EXECUTIVE OFFICES
James S. Nicholson
Vice President, Treasurer
and Chief Financial Officer (TECUMSEH LOGO)
September 13, 2007
United States Securities and Exchange Commission
Division of Corporation Finance
100 F Street, N.E., Mail Stop 7010
Washington, DC 20549-7010
Attn: Tracey Houser, Staff Accountant
Terence O'Brien, Accounting Branch Chief
RE: TECUMSEH PRODUCTS COMPANY
FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006
FILED APRIL 10, 2007
FORM 10-Q FOR THE FISCAL QUARTER ENDED MARCH 31, 2007
FILE NO. 0-452
Dear Ms. Houser and Mr. O'Brien:
This letter is in response to your comment letter dated May 25, 2007 to Tecumseh
Products Company. Your comments are reproduced below, followed in each case by
Tecumseh's response in italics.
Form 10-K for the Fiscal Year Ended December 31, 2006
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations, page 25
Liquidity and Capital Resources, page 39
1. We note your response to comment 3 in our letter dated February 2, 2007
regarding the increase in average days sales outstanding as of September
30, 2006 as compared to December 31, 2005. Specifically, we note that a
portion of the increase in average days sales outstanding is that your
largest customer in your Engine & Power Train Group increased as a
percentage of accounts receivable and it has longer than normal payment
terms. Furthermore, we note that average days sales outstanding as of
December 31, 2006 exceeded the number of days as of December 31, 2005 due
in part for the same reason. In addition to automotive customers in the
Electrical Components Group average days sales outstanding also increased
due to these customers becoming a larger portion of Electrical Components
Group's accounts receivable balance and receiving more extended payment
terms than other customers within Electrical Components Group. Please
Securities and Exchange Commission
September 13, 2007
Page 2 of 21
tell us and revise your disclosure in future filings to explain the cause
for the customer in Engine & Power Train Group and the automotive customers
in Electrical Components Group's increase as a percentage of accounts
receivable as of December 31, 2006. If the explanation is due to an
increase in sales, please also provide an explanation for this increase.
Finally, please tell us why you have provided certain key customers with
extended payment terms, including the benefit to you for extending such
terms to the key customers in Engine & Power Train Group and the automotive
customers in Electrical Components Group.
Answer:
The key customer at the Engine & Power Train segment that was discussed in
our Annual Report on Form 10-K for the year ended December 31, 2006
accounted for approximately the same proportion of that Group's overall
accounts receivable balance at the end of both 2006 and 2005 (49% and 50%
of the total balance, respectively). The average days to collection for
that customer increased by six days over the course of 2006, from 62 days
at December 31, 2005 to 68 days at the end of 2006. Of the four day
increase in DSO for the Engine & Power Train group in 2006, three days are
attributable to the longer time to collection for this particular customer.
The payment terms for the domestic entities of this Engine customer were
changed from 2% 10 net 30 to 60 days during 2005. We negotiated this change
in terms with the customer because we considered the delay in payment
preferable to the continuation of the discount. In order to bring
consistency in payment terms to all entities of this customer, its German
entity's terms were also changed, from net 30 to net 60 days. The
customer's German entity delayed full implementation of these extended
payment terms into 2006, and as of December 31, 2005 that entity had a DSO
of 47 days. The six-day increase in DSO for this customer over the course
of 2006 was the result of the implementation during the year of the 60 day
payment terms for that German entity, as well as some extension of time to
payment by the customer's domestic entities.
The increase in sales to automotive customers in the Electrical Components
Group, both in real terms and as a proportion of overall Group sales, was
the result of increases in automotive product line sales due to the
introduction of new automotive products, concurrent with the decline of
sales volumes in the residential & commercial product lines when compared
to the same period in the prior year. Automotive customers receive longer
payment terms than other customers within Electrical Components; these
longer payment terms are deemed necessary in order to compete effectively
in the automotive industry.
Securities and Exchange Commission
September 13, 2007
Page 3 of 21
Significant Accounting Policies and Critical Accounting Estimates, page 46
2. There is a concern that your goodwill and other intangible assets may be
impaired. In this regard, we note that your market capitalization has been
significantly less than the net carrying value of your assets since
December 31, 2003. We also note that the disparity between the two measures
has increased dramatically through March 31, 2007. Therefore, it appears
that an impairment charge is required given the SFAS 142 guidance that fair
values be based on objective measures such as quoted market prices and
marketplace assumptions.
Further, there is a concern that your goodwill impairment tests conducted
during the fourth quarters of fiscal years 2005 and 2006 are not fully
compliant with paragraph 24 of SFAS 142. The guidance therein requires that
your cash flow estimates consider all available evidence and "incorporate
assumptions that marketplace participants would use in their estimates of
fair value." In this regard, the aggregate fair values of the reporting
units may reasonably be expected to approximate the fair value of the
combined entity. The consistent, material excess of net carrying value of
your assets over your market capitalization appears to indicate that you
may be using future cash flow assumptions that are materially different
from the implied market-based assumptions inherent in the quoted market
prices of your equity securities. As such, please provide us with a more
detailed explanation regarding the fair value of each reporting unit
exceeding carrying value by providing us with sufficient information to
understand how the estimated fair value of the individual reporting units
compares to the quoted market value of the entity taken as a whole. Refer
to paragraphs 23-25 of SFAS 142 for additional guidance.
