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 September 30, 2008
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)
1136 OAK VALLEY DRIVE
ANN ARBOR, MICHIGAN 48108
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code:
(734) 585-9500
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, a non-accelerated filer or a smaller reporting company. See
the definitions of "large accelerated filer," "accelerated filer," and "smaller
reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [X]
Non-accelerated filer [ ] Smaller reporting company [ ]
(Do not check if a smaller reporting company)
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 September 30, 2008
- ------------------------------------- ---------------------------------
Class B Common Stock, $1.00 par value 5,077,746
Class A Common Stock, $1.00 par value 13,401,938
TABLE OF CONTENTS
Page
--------
Part I. Financial Information (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 .. 40
Item 4. Controls and Procedures ..................................... 42
Part II. Other Information
Item 1. Legal Proceedings ........................................... 43
Item 6. Exhibits .................................................... 44
Signatures ............................................................. 45
Certification of CEO Pursuant to Section 302 ........................... Exh 31.1
Certification of CFO Pursuant to Section 302 ........................... Exh 31.2
Certification of CEO 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)
(Dollars in millions, except share data) SEPTEMBER 30, December 31,
2008 2007
------------- ------------
ASSETS
Current Assets:
Cash and cash equivalents $ 126.1 $ 76.8
Restricted cash 14.3 6.8
Short-term investments 5.0 5.0
Accounts receivable, trade, less allowance for doubtful accounts
of $1.4 in 2008 and $5.7 in 2007 115.2 93.2
Inventories 125.9 143.4
Deferred and recoverable income taxes 26.0 10.7
Recoverable non-income taxes 77.1 19.5
Assets held for sale 20.2 21.9
Other current assets 12.2 20.4
-------- --------
Total current assets 522.0 397.7
Property, plant, and equipment, net 283.8 353.3
Goodwill 18.5 20.2
Prepaid pension expense 129.7 233.4
Deferred and recoverable income taxes -- 13.9
Recoverable non-income taxes 47.2 102.2
Other assets 40.9 44.2
-------- --------
Total assets $1,042.1 $1,164.9
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable, trade $ 117.2 $ 123.0
Short-term borrowings 55.6 59.5
Liabilities held for sale 2.4 2.6
Accrued liabilities:
Employee compensation 32.2 31.1
Product warranty and self-insured risks 14.9 17.2
Payroll tax 9.3 10.3
Fair value of hedge 9.5 --
Other postretirement benefits 7.8 7.8
Reserve for customer rebates 3.5 4.1
Other 4.5 13.7
-------- --------
Total current liabilities 256.9 269.3
Long-term debt 1.1 3.3
Deferred income taxes 13.2 10.2
Other postretirement benefit liabilities 32.1 74.3
Product warranty and self-insured risks 8.2 10.0
Pension liabilities 14.5 14.8
Other non-current liabilities 34.3 37.1
-------- --------
Total liabilities 360.3 419.0
-------- --------
Stockholders' Equity
Class A common stock, $1 par value; authorized 75,000,000 shares; issued and
outstanding 13,401,938 shares in 2008 and 2007 13.4 13.4
Class B common stock, $1 par value; authorized 25,000,000 shares; issued and
outstanding 5,077,746 shares in 2008 and 2007 5.1 5.1
Paid in capital 11.0 11.0
Retained earnings 565.4 547.9
Accumulated other comprehensive income 86.9 168.5
-------- --------
Total stockholders' equity 681.8 745.9
-------- --------
Total liabilities and stockholders' equity $1,042.1 $1,164.9
======== ========
The accompanying notes are an integral part of these Consolidated Condensed
Financial Statements.
Page 3
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION - ITEM 1
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
(Dollars in millions, except per share data) 2008 2007 2008 2007
-------- ------- ------- --------
Net sales $ 256.2 $ 278.4 $ 805.2 $ 864.7
Cost of sales 238.7 244.4 708.6 760.5
Selling and administrative expenses 33.7 28.8 99.6 97.7
Impairments, restructuring charges, and other items 16.2 (0.1) 20.0 1.6
-------- ------- ------- --------
Operating (loss) income (32.4) 5.3 (23.0) 4.9
Interest expense 7.0 6.6 20.5 23.2
Interest income and other, net 2.7 1.3 7.8 4.6
-------- ------- ------- --------
(Loss) income from continuing operations before taxes (36.7) (0.0) (35.7) (13.7)
Tax (benefit) expense (0.2) (2.2) 0.6 (5.5)
-------- ------- ------- --------
(Loss) income from continuing operations (36.5) 2.2 (36.3) (8.2)
Income (loss) from discontinued operations, net of tax 23.3 (79.4) 49.1 (174.0)
-------- ------- ------- --------
Net income (loss) ($ 13.2) ($ 77.2) $ 12.8 ($ 182.2)
======== ======= ======= ========
Basic earnings (loss) per share:*
(Loss) income from continuing operations (1.98) 0.12 (1.96) (0.44)
Income (loss) from discontinued operations, net of tax 1.27 (4.30) 2.65 (9.42)
-------- ------- ------- --------
Net income (loss) per share, basic ($ 0.71) ($ 4.18) $ 0.69 ($ 9.86)
======== ======= ======= ========
Diluted earnings (loss) per share:**
(Loss) income from continuing operations (1.98) 0.11 (1.96) (0.44)
Income (loss) from discontinued operations, net of tax 1.27 (4.00) 2.65 (9.42)
-------- ------- ------- --------
Net income (loss) per share, diluted ($ 0.71) ($ 3.89) $ 0.69 ($ 9.86)
======== ======= ======= ========
Weighted average shares, basic (in thousands) 18,480 18,480 18,480 18,480
Weighted average shares, diluted (in thousands) 19,871 19,871 19,871 19,368
-------- ------- ------- --------
Cash dividends declared per share $ 0.00 $ 0.00 $ 0.00 $ 0.00
-------- ------- ------- --------
* Based on 18,479,684 shares issued and outstanding throughout all periods
presented.
