believe it is not more likely than not that the deferred taxes will be realized.
As of June 30, 2007, the valuation allowance related to the Europe subsidiary of
our Compressor business segment was released, since management now believes that
realization of their deferred tax assets is more likely than not. The net impact
of this change decreased income tax by $0.4 million in the second quarter.
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 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.
Page 20
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
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. The impact of FIN 48 for the first six months of 2007 is a
benefit of $0.2 million.
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.
13. Commitments and Contingencies
A lawsuit filed against us and other defendants alleged 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 sought an injunction, compensatory and
punitive damages, and attorneys' fees. On March 30, 2007, the Court entered an
order dismissing the complaint subject to the ability to re-plead certain
claims, pursuant to a detailed written order to follow. We expect the plaintiffs
will appeal the dismissal order, and that even if it is upheld, they will
re-plead their claims to the extent permitted by the order. 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.
14. Impairments, Restructuring Charges, and Other Items
We recorded $0.9 million in impairments, restructuring charges, or other items
in the three months ended June 30, 2007, and a net credit of $0.5 million in the
six months ended June 30, 2007. As a result of the previously announced closure
of our Engine & Power Train facility in New Holstein, Wisconsin and the
associated curtailment of pension and retiree benefits of its employees, we
recognized a net gain of $6.9 million in the second quarter of 2007. We also
recorded $5.7 million ($0.31 per share) in obsolescence charges associated with
the completion of our lawn and garden selling season and the cessation of
business sourced from Brazil at the Engine & Power Train group, and $2.0 million
($0.11 per share) in charges related to a reduction in force executed during the
period across several of our business units.
We also recorded impairment charges as part of our loss from discontinued
operations in the three and six months ended June 30, 2007. These impairments
included $39.3 million of the goodwill balance associated with the Electrical
Components business, as well as $25.8 million in long-lived
Page 21
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
assets and $3.4 million in intangible assets associated with the Automotive &
Specialty division of the Electrical Components business. Refer to Note 7,
"Goodwill and Other Intangible Assets," for further details on these impairment
charges.
We recognized asset impairment charges of $2.7 million and $3.2 million for the
three and six months ended June 30, 2006, respectively. During the second
quarter 2006, we incurred asset impairment and other charges of $2.6 million
($0.14 per share) related to the Engine & Power Train business for the
consolidation of transmission production into a single U.S. facility. The
remainder of the impairment charges through the first six months of 2006 related
to the completion of programs initiated in 2005.
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.
Page 22
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Executive Summary
We are one of the largest independent producers of hermetically sealed
compressors in the world, and a manufacturer of small gasoline engines and power
train products used in lawn and garden applications. Until recently, we were
also one of the leading manufacturers of fractional horsepower motors for the
United States market; however, as a result of the decision made by our board of
directors to sell all of the businesses associated with those product lines, we
will no longer compete in those markets. 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. 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 63% of total
consolidated net sales (excluding the Electrical Components Group) 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 macroeconomic
trends, which expand and contract, and other external factors which affect
demand, such as weather.
On July 3, 2007, we announced that we had signed an agreement with Regal Beloit
Corporation to sell to Regal Beloit the Residential & Commercial and Asia
Pacific divisions of our Electrical Components business segment for $220 million
in cash, subject to customary adjustments at closing. Completion of this
transaction, which is subject to regulatory approval by the Federal Trade
Commission and other customary closing conditions, is currently expected to
close in the third quarter. The principal terms of our purchase agreement with
Regal Beloit were disclosed in a Current Report on Form 8-K that we filed on
July 10, 2007, and the purchase agreement is filed with this report as Exhibit
10.1. Our board of directors has also authorized the sale of the remaining
divisions within the Electrical Components business segment, including the
Automotive & Specialty product lines. Accordingly, our entire Electrical
Components business segment has been classified as discontinued operations, and
its assets have been reclassified as held for sale. Refer to Note 3 in the Notes
to the Consolidated Condensed Financial Statements for additional information.
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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
Net proceeds of this sale transaction are estimated to be approximately $195
million at closing. The proceeds will be utilized to repay our Second Lien
lender in full, including principal, penalties and fees, and both cash and PIK
interest. The remainder of the proceeds, or approximately $90 million, will be
utilized to reduce the outstanding balance on our First Lien debt.
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 certain 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 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 June 30, 2007, and is now
accounted for under the equity method. See Note 1 of the Notes to the
Consolidated Condensed Financial Statements for further details on TMT Motoco's
assets and liabilities.
TMT Motoco's restructuring plan was filed in Brazilian court on May 28, and the
court is currently evaluating the submitted plan. Deliveries for the 2007 lawn &
garden season are essentially complete. Based on the Brazilian court's
evaluation of our submitted restructuring plan, we may implement one of several
alternatives for the future of TMT Motoco and the 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. We expect that the most likely outcome will be a
controlled liquidation. In the event that we are unable to resume production at
this facility, the business would not have an available supply of engines with
vertically-oriented shafts for the 2008 lawn and garden season. Accordingly, we
would not be able to provide engines to our customers for these product lines
until such time as an alternate source of production could be established.