In this regard, we note that as of March 31, 2007 $109.1 million of
goodwill and $51.9 million of other intangible assets have been allocated
to the Electrical Components reportable segment. We further note that sales
have been relatively flat over the three years ended December 31, 2006 with
a downward profit trend for each of the three years ended December 31, 2006
and the three months ended March 31, 2007. On page 30 of your December 31,
2006 Form 10-K, you state that the $108 million goodwill impairment charge
recognized during fiscal year 2005 for FASCO, the reporting unit in your
Electrical Components segment, was due to your failure to achieve the 2005
business plan due to (a) expected market conditions; (b) deterioration of
volumes; and (c) inability to recover higher commodity and transportation
costs through price increases. These factors causing the impairment you
recognized during fiscal year 2005 appear to continue to be negatively
impacting FASCO's operating results and cash flows. While sales did
increase in fiscal year 2006 by 4.8%, you note on page 33 of your December
31, 2006 Form 10-K that unit volumes were lower in the residential,
commercial and automotive markets. In addition, you note that you lost
market share in your automotive market. Furthermore, you recognized an
operating loss of $4.7 million
Securities and Exchange Commission
September 13, 2007
Page 4 of 21
in fiscal year 2006 versus an operating profit of $7.5 million in fiscal
year 2005. In this regard, you note that price increases were unable to
cover increases in commodity costs by $10.7 million. Finally, you note that
inefficiencies in materials management, high levels of personnel turnover
and Oracle implementation issues at your Juarez, Mexico facility exceeded
the purchasing and productivity improvements from other locations. For the
three months ended March 31, 2007, your operating profits fell below the
results of the comparative period due to volume declines and a less
favorable product sales mix.
Finally, we note your disclosure on page 33 of your March 31, 2007 Form
10-Q that with the continued improvement initiatives, additional assets
will become impaired and could have a significant impact to your
consolidated financial position and future results of operations. Please
tell us if you expect to record a material intangible asset impairment
charge during the June 30, 2007 quarter. If no impairment charges are
planned, please provide us with a detailed explanation of how your
accounting for these assets complies with the quoted market
prices/marketplace assumptions required to be taken into account per
paragraphs 23 and 24 of SFAS 142. In order for us to better understand the
company's accounting in this area, please also provide us with the SFAS 142
impairment tests performed in the fourth quarter of fiscal years 2005 and
2006. Please provide an explanation for the material assumptions therein in
a sufficient amount of detail so that the reasonableness of the assumption
can be clearly assessed. If there is a significant disparity between the
forecast data and the comparable historical data in the company's filings,
then please provide reconciling information. Also, we would expect to see
an analysis of the range of possible outcomes as required by paragraph 24
of SFAS 142. Compliance with the guidance in Appendix E to SFAS 142 should
be clearly evident. Finally, if any appraisals of your intangible assets
have been obtained, please also provide us with copies of such appraisals
or valuation reports.
Answer:
In evaluating the results of our annual and (as needed) interim impairment
analyses, we consider whether the indicated results are consistent with
all known information, including the public market valuation of our
Company. We acknowledge that there has been a disparity between our market
capitalization and the net book value of our total assets. However, we
believe there are reasonable explanations for the variations that allow us
to conclude that the results of our discounted cash flow valuation
methodology are valid. We further believe that such conditions were
contemplated in paragraph 23 of SFAS 142. which states that "the market
capitalization of a reporting unit... may not be representative of the fair
value of the reporting unit as a whole."
Securities and Exchange Commission
September 13, 2007
Page 5 of 21
First, the sum of the total assets of the three business units that carry
goodwill represent less than 27% of our total assets. Our Engine & Power
Train Group, which does not report goodwill, has incurred significant
losses over the last several years. The losses have been substantial enough
to conclude that this business can be ascribed a significant negative value
when evaluating the total value of the enterprise. Accordingly, we believe
that the aggregate value of our other business segments can exceed the
market capitalization value of the entire enterprise.
Second, there has also been significant volatility in our market
capitalization, particularly over the last several months, as we have
publicly disclosed violations of debt covenants and subsequently
successfully negotiated amendments to the covenants to our domestic credit
agreements. The threat of potential illiquidity during these time periods
also reduced the correlation between the market capitalization of the
enterprise versus the net asset value for those business entities that
carry goodwill.
In consideration of the above, we believe that we have utilized forecasts
of future cash flows that are consistent with those that market
participants would use in their own analyses if considering each business
unit separately, and that such forecasts are those used to establish
estimated cash flows for the Company as a whole. The cash flow information
that we use for our impairment computations are the same as reflected in
our internal business plans for 2007 and beyond and are the same that are
used for projections supplied to our lenders and used in information
memorandum for potential buyer evaluation. The projections include what we
believe are reasonable assumptions regarding year-over-year improvements,
including the non-recurrence of certain one-time charges experienced in
2006 and prior, productivity improvements, and reductions in fixed cost
structure. Please refer to the response to Comment #4 for further details
of the anticipated improvements incorporated in the 2007 business plan. The
same improvements are forecasted to carry forward beyond 2007 as well.
Securities and Exchange Commission
September 13, 2007
Page 6 of 21
The following is a summary of our SFAS 142 goodwill impairment tests
performed at the end of 2005 and 2006.