** On April 9, 2007, we issued a warrant to a lender to purchase 1,390,944
shares of our Class A Common Stock, which is equivalent to 7% of our fully
diluted common stock (including both Class A and Class B shares). Diluted
earnings per share for the three months ended September 30, 2007 are
therefore calculated based on a total of 19,870,628 shares. For the three
and nine months ended September 30, 2008 and the nine months ended
September 30, 2007, however, this warrant is not included in diluted
earnings (loss) per share, as the effect would be antidilutive due to the
losses recorded in continuing operations.
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)
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------
(Dollars in millions) 2008 2007
------ --------
Cash Flows from Operating Activities:
Net income (loss) $ 12.8 ($ 182.2)
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization 34.6 40.1
Impairment of long-lived assets and goodwill 13.4 95.6
(Gain) Loss on sale of discontinued operations (7.9) 47.4
Gain on disposal of property and equipment (3.5) (3.6)
Changes in assets and liabilities:
Accounts receivable (36.9) 8.6
Inventories 8.0 49.8
Payables and accrued expenses (2.8) (32.0)
Employee retirement benefits 34.4 (15.9)
Deferred and recoverable taxes 3.3 (0.8)
Other (31.3) (31.5)
------ --------
Cash provided by (used in) operating activities 24.1 (24.5)
------ --------
Cash Flows from Investing Activities:
Proceeds from sale of assets 22.6 205.9
Capital expenditures (5.5) (5.9)
Change in restricted cash (7.6) --
------ --------
Cash provided by investing activities 9.5 200.0
------ --------
Cash Flows from Financing Activities:
Proceeds / (repayments) from First Lien Credit Agreement, net -- (82.8)
Debt issuance / amendment costs (1.6) (2.9)
Repayment of Second Lien Credit Agreement -- (100.0)
Other borrowings / (repayments), net 0.5 (16.1)
------ --------
Cash used in financing activities (1.1) (201.8)
------ --------
Effect of exchange rate changes on cash 16.8 1.6
------ --------
Increase (decrease) in cash and cash equivalents 49.3 (24.7)
Cash and Cash Equivalents:
Beginning of period 76.8 81.9
------ --------
End of period $126.1 $ 57.2
====== ========
Supplemental Schedule of Noncash Investing and Financing Activities:
Warrants issued in conjunction with debt financing -- $ 7.3
Cash paid (refunds received) for taxes (4.0) 6.0
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, 2007 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, 2007. 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.
Prior period results of operations have been reclassed to reflect engineering
expense as part of selling and administrative ("S&A") expenses; previously,
engineering expense was included in cost of sales. The amount of expense
reclassed to S&A was $5.5 million and $17.8 million for the three and nine
months ended September 30, 2007 respectively.
2. Restricted Cash
Restricted cash as of December 31, 2007 represented cash deposits related to
letters of credit. These restrictions were lifted upon the termination of our
previous First Lien credit agreement.
As is further discussed in Note 10, a portion of the overfunding for the
terminated salaried retirement plan was utilized to pre-fund the benefits for
both the defined benefit and defined contribution replacement plans for
approximately the next six to eight years. As part of this pre-funding, a fund
was established to allow the Company to fund future company contributions to its
defined contribution plan. This fund is 100% invested in money market accounts.
The balance in this fund is estimated to be more than sufficient to provide all
Company contributions for the next seven years. At September 30, 2008, the
balance of cash restricted for this purpose was $14.3 million.
3. Discontinued Operations and Sale of Businesses
Electrical Components
During the second quarter of 2007, our Board of Directors approved a plan to
sell the assets of our Electrical Components business. On August 31, 2007, we
completed an agreement to sell the Residential & Commercial and Asia Pacific
operations of this business for $220 million in gross proceeds.
On November 1, 2007, we signed an agreement to sell our Automotive & Specialty
business operations for $10 million in cash, subject to customary adjustments at
closing. The sale transaction closed on December 7, 2007.