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
the Notes to the Consolidated Condensed Financial Statements
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
Page 24
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
of the uncertainties created by these events. Having obtained the necessary
amendments to bring our U.S. credit agreements into compliance, we continue to
negotiate 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. 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, 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 7 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 six 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. 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. During the first half of 2007, the
Brazilian Real strengthened by 9.9%.
In addition, 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 July 31, 2007, the price of copper, which has a significant impact on
the cost of our products, has increased by approximately 28.0%. 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.
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 two
quarters of 2007 and the full year of 2006, the
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
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FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Company recognized fees of $5.3 million and $21.1 million, respectively, related
to the AlixPartners engagement.
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 the subsequent 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. These payments were complete effective July 31, 2007.
On January 19, 2007, 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, AlixPartners fees will continue to be incurred after our new Chief
Executive Officer assumes his duties, through a yet-to-be determined transition
period.
Our success in generating cash flow will depend, in part, on our ability to
efficiently manage working capital. In this regard, improvements in inventory
management practices, including the completion of restructuring programs which
required temporary increases in inventory levels to accommodate production
transfers, have resulted in positive working capital as of June 30, 2007. 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 more than 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.
Upon the completion of the divestiture of the respective divisions of the
Electrical Components business segment and other potential divestitures, we will
be re-evaluating our corporate infrastructure in relation to the level of
business activity that remains. This analysis could result in new restructuring
programs. While no such activities have been planned at this time, these and
other potential actions
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
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FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 operating results.
On August 1, 2007, we announced the appointment of Edwin "Ed" L. Buker as our
permanent Chief Executive Officer. Mr. Buker's appointment will be effective on
August 13, 2007. The principal terms of our employment agreement with Mr. Buker
were disclosed in a Current Report on Form 8-K that we filed on August 6, 2007.
James Bonsall, who has been our President and Chief Operating Officer since
January of this year, will continue to provide services to the Company through a
transition period that has yet to be determined. Given that a significant
portion of Mr. Buker's compensation will be based upon performance objectives,
we cannot say with certainty whether his compensation costs will be greater than
or less than fees paid to AlixPartners during the tenure of Mr. Bonsall as our
principal executive officer.
In addition, in accordance with a settlement agreement dated April 2, 2007
between the Company, members of its board of directors, members the Herrick
family and parties affiliated with them, Mr. Albert A. Koch resigned from our
board of directors effective July 31, 2007, as was also disclosed in the Current
Report on Form 8-K that we filed on August 6, 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 JUNE 30,
(dollars in millions) 2007 % 2006 %
------- ----- ------- -----
Net sales $ 350.7 100.0% $ 349.4 100.0%
Cost of sales 323.3 92.2% 333.7 95.5%
Selling and administrative expenses 34.7 9.9% 34.3 9.8%
Impairments, restructuring charges, and other items 0.9 0.3% 2.7 0.8%
------- -------
Operating loss (8.2) (2.3%) (21.3) (6.1%)
Interest expense (10.3) (2.9%) (7.0) (2.0%)
Interest income and other, net 1.8 0.5% 3.1 0.9%
------- -------
Loss from continuing operations before taxes (16.7) (4.7%) (25.2) (7.2%)
Tax benefit (2.2) 0.6% (6.9) 2.0%
------- -------
Loss from continuing operations ($14.5) (4.1%) ($18.3) (5.2%)
======= =======
Three Months Ended June 30, 2007 vs. Three Months Ended June 30, 2006
Consolidated net sales from continuing operations in the second quarter of 2007
increased to $350.7 million from $349.4 million in 2006. Sales increases
attributable to the Compressor segment ($23.7 million, of which $19.6 was due to
the effect of currency translation) were offset by a substantial decline ($22.4
million) in sales in the Engine & Power Train segment.
Cost of sales was $323.3 million in the three months ended June 30, 2007, as
compared to $333.7 million in the three months ended June 30, 2006. As a
percentage of net sales, cost of sales was 92.2% and 95.5% in the second
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 ("SG&A") expenses were $34.7 million in the
three months ended June 30, 2007, as compared to $34.3 million in the three
months ended June 30, 2006. As a percentage of net sales, selling, general and
administrative expenses were 9.9% and 9.8% in the second 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; $2.2 million was expensed in the
second quarter of 2007 for AlixPartners services, including the services of
James Bonsall, while $4.1 million was incurred in the second quarter of 2006 for
their consulting services provided to our Engine & Power Train business.