EUROPE - DECEMBER 31, 2005
Assumptions:
Growth Per forecast, otherwise 3.0%
Dollar / Euro 0.85
Discount rate 9.25%
Calculated Value 84.700
Book net assets 67.652
(in millions) 2006 2007 2008 2009 2010 Terminal
------- ------- ------- ------- ------- --------
Proj. Sales 240.000 251.765 263.529 271.435 279.578 287.966
Growth Rate 4.9% 4.7% 3.0% 3.0% 3.0%
OPBIT (2.762) 3.152 7.524 10.500 10.815 11.139
Depreciation 6.588 6.106 5.765 5.882 6.000 6.118
Adj. Cash Flow 3.826 9.258 13.288 16.382 16.815 17.257
Capex 14.118 8.235 7.059 7.271 7.343 7.417
Chg in working capital .118 .118 .079 .081 .084
Free Cash Flow (after tax) (9.353) (0.167) 3.554 5.463 5.713 95.505
INDIA - DECEMBER 31, 2005
Assumptions:
Growth Per forecast, otherwise 3.0%
Discount rate 9.25%
Calculated Value 107.818
Book net assets 60.458
(in millions) 2006 2007 2008 2009 2010 Terminal
------- ------- ------- ------- ------- --------
Proj. Sales 124.175 167.573 216.311 222.800 229.484 236.369
Growth Rate 34.9% 29.1% 3.0% 3.0% 3.0%
OPBIT (.983) 6.394 13.399 13.801 14.215 14.641
Depreciation 7.544 7.776 9.627 10.108 10.614 11.144
Adj. Cash Flow 6.561 14.170 23.026 23.909 24.829 25.786
Capex 3.358 6.179 22.966 10.000 10.500 11.025
Chg in working capital .434 .487 .065 .067 .069
Free Cash Flow (after tax) 3.537 5.383 (4.983) 9.152 9.429 155.423
Securities and Exchange Commission
September 13, 2007
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FASCO - DECEMBER 31, 2005
Assumptions:
Growth Per forecast, otherwise 3.0%
Discount rate 9.25%
Calculated Value 370.626
Book net assets 290.098
(in millions) 2006 2007 2008 2009 2010 Terminal
------- ------- ------- ------- ------- --------
Proj. Sales 412.074 454.906 497.153 512.068 527.430 543.253
Growth Rate 10.4% 9.3% 3.0% 3.0% 3.0%
OPBIT 22.057 33.261 39.226 40.403 41.615 42.863
Depreciation 13.953 14.290 14.100 14.000 8.800 8.800
Adj. Cash Flow 36.010 47.551 53.326 54.403 50.415 51.633
Capex 12.987 9.720 9.700 9.991 10.291 8.800
Chg in working capital .428 .422 .149 .154 .158
Free Cash Flow (after tax) 15.524 26.094 29.867 30.526 25.821 450.105
MOTOCO (CZECH REPUBLIC) - DECEMBER 31, 2005
Assumptions:
Growth Per forecast, otherwise 3.0%
Discount rate 9.25%
Calculated Value 19.438
Book net assets 21.103
(in millions) 2006 2007 2008 2009 2010 Terminal
------ ------ ------ ------ ------ --------
Proj. Sales 16.698 22.100 24.100 26.100 28.100 28.943
Growth Rate 32.4% 9.0% 8.3% 7.7% 3.0%
OPBIT (3.466) (2.000) -- 1.000 2.200 2.500
Depreciation 3.354 3.242 3.197 2.612 2.300 1.855
Adj. Cash Flow (.112) 1.242 3.197 3.612 4.500 4.355
Capex 1.291 1.873 1.800 1.818 1.836 1.855
Chg in working capital .054 .020 .020 .020 .008
Free Cash Flow (after tax) .775 (.005) 1.377 1.434 1.896 26.272
During our annual assessment at the end of 2005, expected cash flows were
lower than had previously been estimated at our Czech Republic operations. The
decline in expected cash flows resulted in a goodwill impairment of $2.7
million, or the entire carrying value.