The net assets of the remaining businesses within the Electrical Components
business have been classified as held for sale as of September 30, 2008. The
results for Electrical Components for the three and nine month periods ended
September 30, 2008 and 2007 are included in the income
Page 6
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
(loss) from discontinued operations.
Following is a summary of pretax loss from discontinued operations related to
the Electrical Components business for the three months ended September 30, 2008
and 2007:
Three Months Three Months
Ended Ended
(Dollars in millions) September 30, 2008 September 30, 2007
------------------ ------------------
Net sales $ 9.2 $ 81.0
Cost of sales 7.9 64.7
Selling and administrative expenses 0.2 6.5
Impairments, restructuring charges, and other items 1.5 26.3
------ -------
Operating loss (0.4) (16.5)
Interest expense, including allocated interest -- (21.6)
------ -------
Loss from discontinued operations before income taxes ($0.4) ($38.1)
====== =======
Following is a summary of pretax income (loss) from discontinued operations
related to the Electrical Components business for the nine months ended
September 30, 2008 and 2007:
Nine Months Nine Months
Ended Ended
(Dollars in millions) September 30, 2008 September 30, 2007
------------------ ------------------
Net sales $23.6 $ 286.0
Cost of sales 20.4 252.5
Selling and administrative expenses 0.5 23.3
Impairments, restructuring charges, and other items 1.0 95.0
----- --------
Operating income (loss) 1.7 (84.8)
Interest expense, including allocated interest -- (31.3)
----- --------
Income (loss) from discontinued operations before
income taxes $ 1.7 ($116.1)
===== ========
Post-closing sales price adjustments related to the divestiture of the
businesses, which netted additional proceeds to the Company of $1.3 million, are
included above in impairments, restructuring charges, and other items in the
nine months ended September 30, 2008.
We recorded impairment charges as part of our loss from discontinued operations
in the nine months ended September 30, 2007. These impairments included $39.3
million of the goodwill balance associated with the 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.
Page 7
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
Engine & Power Train
On October 22, 2007, we signed a Definitive Stock Purchase Agreement to sell our
Engine & Power Train business operations for $51 million in cash, subject to
customary adjustments at closing. The transaction was completed on November 9,
2007. The results for the Engine & Power Train business for the three and nine
month periods ended September 30, 2008 and 2007 are included in the income
(loss) from discontinued operations.
Following is a summary of pretax income (loss) from discontinued operations
related to the Engine & Power Train business for the three months ended
September 30, 2008 and 2007:
Three Months Three Months
Ended Ended
(Dollars in millions) September 30, 2008 September 30, 2007
------------------ ------------------
Net sales $ -- $ 53.8
Cost of sales -- 49.9
Selling and administrative expenses -- 3.8
Impairments, restructuring charges, and other items (28.3) 21.4
------ -------
Operating income (loss) 28.3 (21.3)
Interest expense -- 0.2
------ -------
Income (loss) from discontinued operations before
income taxes $ 28.3 ($21.5)
====== =======
Following is a summary of pretax income (loss) from discontinued operations
related to the Engine & Power Train business for the nine months ended September
30, 2008 and 2007:
Nine Months Nine Months
Ended Ended
(Dollars in millions) September 30, 2008 September 30, 2007
------------------ ------------------
Net sales $ -- $ 165.9
Cost of sales -- 166.9
Selling and administrative expenses -- 15.4
Impairments, restructuring charges, and other items (42.2) 20.3
------ -------
Operating income (loss) 42.2 (36.7)
Interest expense -- 3.9
------ -------
Income (loss) from discontinued operations before
income taxes $ 42.2 ($40.6)
====== =======
The amounts recorded above in impairments, restructuring charges, and other
items in 2008 for the Engine & Power Train business included a curtailment gain
on the salaried retirement plan of $2.9 million, a curtailment gain on the
salaried other postretirement benefit ("OPEB") plan of $6.9 million and
curtailment gains on other OPEB plans of $35.0 million.
Page 8
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
Other businesses
On June 30, 2008 we sold our MP Pumps business for $14.6 million in gross cash
proceeds. We recorded a gain of $7.9 million upon the sale of the business. MP
Pumps was a small subsidiary which was not associated with our Compressor
business or our former Electrical Components or Engine & Power Train business
segments. MP Pumps recorded sales of $3.9 million and profit of $0.7 million for
the three months ended September 30, 2007. Sales of $9.5 million and $12.6
million and profit of $1.8 million and $2.4 million were recorded in MP Pumps
for the nine months ended September 30, 2008 and 2007 respectively.
The following summary balance sheet information is derived from the businesses
that are classified as held for sale as of September 30, 2008, which management
believes is representative of the net assets of the remaining businesses within
the former Electrical Components business.