However, professional fees for the business as a whole were $10.9 million in the
second quarter of 2007 (as compared to $7.7 million in the same period of 2006),
which included $6.2 million in fees associated with the amendments to our First
and Second Lien credit agreements, the legal proceedings relating to governance
issues, and our efforts to market portions of the business.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
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FINANCIAL CONDITION AND RESULTS OF OPERATIONS
There were $0.9 million in impairments, restructuring charges or other items in
the three months ended June 30, 2007, compared to $2.7 million in the three
months ended June 30, 2006. As a result of the previously announced closure of
our Engine & Power Train facility in New Holstein, Wisconsin and the associated
curtailment of pension and retiree benefits of its employees, we recognized a
net gain of $6.9 million ($0.37 per share) in the second quarter of 2007. We
also recorded $5.7 million ($0.31 per share) in obsolescence charges associated
with the completion of our lawn and garden selling season and the cessation of
business sourced from Brazil at the Engine & Power Train group, and $2.0 million
($0.11 per share) in charges related to a reduction in force executed during the
period across several of our business units. During the second quarter of 2006,
we incurred asset impairment and other charges of $2.6 million ($0.14 per share)
related to the Engine & Power Train business for the consolidation of
transmission production into a single U.S. facility.
Interest expense amounted to $10.3 million in the second quarter of 2007
compared to 7.0 million in the second quarter of 2006. The increase was
primarily related to the amortization of debt costs ($2.1 million).
Interest income and other, net was $1.8 million in the second quarter of 2007
compared to $3.1 million in the second quarter of 2006.
The consolidated condensed statement of operations reflects a $2.2 million
income tax benefit for the second quarter 2007 and a $6.9 million income tax
benefit for the second 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 June 30, 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 June 30, 2007, we recorded net losses from continuing and
discontinued operations, but income in OCI. In the three months ended June 30,
2006, we reported losses from continuing operations, but income in OCI, as well
as income from discontinued operations. In accordance with paragraph 140, we
recorded federal tax benefits for continuing operations, and federal tax expense
in discontinued operations and 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. As of June 30, 2007, the valuation allowance related to the Europe
subsidiary of our Compressor business segment was released, since this business
now has cumulative three year income and management believes that realization of
the deferred tax asset is more likely than not. The net impact of this change
decreased income tax by $0.4 million in the second quarter.
Net loss from continuing operations in the second quarter of 2007 was $14.5
million ($0.78 per share) as compared to net loss of $18.3 million ($0.99 per
share) in the second quarter of 2006. The improvement was the result of the
factors described above.
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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
Reportable Operating Segments
The segment financial information presented in this report is for our two
reportable operating segments for the periods presented: Compressor and Engine &
Power Train. Previously, we also reported an Electrical Components product
segment; however, as a result of the decision made by our board of directors to
sell all of the businesses associated with that segment, its operations are no
longer reported in continuing operations before tax. 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 (U.S. GAAP). Such measures are presented
because we evaluate the performance of our reportable operating segments, in
part, based on income (loss) before interest, other expense, income taxes, and
impairments, restructuring charges, and other items. These measures should not
be considered in isolation or as a substitute for net income, net cash provided
by operating activities or other income statement or cash flow statement data
prepared in accordance with U.S. 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 6 in the Notes to our
Consolidated Condensed Financial Statements.
Compressor Products
Second quarter 2007 sales in the Compressor segment increased to $297.0 million
from $273.3 million in the prior year. $19.6 million of the $23.7 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 $16.3 million), an increase of 17.3%. The majority of this increase
was attributable to pricing advances and foreign currency translation; however,
growth in new markets in India also contributed to the increase. Sales were also
higher for the commercial compressor product lines (up $8.4 million). This sales
increase was attributable to pricing advances rather than unit volumes.
Compressor business operating results for the second quarter of 2007 were income
of $10.8 million compared to an operating loss of $3.8 million in the second
quarter of 2006. The higher operating income of $14.6 million was attributable
to the net favorable impact of volume and pricing changes ($18.7 million) and
productivity and other improvements ($7.0 million). These year-on-year
improvements were partially offset by unfavorable foreign currency exchange
rates ($5.5 million). For the second quarter, the Brazilian Real was on average
9.0% stronger against the U.S. Dollar in 2007 versus 2006. The price of copper
and other commodities also contributed unfavorably to results in the second
quarter of 2007. Including the effects of hedging activities, the Company
estimates that the continued escalation in commodity pricing decreased operating
income by approximately $6.6 million compared to the second quarter of 2006.
Engine & Power Train Products
Engine & Power Train business sales were $49.1 million in the second quarter of
2007 compared to $71.5 million for the same period a year ago. Declines were led
by engines for walk behind mowers (down $7.2 million), a decline of 26.9%. Sales
of engines for snowthrowers declined by $7.1 or 44.0%
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
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FINANCIAL CONDITION AND RESULTS OF OPERATIONS
when compared to the second quarter of 2006. This decline was due to the
carryover of excess inventories from the prior season by our customers and
retailers, as well as conservative buying patterns by those same customers as we
enter the current selling season. Engines for generators were also down by $3.1
million, declining by 66.0%, due to the lack of significant hurricane or other
storm activity in recent months. Engines for riding mowers were down by $1.6
million or 30.9%. Reductions in both walk behind and riding mower engines were a
result of the disruption in supply from Brazil, as customers sought alternative
supply sources. The remaining decreases in the Engine & Power Train Group were
spread across multiple product lines.