Securities and Exchange Commission
September 13, 2007
Page 8 of 21
EUROPE - DECEMBER 31, 2006
Assumptions:
Growth Per forecast, otherwise 3.0%
Dollar / Euro .79695
Discount rate 8.16%
Calculated Value 105.355
Book net assets 66.565
(in millions) 2007 2008 2009 2010 2011 Terminal
------- ------- ------- ------- ------- --------
Proj. Sales 291.140 292.764 301.547 310.593 319.911 329.508
Growth Rate 0.6% 3.0% 3.0% 3.0% 3.0%
OPBIT 9.772 9.692 9.983 10.282 10.591 10.908
Depreciation 7.311 6.148 6.274 6.399 6.525 5.714
Adj. Cash Flow 17.083 15.840 16.257 16.681 17.116 16.623
Capex 4.489 5.280 5.438 5.602 5.658 5.714
Chg in working capital .016 .088 .090 .093 .096
Free Cash Flow (after tax) 12.594 10.544 10.731 10.989 11.365 96.880
INDIA - DECEMBER 31, 2006
Assumptions:
Growth Per forecast, otherwise 3.0%
Discount rate 8.16%
Calculated Value 86.987
Book net assets 79.225
(in millions) 2007 2008 2009 2010 2011 Terminal
------- ------- ------- ------- ------- --------
Proj. Sales 116.673 125.859 132.152 138.760 145.698 152.982
Growth Rate 7.9% 5.0% 5.0% 5.0% 5.0%
OPBIT 1.851 3.300 3.465 3.638 3.820 4.011
Depreciation 6.082 6.000 5.500 5.000 4.000 3.200
Adj. Cash Flow 27.933 9.300 8.965 8.638 7.820 7.211
Capex .993 1.000 1.050 1.103 1.158 1.216
Chg in working capital .092 .063 .066 .069 .073
Free Cash Flow (after tax) 26.703 8.208 7.852 7.470 6.593 62.703
Securities and Exchange Commission
September 13, 2007
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FASCO - DECEMBER 31, 2006
Assumptions:
Growth Per forecast, otherwise 3.0%
Discount rate 8.16%
Calculated Value 330.593
Book net assets 328.966
(in millions) 2007 2008 2009 2010 2011 Terminal
------- ------- ------- ------- ------- --------
Proj. Sales 411.200 426.923 439.731 452.923 466.510 480.506
Growth Rate 3.8% 3.0% 3.0% 3.0% 3.0%
OPBIT (0.123) 12.925 16.612 22.646 23.326 24.025
Deprec & Amort 17.596 17.396 16.000 14.500 13.050 6.500
Adj. Cash Flow 17.473 30.321 32.612 37.828 42.908 43.979
Capex 3.500 3.500 4.000 4.040 4.080 5.000
Chg in working capital .157 .128 .132 .136 .140
Free Cash Flow (after tax) 13.973 26.664 28.484 33.656 38.692 354.852
Aside from the changes in assumptions applied to the goodwill valuation
model from 2005 to 2006, some modifications were made to the model as well.
These modifications included eliminating any assumptions regarding the
effect of income taxes during the first five years of the model, and a
change in the methodology for calculating the terminal value from
calculating the terminal value as a perpetuity to assuming a 15-year
duration). Please note that if these changes in methodology had been
applied to the 2005 year-end model, they would not have had a material
impact on the outcome of that analysis.
Our analysis does not incorporate a range of possible outcomes, but instead
uses a traditional cash flow approach, applying an estimate of the single
most-likely amount as our best estimate of future cash flows. We considered
both the traditional cash flow methodology as well as the expected cash
flow approach (which employs a range of outcomes) in designing fair value
models for our SFAS 142 impairment tests at the time of adoption. We
determined that the traditional approach was appropriate and consistent
with Paragraph 48 of Appendix E of SFAS 142, as well as a more common
industry practice. Paragraph 48 of Appendix E to SFAS 142 states that the
expected cash flow approach is "allowed, but not required" when estimating
fair value.
Our goodwill impairment test performed at the end of 2005 also included an
analysis of the Little Giant Pump Company, which was classified as held for
sale as of that reporting date. Applying our goodwill model for Little
Giant yielded a
Securities and Exchange Commission
September 13, 2007
Page 10 of 21
calculated fair value of $86.8 million. In April of 2006, Little Giant Pump
Company was sold for proceeds of $120.7 million. This transaction
substantiated that our goodwill valuation methodology provided a reasonable
approximation of fair value and was consistent with assumptions being used
by market participants.
In addition, we have been engaged for several months in the process of
evaluating the merits of a potential sale of our Fasco business entity,
either as a whole or in individual business units. Prior to filing our
Quarterly Report on Form 10-Q for the period ended March 31, 2007, we had
received initial indications of value from potential buyers totaling $300
million, which was within 10% of the fair value calculated during our 2006
impairment assessment. We considered these indications to be further
substantiation that our methodology for calculating the value of our
entities that record goodwill is approximately commensurate with those that
market participants would utilize.
However, during the second quarter of 2007, subsequent to the filing of our
Quarterly Report on Form 10-Q for the period ended March 31, 2007,
continued weakness in housing markets resulted in sales declines in our
Residential & Commercial product lines, which resulted in the Company
reducing its forecasts for the remainder of the year. The reduced forecasts
for both sales volume and profitability were communicated to the potential
buyers prior to receiving second round bids. As a result, the second round
bids received from interested parties were lower than the original
indications, aggregating $230 million, and reflected the decrease in
expected 2007 results. We consider that the timing of these events
indicates that the triggering event for further impairment analysis for the
Fasco business unit occurred in the second quarter of 2007.
On July 3, 2007, we announced that we had signed an agreement with Regal
Beloit Corporation to sell 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. Accordingly, 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 $109.1
million of total goodwill balance associated with the Electrical Components
business was impaired. All of the goodwill balance associated with the
Electrical Components business has been reclassified as an asset held for
sale.
Securities and Exchange Commission
September 13, 2007
Page 11 of 21
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 as well as $25.8 million in long-lived
assets associated with the Automotive & Specialty division of the
Electrical Components business was impaired. All of the other intangible
assets of the Company were related to the Electrical Components business
segment, and were reclassified as assets held for sale as of June 30, 2007.