SEPTEMBER 30,
(Dollars in millions) 2008
-------------
ASSETS:
Accounts receivable, net $ 3.9
Inventories 6.0
Other assets 0.7
Property, plant, and equipment, net 9.6
-----
Total assets held for sale $20.2
=====
LIABILITIES:
Accounts payable, trade $ 1.7
Accrued liabilities 0.7
-----
Total liabilities held for sale $ 2.4
=====
Net assets held for sale $17.8
=====
4. Comprehensive Income
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
(Dollars in millions) 2008 2007 2008 2007
-------- ------- ------- --------
Net (loss) income ($13.2) ($77.2) $12.8 ($182.2)
Other comprehensive income (loss):
Foreign currency translation adjustments (64.0) 8.3 (31.5) 38.2
Curtailments (Note 9) -- (0.5) -- (4.0)
Gain (loss) on derivatives, net of tax (26.2) (2.0) (17.6) 1.6
------- ------ ------ -------
Total comprehensive loss ($103.4) ($71.4) ($36.3) ($146.4)
======= ====== ====== =======
Page 9
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
5. Inventories
SEPTEMBER 30, December 31,
(Dollars in millions) 2008 2007
------------- ------------
Raw material $ 65.6 $ 79.6
Work in progress 7.3 9.0
Finished goods 53.0 54.8
------ ------
Total inventories $125.9 $143.4
====== ======
The above amounts include an allowance for obsolescence of $6.9 million and $9.0
million at September 30, 2008 and December 31, 2007 respectively.
6. Recoverable Non-income Taxes
We pay various value-added taxes in jurisdictions outside of the United States.
These include taxes levied on material purchases, fixed asset purchases, and
various social taxes. The majority of these taxes are creditable when goods are
sold to customers domestically or against income taxes due. Since the taxes are
recoverable upon completion of these procedures, they are recorded as assets
upon payment of the taxes.
Historically, due to the concentration of exports, such taxes were typically
credited against income taxes due. However, with reduced profitability,
primarily in Brazil, we must seek refunds via procedures that can be lengthy. As
a result, there has been a substantial increase in the balance of these
recoverable taxes. We have instituted the necessary refund procedures, which
include audits of the recoverable amounts that are currently underway. We
currently expect to recover approximately half of the outstanding refundable
taxes by the end of 2008, and the remainder in 2009.
Following is a summary of the recoverable non-income taxes recorded on our
balance sheet at September 30, 2008 and December 31, 2007:
SEPTEMBER 30, December 31,
(Dollars in millions) 2008 2007
------------- ------------
Brazil $115.9 $114.5
India 8.4 7.2
------ ------
Total recoverable non-income taxes $124.3 $121.7
====== ======
At September 30, 2008, $77.1 million was included in current assets and $47.2
million was included in non-current assets.
Subsequent to September 30, 2008, we began to receive the expected refunds of
the outstanding Brazilian taxes. As of October 27, 2008, and based upon the
exchange rate between the U.S. dollar and the Brazilian real as of September 30,
we had received approximately $53.5 million in refunds. We currently expect to
receive approximately $5.6 million in further refunds by the end of 2008. Due to
the recent volatility in the exchange rate between the U.S. dollar and the
Brazilian real, the actual amounts received as expressed in U.S. dollars will
vary depending on the exchange rate at the time of receipt or future reporting
date.
Page 10
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
7. Fair Value
In accordance with SFAS No. 157, "Fair Value Measurements" ("SFAS 157"), we
utilize fair value measurements to record fair value adjustments to certain
assets and liabilities and to determine fair value disclosures. Derivative
instruments, including foreign currency forward purchases, are recorded at fair
value on a recurring basis. From time to time, we may also record other assets
or liabilities at fair value.
We group assets and liabilities at fair value in three levels, based on the
markets in which the assets and liabilities are traded and the reliability of
the assumptions used to determine fair value. These levels are as follows:
Level 1 Valuation is based upon quoted prices for identical instruments traded
in active markets.
Level 2 Valuation is based upon quoted prices for similar instruments in active
markets, quoted prices for identical or similar instruments in markets
that are not active, and model-based valuation techniques for which all
significant assumptions are observable in the market.
Level 3 Valuation is generated from model-based techniques that use at least one
significant assumption not observable in the market. These unobservable
assumptions reflect estimates of assumptions that market participants
would use in pricing the asset or liability.
The following is a description of valuation methodologies used for our assets
and liabilities recorded at fair value.
Foreign currency forward purchases and commodity futures contracts
Our derivative instruments consist of foreign currency forward exchange
contracts and commodity futures contracts. These contracts are recognized on our
balance sheet at the estimated amount at which they could be settled based on
market observable inputs, such as forward market exchange rates. We classify our
derivative instruments as Level 2.
Assets and liabilities recorded at fair value on a recurring basis
We did not have any material assets that were required to be measured at fair
value on a recurring basis as of September 30, 2008. The table below presents
the recorded amount of liabilities measured at fair value on a recurring basis
as of September 30, 2008.