Engine & Power Train business operating loss for the second quarter of 2007 was
$8.5 million compared to a loss of $11.2 million during the same period a year
ago. Productivity and purchasing improvements accounted for $12.7 million of the
favorable results. In addition, while $4.1 million in fees were paid to
AlixPartners in the second quarter of 2006, no such expense was recorded in the
same period of 2007. These improvements to second quarter 2007 results were
offset by the impact of volume declines of $13.0 million.
Six Months Ended June 30, 2007 vs. Six Months Ended June 30, 2006
SIX MONTHS ENDED JUNE 30,
(dollars in millions) 2007 % 2006 %
------- ----- ------- -----
Net sales $ 707.9 100.0% $ 686.4 100.0%
Cost of sales 651.9 92.1% 649.4 94.6%
Selling and administrative expenses 70.4 9.9% 71.2 10.4%
Impairments, restructuring charges, and other items (0.5) (0.1%) 3.2 0.5%
------- -------
Operating loss (14.0) (2.0%) (37.4) (5.5%)
Interest expense (18.9) 2.6% (11.1) 1.6%
Interest income and other, net 3.7 0.5% 8.3 1.2%
------- -------
Loss from continuing operations before taxes (29.2) (4.1%) (40.2) (5.9%)
Tax expense (benefit) (3.2) 0.5% (9.6) (1.4%)
------- -------
Loss from continuing operations ($26.0) (3.6%) ($30.6) (4.5%)
======= =======
Consolidated net sales from continuing operations in the first six months of
2007 increased to $707.9 million from $686.4 million in 2006. Excluding the
increase in sales due to the effects of currency fluctuation of $33.0 million,
2007 first half sales decreased by $11.5 million or 1.7%. Sales increases
attributable to the Compressor segment were more than offset by a significant
decline in sales in the Engine & Power Train segment.
Cost of sales was $651.9 million in the six months ended June 30, 2007, as
compared to $649.4 million in the six months ended June 30, 2006. As a
percentage of net sales, cost of sales was 92.1% and 94.6% in the first six
months of 2007 and 2006, respectively. Pricing advances, net of unfavorable
volume impacts, led the year-on-year improvement. Productivity and purchasing
improvements also contributed favorably to 2007 results. These favorable results
were offset by unfavorable foreign currency rates and higher commodity costs.
Selling, general and administrative expenses were $70.4 million in the six
months ended June 30, 2007, as compared to $71.2 million in the six months ended
June 30, 2006. As a percentage of net
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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
sales, selling, general and administrative expenses were 9.9% and 10.4% in the
first six months 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;
$5.3 million was expensed in the first six months of 2007 for AlixPartners
services, including the services of James Bonsall and other supporting
personnel, while $13.1 million was incurred in the same period of 2006 for their
consulting services provided to our Engine & Power Train business. However,
professional fees for the business as a whole were $22.1 million in the first
six months of 2007, (as compared to $18.9 million in the first six months of
2006), which included $15.5 million in fees associated with the amendments to
our First and Second Lien credit agreements, the legal proceedings relating to
governance issues, and our efforts to market portions of the business.
Impairments, restructuring charges and other items were a credit of $0.5 million
($0.03 per share) in the six months ended June 30, 2007, compared to expense of
$3.2 million ($0.17 per share) in the three months ended June 30, 2006. As a
percentage of net sales, impairments, restructuring charges and other items were
(0.1%) and 0.5% respectively in 2007 and 2006. As a result of the previously
announced closure of our Engine & Power Train facility in New Holstein,
Wisconsin and the associated curtailment of pension and retiree benefits of its
employees, we recognized a net gain of $6.9 million ($0.37 per share) in the
second quarter of 2007. We also recorded $5.7 million ($0.31 per share) in
obsolescence charges associated with the completion of our lawn and garden
selling season and the cessation of business sourced from Brazil at the Engine &
Power Train group, and $2.0 million ($0.11 per share) in charges related to
reductions in force executed during the period across several of our business
units.
During the second quarter 2006, we incurred asset impairment and restructuring
charges of $2.6 million ($0.14 per share) related to the Engine & Power Train
business for the consolidation of transmission production into a single U.S.
facility. First quarter 2006 charges amounted to $0.6 million ($0.03 per share)
and were the result of the continuation of previously announced programs.
Included in Selling, General and Administrative expenses are corporate expenses
of $20.0 million for the first six months of 2007. These expenses increased from
$8.2 million in the prior year, primarily as a result of increases in
professional fees as discussed above.
Interest expense amounted to $18.9 million in the first six months of 2007
compared to $11.1 million in the first six months of 2006. The increase was
primarily related to the amortization of debt costs ($3.4 million), and the
higher average interest rates associated with our current borrowing arrangements
as compared to the same period in 2006.