A summary of our impairment analysis under SFAS 142 of intangible assets as of
December 31, 2006 is as follows:
(in millions)
Remaining NBV Undiscounted Disc PV
Intangible Asset Life (Yrs) 1/1/07 Cash flows @ 8.16%
---------------- ---------- ------ ------------ -------
Trade Name Indefinite 16.9 25.5 21.9
Customer Relationships-Non Auto 11.0 25.9 65.0 47.2
Customer Relationships-Auto 11.0 2.4 39.2 24.8
Customer Contracts-Auto 2.0 0.2 1.5 1.5
Technology:
110V Starters 1.0 0.1 0.3 0.2
Door Opener 14.0 0.9 1.1 0.7
Brushless Motor 2.0 0.1 0.1 0.1
IMT 10.0 1.9 1st yr acq.
Total Auto / Specialty DC 3.0 1.5 1.0
Blowers 7.0 4.6 11.7 8.6
TOTAL 53.0 144.4 105.0
A summary of our impairment analysis under SFAS 142 of intangible assets as of
December 31, 2005 is as follows:
(in millions)
Remaining NBV Undiscounted
Intangible Asset Life (Yrs) 1/1/06 Cash flows
---------------- ---------- ------ ------------
Trade Name Indefinite 16.9 17.8
Customer Relationships-Non Auto 12.0 28.3 48.9
Customer Relationships-Auto 12.0 2.6 29.6
Customer Contracts-Auto 3.0 0.3 2.0
Technology:
110V Starters 2.0 0.2 0.5
Door Opener 15.0 1.1 1.4
Brushless Motor 3.0 0.1 0.1
Total Auto / Specialty DC 1.4 2.0
Blowers 7.0 5.3 10.2
TOTAL 54.8 110.5
Securities and Exchange Commission
September 13, 2007
Page 12 of 21
3. We note that you are using the Ibbotson rate for the SIC code 3 as your
discount rate in estimating discounted cash flows for testing goodwill for
impairment. At December 31, 2006, you state this rate is 8.16%. It remains
unclear to us why you are not using your cost of capital as your discount
rate. As you note on page 42 of your 2006 Form 10-K, your weighted average
debt interest rate is 10%. As equity instruments are typically riskier than
debt instruments, the cost of equity should be at a higher rate than the
cost of debt.
Furthermore, the rate obtained from Ibbotson is an average of the companies
included in the corresponding SIC code and should be adjusted depending on
the risks associated with Tecumseh versus the other companies. In this
regard, we note that your current beta is 1.88, which means your cost of
equity is greater than companies within your SIC code. Finally, we note
that you are using the Ibbotson rate for the SIC code 3 even though you are
classified within SIC code 3585.
Based on the above, please provide us with the following information:
- How you determined the Ibbotson rate is representative of your
cost of capital and is commensurate with the risk inherent in the
expected cash flows in accordance with paragraph 24 and Appendix
E of SFAS 142.
- How you determined it is appropriate to use the Ibbotson rate for
SIC code 3 instead of SIC code 3585.
- Confirm to us that you are considering capital expenditures when
estimating cash flows for step 1 of the goodwill impairment test.
- The fair value and carrying value of Compressor - India and
Electrical Components reporting unit for the September 30, 2006
interim test.
- The fair value and carrying value of all reporting units with
goodwill as of the fourth quarter of fiscal year 2006 impairment
test.
- The sensitivity analysis of the discount rate used as of
September 30, 2006 and December 31, 2006 for the corresponding
reporting units.
If you determine that your discount rate should have been higher, please
revise your goodwill impairment tests accordingly. Please provide us with
the results of any revised tests for each reporting unit, as well.
Answer:
Paragraph 24 of SFAS 142 states that if market data is not available to
value individual business entities, then a valuation utilizing the present
value of future forecasted cash flows is an appropriate methodology. As the
Staff notes in Comment #2 above, SFAS 142 indicates that such an analysis
should "incorporate assumptions that marketplace participants would use in
their estimates of fair value." Such assumptions would include our
determination as to the most appropriate discount rate to use in our
analysis of future cash flows.
Securities and Exchange Commission
September 13, 2007
Page 13 of 21
SFAS 142 does not specifically require that our weighted average cost of
capital be utilized as the discount rate. We believe that the cost of
capital for our entire business is not directly correlated to the
risk-adjusted rate applicable to the individual entities that record
goodwill. Our weighted average cost of capital, for example, has been
significantly influenced by the interest rate associated with our Second
Lien Credit agreement (13.5% as of December 31, 2006); however, that debt
was not directly associated with any of those entities. Further,a potential
purchaser of a business would most likely apply its own weighted average
cost of capital, supporting the assertion that the industry rate is the
most appropriate since it would represent the average cost of capital of
all potential buyers of the business. Accordingly, we have considered it
more appropriate to consistently apply externally derived market rates. To
maintain consistency and objectivity in our process, we have historically
applied the market rate for SIC code 3 published by Ibbotson. As noted in
our response to Comment #4 in the Staff's letter dated February 2, 2007,
until recently the Ibbotson rate was higher than our company-specific cost
of capital. In addition, recent updates to the Ibbotson rate, available in
the second quarter of 2007, indicate increases in the rate that could
result in the Ibbotson rate once again surpassing our cost of capital. We
have consistently applied the Ibbotson rate since the adoption of SFAS 142
regardless of its relation to our cost of capital. The intent of this
policy has been to reduce subjectivity and volatility of our annual and
interim evaluations.