(Dollars in millions) TOTAL FAIR VALUE LEVEL 1 LEVEL 2 LEVEL 3
---------------- ------- ------- -------
Liabilities:
Commodity futures contracts $2.7 $-- $2.7 $--
Foreign currency derivatives $6.8 $-- $6.8 $--
---- --- ---- ---
Balance as of September 30, 2008 $9.5 $-- $9.5 $--
==== === ==== ===
Page 11
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
8. Business Segments
In accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information," we previously reported three operating segments;
Compressor Products, Electrical Components, and Engine & Power Train. However,
as a result of the sale of the majority of the Electrical Components business
and the entire Engine & Power Train business during 2007, these segments are no
longer reported. The remaining unsold businesses within Electrical Components
are included in discontinued operations.
We also previously reported sales and operating income in "Other," which
included information about businesses not included with any major business
segment. MP Pumps, which we sold on June 30, 2008, was the only business
categorized within "Other."
Accordingly, our remaining operations consist solely of businesses formerly
reported under our Compressor Products segment.
9. Goodwill and Other Intangible Assets
At September 30, 2008, the following entities reported goodwill:
(Dollars in millions) EUROPE INDIA TOTAL
------ ----- -----
Balance at 1/1/2008 $12.4 $7.8 $20.2
Foreign currency translation (0.5) (1.2) (1.7)
----- ---- -----
Balance at 9/30/2008 $11.9 $6.6 $18.5
===== ==== =====
The only changes in goodwill during 2008 have been due to the effects of foreign
currency fluctuations.
At December 31, 2007, goodwill consisted of the following:
ELECTRICAL
(Dollars in millions) EUROPE INDIA COMPONENTS TOTAL
------ ----- ---------- ------
Balance at 1/1/2007 $11.2 $7.0 $108.8 $127.0
Impairment -- -- (39.3) (39.3)
Sale of Residential & Commercial and Asia
Pacific operations -- -- (72.1) (72.1)
Foreign currency translation 1.2 0.8 2.6 4.6
----- ---- ------ ------
Balance at 12/31/2007 $12.4 $7.8 $ -- $ 20.2
===== ==== ====== ======
In light of the classification of the Electrical Components business as a
discontinued operation as of the end of the second quarter of 2007, we performed
an interim analysis of the fair value of the business unit at June 30. We
utilized the final purchase price as an indication of fair market value
Page 12
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
of the Residential & Commercial and Asia Pacific operations 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 was associated with the
Residential & Commercial operations and was included with the sale of those
operations, which was completed on August 31, 2007. The only other changes in
goodwill during 2007 were due to foreign currency fluctuations.
Page 13
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
10. Pension and Other Postretirement Benefit (OPEB) Plans
Components of net periodic benefit (income) cost are as follows:
PENSION BENEFITS OTHER BENEFITS
------------------ -------------------
THREE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -------------------
(Dollars in millions) 2008 2007 2008 2007
------- -------- -------- --------
Service cost $ 0.6 $ 1.6 $ 0.3 $ 0.8
Interest cost 3.0 5.7 0.9 1.5
Expected return on plan assets (4.6) (11.3) (0.1) (0.1)
Amortization of prior service costs (0.1) (0.1) (2.5) (2.8)
Amortization of net gain -- -- (0.4) --
------ ------ ------- ------
Net periodic benefit income ($1.1) ($4.1) ($1.8) ($0.6)
Curtailment gains, settlement gains and
special termination benefits -- -- (30.2) (2.0)
------ ------ ------- ------
Total pension income ($1.1) ($4.1) ($32.0) ($2.6)
====== ====== ======= ======
PENSION BENEFITS OTHER BENEFITS
------------------ -------------------
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -------------------
2008 2007 2008 2007
------- -------- -------- --------
Service cost $ 1.8 $ 6.0 $ 1.0 $ 2.7
Interest cost 10.8 16.9 3.1 5.6
Expected return on plan assets (17.0) (33.9) (0.2) (0.2)
Amortization of prior service costs (0.4) (0.4) (8.1) (8.0)
Amortization of net gain -- -- (1.4) --
------ ------ ------- ------
Net periodic benefit (income) cost ($4.8) ($11.4) ($5.6) $ 0.1
Curtailment gains, settlement gains and
special termination benefits (2.0) 3.8 (60.9) (12.7)
------ ------ ------- ------
Net periodic benefit income ($6.8) ($7.6) ($66.5) ($12.6)
====== ====== ======= ======
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
A summary of the curtailment losses (gains), settlement gains and special
termination charges under the various plans for the three and nine months ended
September 30 is as follows:
PENSION BENEFITS OTHER BENEFITS
------------------ -------------------
THREE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -------------------
(Dollars in millions) 2008 2007 2008 2007
------- -------- -------- --------
Recorded in discontinued operations:
Engine & Power Train curtailment gains $-- $-- ($30.2) ($2.0)
--- --- ------ -----
Total - curtailment gains, settlement gains
and special termination benefits $-- $-- ($30.2) ($2.0)
=== === ====== =====
PENSION BENEFITS OTHER BENEFITS
------------------ -------------------
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -------------------
(Dollars in millions) 2008 2007 2008 2007
------- -------- -------- --------
Recorded in continuing operations:
Hourly pension plan curtailment loss $ 3.9 $ -- $ -- $ --
Hourly plan special termination
benefit charge 2.4 -- -- --
Salaried plan settlement gain
on annuities (6.3) -- -- --
Salaried plan special termination
benefit charge 1.0 -- -- --
Hourly plan OPEB curtailment gain -- -- (19.1) --
------ ---- ------- -------
Total - continuing operations 1.0 -- (19.1) --
------ ---- ------- -------
Recorded in discontinued operations:
Salaried plan curtailment gain (2.9) -- -- --
Consolidated plan curtailment gain (0.1) -- -- --
Salaried OPEB plan curtailment gain -- -- (6.9) --
Engine & Power Train curtailments -- 3.8 (34.9) (12.7)
------ ---- ------- -------
Total - discontinued operations (3.0) 3.8 (41.8) (12.7)
------ ---- ------- -------
Total - curtailment losses (gains),
settlement charges (gains) and special
termination charges (benefits) ($2.0) $3.8 ($60.9) ($12.7)
====== ==== ======= ======
All of the curtailment losses (gains), settlement gains and special termination
charges that are recorded as part of continuing operations are included in
impairments, restructuring, and other items.