Interest income and other, net was $3.7 million in the first six months of 2007
compared to $8.3 million in the first six months of 2006. In 2006, we recognized
a gain of $3.6 million ($2.6 million net of tax or $0.14 per share) on the sale
of our interest in Kulthorn Kirby Public Company Limited, a manufacturer of
compressors based in Thailand during the first quarter. The sale of the stock
was completed in conjunction with the end of a licensing agreement between the
Company's Compressor operations and Kulthorn Kirby. The remainder of the
decrease in 2007 was due to lower interest income on lower cash balances.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
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The consolidated statement of operations reflects a $3.2 million income tax
benefit for the first six months of 2007 and a $9.6 million income tax benefit
for the first six months of 2006. Income taxes are recorded pursuant to SFAS No.
109, "Accounting for Income Taxes," which specifies the allocation method of
income taxes between categories of income defined by that statement as those
that are included in net income (continuing operations and discontinued
operations) and those included in comprehensive income but excluded from net
income.
SFAS 109 is applied by tax jurisdiction, and in periods in which there is a
pre-tax loss from continuing operations and pre-tax income in another category
of income (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 pursuant to SFAS 109, paragraph 140. The first
six months of 2007 reflects a tax benefit in both continuing and discontinued
operations, and a tax expense in other comprehensive income. The first six
months of 2006 reflects a tax benefit in the statement of operations and tax
expense in other comprehensive income and discontinued operations.
At June 30, 2007 and December 31, 2006, full valuation allowances are recorded
for net operating loss carryovers for those tax jurisdictions in which the
Company believes it is not more likely than not that the deferred taxes will be
realized.
Net loss from continuing operations in the first six months of 2007 was $26.0
million ($1.40 per share) as compared to net loss of $30.6 million ($1.66 per
share) in the first six months of 2006. The change was primarily the result of
the factors described above.
Compressor Products
Compressor business sales in the first six months of 2007 increased to $586.3
million from $524.8 million in the first six months of 2006. Excluding the
increase in sales due to the effects of foreign currency translation of $31.5
million, sales increased by 5.7% in the first six months of 2007. Sales
increases in this segment were led by the refrigeration and freezer product
lines (up $36.8 million), an increase of 20.3%. While the majority of this
increase was attributable to pricing advances and foreign currency translation,
growth in new markets in India also contributed to the increase. While sales
were also higher for the commercial compressor product lines (up $20.3 million
or 8.3%), this sales increase was attributable to pricing advances rather than
unit volumes.
Operating income for the six months ended June 30, 2007 amounted to $21.3
million compared to $2.8 million for the first six months of 2006. The higher
operating income was attributable to price advances, net of volume impacts
($41.9 million) and productivity, purchasing, and other improvements ($16.0
million). These improvements were offset by unfavorable currency exchange
impacts ($21.8 million) and higher commodity costs ($17.5 million). Through the
first six months of 2007, the Brazilian Real was on average 7.1% stronger
against the U.S. Dollar compared to the same period in 2006, and the average
price of copper increased by 10.8% over the same period.
Engine & Power Train Products
First half 2007 sales amounted to $112.1 million compared to $152.4 million in
the first half of 2006. The decline in sales for the first half of the year was
primarily due to the lower sales of $12.3 million or 19.8% in engines for walk
behind mowers. Sales of engines for snowthrowers declined by $7.4 million or
43.8% when compared to the first six months of 2006. This decline was due to the
carryover of excess inventories from the prior season by our customers, as well
as conservative buying patterns by
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
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FINANCIAL CONDITION AND RESULTS OF OPERATIONS
those same customers as we enter the current selling season. Engines for
generators were also down by $7.8 million, a decline of 67.3%, due to lack of
significant hurricane or other storm activity in recent months. Engines for
riding mowers were also down by $4.1 million or 24.1%. Reductions in both walk
behind and riding mower engines were a result of our disruption in supply from
Brazil, as customers sought alternative supply sources. The remaining decreases
in the Engine & Power Train Group were spread across multiple product lines.
For the first half of 2007, the business incurred an operating loss of $16.5
million compared to an operating loss of $29.7 million in 2006. Productivity and
purchasing improvements of $15.0 million contributed to the favorable result; in
addition, fees paid to AlixPartners were reduced by $11.8 million year-on-year.
These improvements were offset by the effect of volume declines, net of pricing
impacts, of $9.2 million. In addition, a gain of $3.5 million was recorded in
the first half of 2006 on the sales of our facility in Douglas, Georgia, whereas
no similar gain was realized in 2007.
OTHER MATTERS
Environmental Matters
We are subject to various federal, state and local laws relating to the
protection of the environment and are actively involved in various stages of
investigation or remediation for sites where contamination has been alleged.
(See Note 11 to the financial statements.) Liabilities relating to probable
remediation activities are recorded when the costs of such activities can be
reasonably estimated based on the facts and circumstances currently known.