Although our company is classified under SIC code 3585, that SIC code is
for Air Conditioning, Warm Air Heating, and Commercial Refrigeration
Equipment. While this SIC classification is descriptive of our Compressor
business, and would have resulted in the utilization of a lower discount
rate for our analysis as of December 31, 2006 (7.97% instead of 8.16%), and
thereby a higher fair value calculation, we have historically considered
that our business as a whole is more widely diversified than such a
classification would imply. Approximately half our assets as of the end of
2006 were associated with entities outside the Compressor business segment.
We have consistently maintained that the utilization of SIC code 3 better
captures the diversity of our business and allows a consistent application
of a discount rate from period to period.
Capital expenditures are included in our discounted cash flow assumptions
for Step 1 of our goodwill impairment tests.
Fair value and carrying values of the India and Fasco reporting units as of
September 30, 2006 were as follows:
Compressor-India Fasco
---------------- ------
Fair Value $91.5 $352.6
Carrying Value 78.8 301.2
----- ------
Excess $12.7 $ 51.4
Securities and Exchange Commission
September 13, 2007
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Fair value and carrying values of all reporting units with goodwill as of
December 31, 2006 were as follows:
Compressor-Europe Compressor-India Fasco
----------------- ---------------- ------
Fair Value $105.4 $87.0 $330.6
Carrying Value 66.6 79.2 329.0
------ ----- ------
Excess $ 38.8 $ 7.8 $ 1.6
The results of the sensitivity analysis of the discount rate performed as
of September 30, 2006 for the reporting units was as follows:
Compressor-Europe Compressor-India Fasco
----------------- ---------------- ------
Fair Value $ 99.4 $ 91.5 $352.6
1% increase in discount rate 86.2 76.7 336.6
1% decrease in discount rate 119.0 113.3 369.6
The results of the sensitivity analysis of the discount rate performed as
of December 31, 2006 for the reporting units was as follows:
Compressor-Europe Compressor-India Fasco
----------------- ---------------- ------
Fair Value $105.4 $87.0 $330.6
1% increase in discount rate 101.0 84.0 315.5
1% decrease in discount rate 110.0 90.2 346.7
These results were summarized in our Annual Report on Form 10-K for the
year ended December 31, 2006. It was also noted in our 10-K that a 1%
increase in the discount rate would have resulted in the Company performing
a Step 2 analysis for the Fasco entity, and that an impairment of the
goodwill may have resulted.
4. We note that you have developed a business plan for fiscal year 2007 for
which you have made assumptions that result in you achieving operating
income improvements of approximately $94 million over fiscal year 2006
results. You further state that of this $94 million, $36 million has a high
probability of achievement. However, for the remaining $58 million, you
state that management is committed to achieving this budgeted amount.
Please confirm to us that you utilized this business plan in preparing your
discounted cash flow estimates of reporting units' fair value. If you did
not, please explain why you did not and how the estimates used for fiscal
year 2007 that you did use differs from the 2007 business plan. If the 2007
business plan was used, please quantitatively and qualitatively explain to
us how the assumptions used in the 2007 business plan to achieve the $94
million of improvements relates to the three reporting units with goodwill.
Please tell us how each of the three reporting units actual results for the
first quarter of fiscal year 2007 compared to the 2007 business plan.
Securities and Exchange Commission
September 13, 2007
Page 15 of 21
Answer:
The elements of the 2007 business plan that relate to the business entities
with goodwill (Compressor-Europe, Compressor-India, and Fasco) were
utilized to prepare the 2007 cash flow estimates included in the 2006
annual goodwill impairment analysis.
The following table shows the projected improvement in operating income
from 2006 to the 2007 business Plan for the three reporting units with
goodwill:
Operating income (in millions)
Compressor-Europe Compressor-India Fasco
----------------- ---------------- ------
FY 2006 - Actual $1.8 ($9.3) ($17.8)
FY 2007 - Plan 7.4 (0.7) (0.1)
---- ----- ------
Projected Improvement $5.6 $ 8.6 $17.7
---- ----- ------
The planned improvements for Compressor-Europe are expected in the form of
selling price increases ($10.7 million) and reductions in one-time charges
when compared to 2006 ($1.4 million). The selling price increases reflect
actions that were already in place as of January 1, 2007. Productivity and
other cost reductions ($0.7 million) and favorable volume and mix ($0.3
million) are also expected improvements. These positive factors are
expected to be somewhat offset by unfavorable commodity and other
purchasing costs ($5.1 million) and unfavorable currency exchange ($2.4
million).
Compressor-India has incorporated similar trends in its 2007 plan.
Year-on-year projected improvements are driven by selling price increases
($8.9 million) and favorable volume & mix ($1.5 million). As with the
Europe entity, the price increases were already in place at January 1.
These improvements are slightly offset by expected unfavorable impacts of
commodity and other purchasing costs ($1.1 million) and unfavorable
currency exchange impacts ($0.7 million).
The most significant improvement in the 2007 plan for Fasco is $12.7
million attributable to expenses incurred in 2006 and not expected to be
repeated in 2007. Other cost reductions, including productivity
improvements, are projected to contribute $8.9 million to year-on-year
results. These projected productivity improvements would include partial
remediation of issues at our Juarez, Mexico facility, as referenced by the
Staff in Comment #2. Pricing increases (in place at January 1, 2007) are
projected to improve results by $8.5 million. Offsetting these improvements
are volume and product mix ($1.7 million), wage and benefit costs ($5.5
million) and increased purchasing costs ($1.0 million). The plan also
includes a contingency ($5.0 million), to allow for potential shortfalls
against productivity improvements.