Under SFAS No. 158, "Employers; Accounting for Defined Benefit Pension and Other
Postretirement Plans" (SFAS 158), plan sponsors who use a measurement date other
than the end of the fiscal year must change to a fiscal year end. We made this
change as of December 31, 2007. As a result of this measurement date change, we
recognized a special recognition gain of $3.1 million for pension plans and $1.6
million for OPEB plans, which was recorded to retained earnings.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
In the first quarter of 2007, we announced revisions to our salaried retirement
plan. At December 31, 2007, this plan reported approximately $121 million in
overfunding, out of a total of $231 million for all of our pension plans that
had plan assets in excess of obligations. On May 1, 2007, we implemented a new
retirement program for all Tecumseh salaried employees. This conversion, which
was completed in March of 2008, yielded net cash proceeds to the Company of
approximately $80 million, after consideration for excise taxes of $20 million
which were paid in cash in the second quarter of 2008. The replacement
retirement program includes both defined benefit and defined contribution plans.
A portion of the overfunding for the old plan was utilized to pre-fund the
benefits for both the defined benefit and defined contribution replacement plans
for approximately the next six to seven years.
The impact to net income of the reversion of the salaried retirement plan
amounted to net expense of $13.7 million in the first quarter of 2008. This net
expense resulted from the recognition of $20 million of federal excise tax that
was levied on the gross amount of cash returned to the Company, net of the
recognition of previously deferred settlement gains of $6.3 million dollars as
discussed above. The $100 million in gross proceeds from the reversion generated
a tax gain that has been fully offset against our existing net operating loss
("NOL") carryforwards. Taking into account the cost of all retiree benefits,
both pension and OPEB, total expected income to be recognized in 2008, other
than curtailment gains and losses and excluding potential changes in actuarial
assumptions, is expected to be approximately $15 million - the same amount as in
2007.
The benefits associated with an OPEB plan associated with our former Engine &
Power Train business expired in the third quarter of 2008. Accordingly, we
recognized a curtailment gain in the period of $30.2 million, which is included
with income from discontinued operations.
We expect to make contributions of $0.2 million to our pension plans in 2008.
11. Guarantees and Warranties
A portion of accounts receivable at our Brazilian, European, and Indian
compressor subsidiaries are sold with limited recourse and without recourse at a
discount. Our Brazilian subsidiary also sells portions of its accounts
receivable with recourse. The amount of these receivables sold at September 30,
2008 and December 31, 2007 and excluded from our balance sheet were $39.4
million and $79.2 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.
Page 16
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
Changes in the carrying amount and accrued product warranty costs for the nine
months ended September 30, 2008 and 2007 are summarized as follows:
Nine Months Ended Nine Months Ended
(Dollars in millions) September 30, 2008 September 30, 2007
------------------ ------------------
Balance at January 1 $ 9.7 $26.2
Settlements made (in cash or in kind) (5.4) (9.2)
Current year accrual 5.1 6.4
Adjustments to preexisting warranties (0.2) (2.6)
Effect of foreign currency translation (0.4) 0.4
Reclassification to held for sale* -- (2.0)
Sale of MP Pumps (0.1) --
----- -----
Balance at September 30 $ 8.7 $19.2
===== =====
* At September 30, 2007, balances for the Electrical Components business were
removed from our consolidated balance sheet and reclassified as held for
sale.
At September 30, 2008, $8.2 million was included in current liabilities and $0.5
million was included in non-current liabilities.