Difficulties exist estimating the future timing and ultimate costs to be
incurred due to uncertainties regarding the status of laws, regulations, levels
of required remediation, changes in remediation technology and information
available.
We had accrued $3.1 million and $3.3 million at June 30, 2007 and December 31,
2006, respectively, for environmental remediation. As these matters continue
toward final resolution, amounts in excess of those already provided may be
necessary to discharge our obligations for these sites. Such amounts, depending
on their amount and timing, could be material to reported net income in the
particular quarter or period in which they are recorded. In addition, the
ultimate resolution of these matters, either individually or in the aggregate,
could be material to the consolidated financial statements.
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 six months of 2007, cash used by operations amounted to $24.0
million, reflecting an operating loss of $105.0 million offset by adjustments to
working capital of $81.0 million. Accounts
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FINANCIAL CONDITION AND RESULTS OF OPERATIONS
receivable increased by $19.2 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 second 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 $25.1 million in the May 1 to
June 30, 2007 period when compared to November and December of 2006. In
addition, when evaluating days to collection for outstanding receivables, there
was an increase of three days to collection as of June 30, 2007 when compared to
the end of 2006. This increase was driven by the Compressor segment, whose days
sales outstanding ("DSO") increased from 61 at the end of the year to 64 at June
30 (before consideration for discounted accounts receivable at the segment's
foreign subsidiaries), due to increased time for collection at its Brazilian
subsidiary. The Engine & Power Train segment also increased its days sales
outstanding, from 54 at the end of the year to 56 as of June 30. Although DSO
trends improved in North America for Engine & Power Train, the metric was
significantly higher at June 30 for the UK operation when compared to the end of
2006. Volumes for the UK operation were a much higher proportion of overall
segment sales at the end of June, and payment terms were significantly longer
than in North America. In contrast, inventories decreased by $34.3 million since
the beginning of the year, reflecting improvements in days inventory on hand at
the Compressor and Engine & Power Train business segments. Increases to accounts
payable and other accrued expenses and liabilities (up $35.7 million since
January 1, 2007) were also included in working capital adjustments. Most of the
remainder of the cash adjustments to working capital is due to the effects of
foreign currency translation.
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 our sales patterns from the
comparison. Average days sales outstanding were 64 days at June 30, 2007 versus
62 days at June 30, 2006, before giving effect to receivables sold. Days
inventory on hand were 64 days at June 30, 2007, down from 74 days at June 30,
2006, due to improving management of inventory balances.
Cash used by investing activities was $3.4 million in the first six months of
2007 versus cash provided by investing activities of $96.1 million for the same
period of 2006. $130.9 million in proceeds were received from the sale of assets
during 2006, while $2.0 in proceeds were recorded in the first six months of
2007. Included in the 2006 sales was the sale of Little Giant Pump Company for
$120.7 million, 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 were applicable to both
our Electrical Components and Compressor segments. The entire purchase price was
allocated to amortizable intangible assets. Capital expenditures were reduced by
$27.4 from the prior year, from $32.8 million in 2006 to $5.4 million in 2007.
Cash used by financing activities was $1.5 million in the first six months of
2007 as compared to a use of cash of $15.3 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.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 six months ended June 30, 2007 and December 31, 2006, our average
outstanding debt balance was $291.0 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 9.3% 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 $90.3 million and $46.5 million
as of June 30, 2007 and December 31, 2006, respectively. We cannot provide any
assurances that these facilities will be available or utilized in the future.
Adequacy of Liquidity Sources
Historically, cash flows from operations and borrowing capacity under previous
credit facilities were sufficient to meet our long-term debt maturities,
projected capital expenditures and anticipated working capital requirements.
However, in 2006 and through the second 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 our needs.
Throughout the second 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. The Adjusted EBITDA covenant applies through
December 31, 2007, and a four-quarter fixed charge coverage ratio covenant
applies beginning on December 31, 2007. During the second quarter, the weighted
average annual interest rate on our borrowings under these agreements was 9.3%.
Under the terms of the First Lien Credit Agreement, as of June 30, 2007 we had
the capacity for additional borrowings under the borrowing base formula of $30.7
million in the U.S. and $24.9 million in foreign jurisdictions. Both the First
Lien Credit Agreement and the Second Lien Credit Agreement have terms expiring
in November, 2009.
On July 3, 2007, we signed an agreement with Regal Beloit Corporation to sell
the Residential & Commercial and Asia Pacific divisions of the Electrical
Components business segment to Regal Beloit for $220 million in cash, subject to
adjustments for working capital changes and a hold back of certain proceeds in
escrow for up to eighteen months to cover any potential claims that may arise
from any breach of representations and warranties as well as the resolution of
certain contingencies. Net proceeds of this sale transaction at closing are
estimated to be approximately $195 million. The proceeds will be utilized to
repay our Second Lien lender in full, including principal, prepayment
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
penalties and fees, and both cash and PIK interest. The remainder of the
proceeds, or approximately $90 million, will be utilized to reduce the
outstanding balance on our First Lien debt.