Securities and Exchange Commission
September 13, 2007
Page 16 of 21
The following table shows the actual results in operating income for the
first quarter of 2007 versus the 2007 business Plan for the three reporting
units with goodwill:
Operating income (loss) (in millions)
Compressor-Europe Compressor-India Fasco
----------------- ---------------- -----
Q1 2007 - Plan ($0.7) $0.6 $0.7
Q1 2007 - Actual 1.1 3.0 (0.5)
----- ---- -----
Better (Worse) vs. Plan $1.8 $2.4 ($1.2)
Although Fasco fell slightly short of its business plan through the first
quarter of the year, we did not at the time consider the shortfall to be
significant nor to be reflective of the anticipated full year performance
against plan. Forecasts of 2007 results at the time the first quarter 10-Q
was filed (including four months of actual results and eight months of
forecast data) indicated that all three business entities expected to
exceed their original business plans. These forecasts were also provided to
the parties that had expressed interest in a potential acquisition of
Fasco.
The following table shows the actual results for the second quarter of 2007
versus the 2007 business plan for the three business units with goodwill:
Operating income (loss) (in millions)
Compressor-Europe Compressor-India Fasco
----------------- ---------------- -----
Q2 2007 - Plan $4.1 $0.8 $0.5
Q2 2007 - Actual 5.7 2.7 (2.6)
---- ---- -----
Better (Worse) vs. Plan $1.6 $1.9 ($3.1)
As was described in our response to Comment #2, continued weakness in
housing markets in the second quarter of 2007 resulted in further sales
declines in our Residential & Commercial product lines, which reduced the
forecasts for operating profit when compared to those that were available
at the time our first quarter 10-Q was filed. The reduced forecasts also
reduced the value that parties interested in acquiring Fasco assigned to
the business, and ultimately the final purchase price for the Residential &
Commercial and Asia Pacific business units within Fasco.
Securities and Exchange Commission
September 13, 2007
Page 17 of 21
Note 10. Debt, page 80
5. In future filings, please disclose your actual cumulative Adjusted EBITDA
level for the most recent balance sheet date. Please also state the amount
available under your credit agreements that would not result in a violation
of your debt covenants. Refer to Section 501.03 of the Financial Reporting
Codification for guidance.
Answer:
Our actual cumulative Adjusted EBITDA level, calculated in accordance with
our First and Second Lien credit agreements, was disclosed in the "Adequacy
of Liquidity Sources" section of our Quarterly Report on Form 10-Q for the
period ended March 31, 2007.
The availability under our credit agreements was disclosed in Note 10 to
our Consolidated Financial Statements in our Annual Report on Form 10-K for
the year ended December 31, 2006. It was also disclosed in both the
"Adequacy of Liquidity Sources" section and in Note 9 to our Consolidated
Financial Statements in the Quarterly Report on Form 10-Q for the period
ended March 31, 2007.
This information was also disclosed in our Quarterly Report on Form 10-Q
for the period ended June 30, 2007, and we intend to continue to disclose
this information in future filings.
6. In future filings, please disclose the terms of the option agreements and
the value of the option agreements entered into between your major
shareholders and Tricap in connection with the November 13, 2006 amendments
to your First and Second Lien Credit Agreements in addition to any other
costs incurred to amend these agreements.
Answer:
Copies of the option agreements entered into between the major shareholders
and Tricap were incorporated in our Annual Report on Form 10-K by reference
(per Exhibit 4.4) to Exhibit 4.1 to our Current Report on Form 8-K filed
November 15, 2006. We will summarize the key terms of these agreements in
future filings.
The value of the option agreements ($3.7 million) was disclosed in the
"Adequacy of Liquidity Sources" section of our Annual Report on Form 10-K
for the period ended December 31, 2006.
Securities and Exchange Commission
September 13, 2007
Page 18 of 21
In accordance with the Staff's request, we will continue to disclose the
key terms and costs of further debt amendments or other credit agreements
as appropriate in future filings.
7. In future filings, please disclose the number of shares of common stock the
Second Lien Credit Holder was granted through warrants and the exercise
price of those warrants.
Answer:
In our Annual Report on Form 10-K for the year ended December 31, 2006, as
well as in our Quarterly Report on Form 10-Q for the period ended March 31,
2007, we disclosed the number of shares of common stock the Second Lien
Credit Holder was granted through warrants as a percentage rather than as
an absolute number. We concur that it would be clearer to the readers of
our financial statements to express that information as a number of shares.
Therefore, we have disclosed that information in our Quarterly Report on
Form 10-Q for the period ended June 30, 2007, specifically, the number of
shares (1,390,944), and the exercise price of the warrant ($5.29). We will
also disclose such information as appropriate in future filings.
Note 16. Impairments, Restructuring Charges, and Other Items, page 92
8. We note in fiscal year 2006 that you recognized $24.1 million for the
impairment of long-lived assets in the Engine Group, which represents 20.5%
of consolidated operating loss for fiscal year 2006. As such, please
include the disclosures required by paragraphs 26.a. and 26.c. of SFAS 144
in future filings.