12. Debt
On March 20, 2008, we terminated our previous $75 million First Lien Credit
Agreement and entered into a $50 million Credit Agreement with JPMorgan Chase
Bank, N.A. as administrative agent and J.P. Morgan Securities Inc. as sole lead
arranger. The agreement provides us with a $50 million revolving line of credit
expiring on March 20, 2013. The agreement contains certain covenants, including
a minimum fixed charge ratio, which would apply only if liquidity, as defined by
the credit agreement, were to fall below a specified level. As of September 30,
2008, we had no borrowings outstanding against this agreement, and our level of
liquidity was such that the covenants did not apply. We paid $1.6 million in
fees associated with the new agreement, which were capitalized and will be
amortized over the term of the agreement. $1.4 million in fees associated with
the previous First Lien Credit Agreement were expensed as interest cost upon its
termination.
Although we have terminated our former Second Lien Credit Agreement, the former
lender still possesses 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 as of the date of issuance at $7.3 million or $5.29 per share,
expires in April of 2012. The costs associated with this warrant, while
originally accounted for as additional interest to be expensed over the
remaining terms of the credit agreement, were expensed as interest cost upon
full repayment of the debt in the third quarter of 2007.
In addition to our North American credit agreement, we have various borrowing
arrangements at our foreign subsidiaries to support working capital needs and
government sponsored borrowings which provide advantageous lending rates. Our
borrowings under these arrangements totaled
Page 17
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
$56.7 million at September 30, 2008. Our weighted average interest rate for all
borrowings was 9.3% at September 30, 2008.
At September 30, 2008, we had outstanding letters of credit of $6.4 million and
the capacity for borrowings under the borrowing base formula of $30.8 million in
the U.S. and $68.8 million in foreign jurisdictions under our U.S. credit
agreement.
13. 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 $2.9
million at September 30, 2008 and $3.0 million at December 31, 2007 for
environmental remediation. Although the majority of these liabilities are
associated with our Engine & Power Train business segment, which we sold during
2007, we have retained certain liabilities that may arise in connection with
these locations. 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 magnitude and
timing, could be material to reported net income in the particular quarter or
period that they are recorded. In addition, the ultimate resolution of these
matters, either individually or in the aggregate, could be material to the
consolidated financial statements.
For additional information on our potential environmental liabilities, including
the Sheboygan River and Harbor Superfund and Hayton Area Remediation Project
sites, see Note 11 to the Financial Statements in our Annual Report on Form 10-K
for the year ended December 31, 2007.
14. 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.
In addition, income taxes are allocated between continuing, discontinued
operations and other comprehensive income in accordance with SFAS No. 109,
"Accounting for Income Taxes," particularly paragraph 140, which states that all
items, including discontinued operations, should be considered for purposes of
determining the amount of tax benefit that results from a loss from continuing
operations and that could be allocated to continuing operations. SFAS No. 109 is
applied by tax jurisdiction, and in periods in which there is a pre-tax loss
from continuing operations and pre-tax income in another category, such as
discontinued operations or other comprehensive income, tax expense is first
allocated to the other sources of income, with a related benefit recorded in
continuing operations.
For the three and nine month periods ended September 30, 2008, we reported loss
from continuing operations and other comprehensive income ("OCI") in U.S.
jurisdictions, and income in discontinued operations. Pursuant to SFAS No. 109,
Paragraph 140, we allocated income taxes between continuing operations,
discontinued operations and OCI. The consolidated condensed statement of
operations reflects a $0.2 million income tax benefit from continuing operations
for the three months ended September 30, 2008 and a $0.6 million income tax
expense from continuing operations for the nine months ended September 30, 2008.
The tax expense for the nine month
Page 18
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
period relates primarily to state and foreign income taxes. A U.S. tax benefit
was reported in continuing operations resulting from the allocation of taxes
between continuing operations, discontinued operations and OCI. The foreign
income tax expense includes expense in several jurisdictions.
The receipt of $100 million in gross proceeds from the reversion of our salaried
retirement plan in the first quarter of 2008 generated a tax gain that was fully
offset for federal tax purposes by our NOL carryforwards.
At September 30, 2008 and December 31, 2007, full valuation allowances were
recorded against deferred tax assets for those tax jurisdictions in which we
believe it is not more likely than not that the deferred taxes will be realized.
We have open tax years from primarily 2004 to 2007, with various significant
taxing jurisdictions including the U.S., Canada, France and Brazil. In the U.S.,
our federal income tax returns through 2002 have been examined by the Internal
Revenue Service. Our 2003 and 2004 U.S. federal income tax returns are currently
under review.
As of September 30, 2008, we do not anticipate any material change in the total
amount of unrecognized tax benefits within the next twelve months.
15. Commitments and Contingencies
A nationwide class-action lawsuit filed against us and other defendants (Ronnie
Phillips et al v. Sears Roebuck Corporation et al., No. 04-L-334 (20th Judicial
Circuit, St. Clair County, IL)) alleged that the horsepower labels on the
products the plaintiffs purchased, which included products manufactured by our
former Engine & Power Train business, were inaccurate. The plaintiffs sought
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. On March 30, 2007, the Court issued an order
granting the defendants' motion to dismiss, and on May 8, 2008 the Court issued
an opinion that (i) dismissed all the claims made under the Racketeer Influenced
and Corrupt Organization (RICO) Act with prejudice; (ii) dismissed all claims of
the 93 non-Illinois plaintiffs with instructions to refile amended claims in
individual state courts; and (iii) ordered that any amended complaint for the
three Illinois plaintiffs be refiled by May 30, 2008. Since that time, three
legal firms have filed numerous class action matters in over twenty states,
asserting claims on behalf of consumers in each of those states with respect to
lawnmower purchases from January 1, 1994 to the present. 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.