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 by the credit agreements, as of June 30, 2007 our cumulative Adjusted
EBITDA was $23.6 million or $6.6 million in excess of the covenant levels.
Upon the closing of the sale transaction of the Residential & Commercial and
Asia Pacific portions of our Electrical Components business, we expect our
minimum cumulative Adjusted EBITDA levels to be modified to reflect the removal
of a pro-rata share of a percentage of the 2007 forecasted financial results of
those business units, as follows (in millions):
Quarterly Period Ending First Lien Agreement
- ----------------------- --------------------
September 30, 2007 $41.1
December 31, 2007 $57.3
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 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, or if the Company continued
to apply its best efforts to engage the new CEO. On August 1, 2007, we announced
that we had appointed a permanent Chief Executive Officer. Since the conditions
of the credit agreement were met through the date of the CEO's appointment, the
additional interest was not assessed.
We paid $625,000 in fees, plus expenses, to the First Lien lender on April 9,
2007 upon execution of the April 9 amendment. In addition to fees paid of
$750,000, plus expenses, to the Second Lien lender,
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FINANCIAL CONDITION AND RESULTS OF OPERATIONS
on April 9 we also granted the Second Lien lender a warrant to purchase
1,390,944 shares of Class A Common Stock, which is equivalent to 7% of our fully
diluted common stock. This warrant, valued at $7.3 million or $5.29 per share,
expires five years from the date of the execution of this amendment to the
Second Lien credit agreement. These costs are being accounted for as additional
interest expense over the remaining terms of the credit agreements, subject to
acceleration upon full repayment of the debt, which we expect to occur in the
third 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
As of June 30, 2007, there had been no reduction in the balance of the Second
Lien Credit Agreement. Therefore, the additional PIK interest will apply
effective beginning July 1, 2007 until such time as those debt balances are
reduced by $20 million. We expect this reduction to occur upon the closing of
the sale transaction of the Residential & Commercial and Asia Pacific portions
of our Electrical Components business to Regal Beloit Corporation as referenced
above.
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.
With the completion of the sale of the Residential and Commercial division of
our Electrical Components business to Regal Beloit Corporation, we will achieve
substantial debt reduction in the United States. To complete the transaction, we
will need to obtain additional modifications to the terms of our credit
agreements to close the sale transaction. We will be seeking additional
modifications to our debt arrangements with our First Lien lender to provide for
more favorable terms in light of the substantial debt reduction. Accordingly, we
would expect to remain in compliance with the terms of our debt agreements.
However, in the event that we fail to close the sale transaction and we fail to
improve performance through the measures noted above, our ability to raise
additional funds through debt financing or further modifications to our lending
arrangements will be limited.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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
June 30, 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
June 30, 2007 for our long-term contractual obligations are as follows:
Payments by Period (in millions)
-------------------------------------
Total Less than 1 Year 1-3 Years
------ ---------------- ---------
Debt Obligations $290.6 $70.3 $220.3
Interest Payments on Debt * 79.3 26.4 52.9
* Debt levels are assumed to remain constant. Interest rate debt obligations
are assumed to remain constant at the current weighted average rate of
9.1%.
These scheduled maturities do not consider any of the targeted debt reductions
that are incorporated, but not mandated, in our credit agreements, nor do they
incorporate our anticipated reduction in debt upon completion of the sale of the
Residential & Commercial and Asia Pacific divisions of the Electrical Components
business unit.
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.
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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
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 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 the balance of 2007 is subject to the same variables that have
negatively impacted us throughout 2006 and the first half of 2007. 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 July 31, 2007, the price of aluminum increased approximately 12%,
and the price of copper increased 69% in the same time frame. In the first six
months of 2007 alone, copper prices escalated by 21%. While copper forward
purchase contracts obtained prior to the cost increase have allowed us to
maintain costs consistent with, or slightly better than, our 2007 business plan,
future costs are expected to continue to rise. We currently hold approximately
70% of our total projected copper requirements for the remainder of 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. The
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.
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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
The Brazilian Real continues to strengthen against the dollar, and strengthened
12.2% from January 1, 2007 to July 31, 2007. From April 1 through June 30, 2007,
the Real strengthened by 6.4%. Recently, we have also been unfavorably affected
by the strengthening of the Indian Rupee, which strengthened by 6.0% in the
second quarter of 2007. Net of currency hedging activities, this continued
strengthening of the Real and the recent strengthening of the Rupee affected our
operating results unfavorably by approximately $9.5 million when compared to our
2007 plan.
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.
Nonetheless, we expect the operating results of both of our business segments to
improve in the third 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,
operational efficiencies and productivity improvements in the Compressor Group
are expected to improve operational margins when compared to the third 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 third quarter of 2006 excluding restructuring
charges. The improvement continues to be driven by the overall restructuring
efforts implemented under the direction of AlixPartners. As part of these
efforts, as previously mentioned, we will be completing the closure of our
engine facility in New Holstein, Wisconsin in the third quarter of 2007. As a
result of the associated curtailment of pension and retiree benefits of the New
Holstein employees, future pension and retiree health care expense will decrease
by $0.9 million per quarter.