Answer:
We will modify disclosures made with respect to impairments in future
filings to comply with paragraphs 26a. and 26c.of SFAS 144.
Note 19. Quarterly Financial Data - Unaudited, page 96
9. We note from your Form 8-K filed on April 16, 2007 that you recognized a
$7.6 million write-off of inventories within cost of sales during the
fourth quarter of 2006. However, you did not disclose this material
transaction within your footnote disclosure or MD&A. In future filings,
please include disclosures, here or in MD&A, for material disposals and
extraordinary, unusual or infrequently occurring items recognized in the
fourth quarter, including the aggregate effect of year-end
Securities and Exchange Commission
September 13, 2007
Page 19 of 21
adjustments that are material to the results of the fourth quarter such as
this transaction. Refer to Item 302(A) of Regulation S-K for guidance.
Answer:
In accordance with the Staff's comment, as circumstances dictate we will
make such disclosures in future filings in accordance with Item 302(A) of
Regulation S-K.
Item 15. Exhibits and Financial Statement Schedules, page 101.
10. We note that you have not included your schedule of valuation and
qualifying accounts for each income statement period, as required by
Article 5-04 of Regulation S-X. We assume that you have not included this
financial information due to immateriality. As such, please confirm to us
that bad debt expense is immaterial to income (loss) from continuing
operations before taxes for each period presented.
Answer:
Historically, we have not filed this schedule because our allowance for bad
debt was not significant. We will include the information in the future to
the extent that it becomes significant.
Bad debt expense for each income statement period included in our Annual
Report on Form 10-K for the period ended December 31, 2006 is as follows:
For the year ended
(in millions): December 31,
------------------
2006 2005 2004
---- ---- ----
Bad Debt Expense $3.6 $6.6 $4.9
Please note that these disclosures include the Electrical Components Group
as continuing operations. This segment has been classified as discontinued
operations effective with the second quarter of 2007. Excluding the
Electrical Components Group, bad debt expense for each period reported in
our most recent Form 10-K would have appeared as follows:
For the year ended
(in millions): December 31,
------------------
2006 2005 2004
---- ---- ----
Bad Debt Expense $3.1 $5.3 $4.3
Securities and Exchange Commission
September 13, 2007
Page 20 of 21
Form 10-Q for the Fiscal Quarter Ended March 31, 2007
Note 1, page 6
11. We note that you have removed TMT Motoco's assets and liabilities from your
consolidated balance sheets as of March 31, 2007. In addition, it does not
appear that you are accounting for your ownership of TMT Motoco under the
equity method of accounting either. Please tell us how you are or are not
reflecting TMT Motoco in your consolidated financial statements, including
the authoritative literature supporting your accounting.
Answer:
We concluded that it was appropriate to report TMT Motoco under the equity
method of accounting on our Consolidated Balance Sheet as of March 31,
2007. We did not specifically note that we were accounting for TMT Motoco
under the equity method; however,we have made that disclosure in our
Quarterly Report on Form 10-Q for the period ended June 30, 2007, and will
do so as appropriate in future filings.
In determining the appropriate accounting treatment for the assets and
liabilities of TMT Motoco as of March 31, 2007, we relied upon guidance
from FAS 94. FAS 94 states that all majority owned subsidiaries of a
company should be consolidated within its financial statements unless
control "does not rest with the majority owner." Paragraph 4 of SFAS 94
also clarifies this guidance, stating that consolidation is not appropriate
"where control is likely to be temporary, or where it does not rest with
the majority owners (as, for instance, where the subsidiary is in legal
reorganization or in bankruptcy)." TMT Motoco's request for judicial
restructuring was approved by the Brazilian courts on March 28, 2007, and
we determined that control no longer resided with the parent company as of
that date. Accordingly, we deconsolidated TMT Motoco's results from our
Consolidated Balance Sheet effective March 28, 2007, and determined that it
would be appropriate from that point forward to account for it under the
equity method.
Utilizing the guidance in EITF 03-13, we further evaluated whether the
entity should be classified as discontinued operations. Although the
operations of TMT Motoco had ceased as of March 31, 2007, we were still
engaged in the process of determining whether the company would exit the
product lines produced by TMT Motoco. Since we could not conclude that the
operations and cash flows of the component would be eliminated from the
ongoing operations of the company, we determined that TMT Motoco does not
qualify at the present time as a discontinued operation under EITF 03-13.
Therefore, the operating results of TMT Motoco continued to be classified
as continuing operations in our Consolidated Statements of Operations in
our first and second quarter 2007 results. We will continue to
Securities and Exchange Commission
September 13, 2007
Page 21 of 21
evaluate when and if TMT Motoco qualifies to be classified as a
discontinued operation.
Tecumseh Products Company acknowledges that:
- The company is responsible for the adequacy and accuracy of the
disclosure in the filing;
- Staff comments or changes to disclosure in response to staff comments
do not foreclose the Commission from taking any action with respect to
the filing; and
- The company may not assert staff comments as a defense in any
proceeding initiated by the Commission or any person under the federal
securities laws of the United States.
Regards,
TECUMSEH PRODUCTS COMPANY
/s/ James S. Nicholson
James S. Nicholson
Vice President, Treasurer and
Chief Financial Officer
JSN/kvk