The restructuring plan for our Brazilian engine subsidiary, TMT Motoco, was
submitted in late May, and the plan is currently under the consideration of the
Brazilian court. Deliveries for the 2007 lawn and garden season are essentially
complete. Based on the Brazilian court's evaluation of our submitted
restructuring plan, we may implement one of several alternatives for the future
of TMT Motoco and the 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. At this
time, we expect that the most likely outcome will be a controlled liquidation.
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 both 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. Upon the completion of the
divestiture of the respective divisions of the Electrical Components business
segment and other potential divestitures, we will be re-evaluating our corporate
infrastructure in relation to the level of business activity that remains. This
analysis could result in new restructuring programs. While no such activities
have been planned at this time, these and other potential actions 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 operating
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
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FINANCIAL CONDITION AND RESULTS OF OPERATIONS
results.
Our weighted average interest rate for long-term debt through the first six
months of 2007 was substantially higher than the same period a year ago,
contributing to 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. We began incurring this interest cost on
July 1, 2007.
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. In this regard, improvements in inventory
management practices, including the completion of restructuring programs which
required temporary increases in inventory levels to accommodate production
transfers, have resulted in positive working capital as of June 30, 2007.
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.
On July 3, 2007, we announced that we had signed an agreement with Regal Beloit
Corporation to sell to Regal Beloit the Residential & Commercial and Asia
Pacific divisions of our Electrical Components business segment for $220 million
in cash, subject to adjustments for working capital changes and a hold back of
certain proceeds in escrow for up to eighteen months to cover any potential
claims that may arise from any breach of reps and warranties as well as the
resolution of certain contingencies. . Completion of this transaction, which is
subject to regulatory approval by the Federal Trade Commission and other
customary closing conditions, is currently expected to close in the third
quarter. The principal terms of our purchase agreement with Regal Beloit were
disclosed in a Current Report on Form 8-K that we filed on July 10, 2007, and
the purchase agreement is filed with this report as Exhibit 10.1.
Due to the continued strengthening of the Brazilian Real, declines in sales
volumes at the Engine & Power Train business segment, and continued increases in
the cost of commodities such as copper, we no longer expect to achieve our
original financial plan, nor can we provide assurance that the business would
meet our EBITDA covenants after adjustment for the sale to Regal Beloit
Corporation or other potential asset sales, due to our inability to project when
such sales may close. In order to close the sale transaction with Regal Beloit,
we will be entering into amendments to modify the credit agreements with our
First and Second Lien lenders to permit actions necessary to prepare the sold
asset for sale, in accordance with the terms of the purchase agreement. As part
of this process, we will also seek additional amendments that will re-define our
EBITDA covenants, to align those requirements with businesses that can
reasonably be expected to remain part of our continuing operations.
Net proceeds of this sale transaction at closing are estimated to be
approximately $195 million. The proceeds will be utilized to repay our Second
Lien lender in full, including principal, prepayment penalties and fees, and
both cash and PIK interest. The remainder of the proceeds, or approximately $90
million, will be utilized to reduce the outstanding balance on our First Lien
debt.
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FINANCIAL CONDITION AND RESULTS OF OPERATIONS
We are also evaluating further potential sales of product lines, divisions, and
various idle assets of the Company, including real estate, equipment, and
Company aircraft. The proceeds from any such sales would be used to reduce our
indebtedness. With respect to idle assets, we expect to realize proceeds of
approximately $12 million prior to the end of the year.
In addition, we are in the process of finalizing the audit of our 2003 tax year,
the resolution of which is expected to result in the refund of federal income
taxes previously paid of approximately $13.0 million. Receipt of such proceeds
is dependent upon final resolution of these audits, estimated to occur within
the next four to seven months.
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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MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAUTIONARY STATEMENTS RELATING TO FORWARD-LOOKING STATEMENTS
This report 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 six 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 June 30, 2007 and December 31, 2006, we held foreign currency
forward contracts with a total notional value of $107.9 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 June 30, 2007 and December 31, 2006, the
Company held a total notional value of $51.1 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 $290.6 million at June 30, 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. While changes in interest rates do not affect the fair value of
our variable-interest rate debt, they do affect future earnings and cash flows.
A 1% increase in interest rates would increase interest expense for the year by
approximately $2.9 million.
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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 June 30, 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 have
resulted 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 June
30, 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 include 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 six months ended June 30, 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.
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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.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS
(a) Exhibit
Number Description
------- -----------
10.1 Purchase Agreement dated as of July 3, 2007 among Regal Beloit
Corporation, Tecumseh Products Company, Fasco Industries, Inc.,
and Motores Fasco de Mexico, S. de R.L. de C.V.
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.
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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: August 9, 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)
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