The purchaser of our former Engine & Power Train business has sought a working
capital adjustment of $20.0 million for which we are in disagreement. Both
parties are in the process of completing the binding arbitration process as
contemplated by the sale agreement. It is not possible at this time to
reasonably estimate the final amount of the working capital adjustment, if any,
but the amount could be material to our financial position, consolidated results
of operations and cash flows.
Page 19
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
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.
16. Impairments, Restructuring Charges, and Other Items
We recorded expense of $16.2 million and $20.0 million in impairments,
restructuring charges, or other items in the three and nine months ended
September 30, 2008, respectively. A summary of these charges (gains) is as
follows:
Three Months Ended Nine Months Ended
(Dollars in millions) September 30, 2008 September 30, 2008
------------------ ------------------
Excise tax expense on proceeds from salaried retirement plan reversion $ -- $ 20.0
Curtailment loss, hourly pension plan -- 3.9
Severance, restructuring costs, and special termination benefits 1.0 6.9
Impairment of buildings and machinery 15.2 15.2
Curtailment gain, hourly OPEB plan -- (19.1)
Settlement gain, salaried retirement plan -- (6.3)
Gain on sale of Dundee, Michigan facility -- (0.6)
----- ------
Total impairments, restructuring charges, and other items $16.2 $ 20.0
===== ======
The $15.2 million recognized for impairments of buildings and machinery for the
three and nine months ended September 30, 2008 was the result of the
acceleration of our plans for relocating and consolidating of certain of our
global manufacturing capabilities in light of the pronounced softening of demand
resulting from the current global financial conditions. The expense was
recognized in Brazil ($11.0 million), North America ($3.6 million), and India
($0.6 million). The severance expense of $6.9 million recorded in 2008 was as a
result of restructuring costs from previously announced actions recognized at
our North American ($3.1 million), European ($0.9 million) and Brazilian ($2.9
million) locations during the period.
We recorded $1.6 million in impairments, restructuring charges, and other items
in the nine months ended September 30, 2007. These charges related to reductions
in force executed during the second quarter of 2007 across several of our
business units.
Page 20
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
17. Recently Issued Accounting Pronouncements
Derivative Instruments and Hedging Activities
In March 2008, the FASB issued Statement No. 161, "Disclosures about Derivative
Instruments and Hedging Activities," ("SFAS 161"), which revised the disclosure
requirements of Statement No. 133, "Accounting for Derivative Instruments and
Hedging Activities." Among other things, SFAS 161 requires enhanced qualitative
disclosures about an entity's objectives and strategies for using derivatives,
requires tabular quantitative disclosures about 1) the fair value of derivative
instruments and 2) gains and losses on derivatives during the reporting period,
and requires disclosures about contingent features in derivative instruments
that relate to credit risk. SFAS 161 is effective for fiscal years and interim
periods beginning on or after November 15, 2008, and we are currently evaluating
the impact of adopting the statement.
Classification and Measurement of Redeemable Securities
On May 1, 2008, the SEC staff announced revisions to EITF Topic D-98,
"Classification and Measurement of Redeemable Securities" ("Topic D-98"). Among
other things, the revisions 1) clarified that the guidance applies to
noncontrolling interests, 2) outlined the SEC's views on the interaction between
Topic D-98 and SFAS 160, "Noncontrolling Interests in Consolidated Financial
Statements," and 3) clarified other provisions of Topic D-98. These revisions
are not expected to have an impact on our financial statements or results of
operations.
18. Share-Based Compensation Arrangements
In the first quarter of 2008, we approved a new Long-Term Incentive Cash Award
Plan for members of our senior management. The plan authorizes two types of
incentive awards, both of which are based upon our Class A shares; stock
appreciation rights ("SARs") and phantom stock shares. We granted all the SARs
and phantom stock shares associated with the plans on March 4, 2008, and with
the exception of one-third of the 325,002 SARs awarded to our Chief Executive
Officer, which vested on August 13, 2008, none will vest or expire during the
current year. Both types of awards are settled in cash.
In general, the SARs vest in equal amounts on the first, second, and third
anniversaries of the grant date, and expire seven years from the grant date, and
the phantom stock shares vest in full on the third anniversary. For some of the
SARs and phantom stock shares awarded to our Chief Executive Officer, however,
these anniversaries are measured from his August 13, 2007 hire date rather than
from the grant date. In the aggregate, we had 147,377 phantom stock shares and
434,932 SARs outstanding as of September 30, 2008. The phantom stock shares had
an initial grant date value of $28.82 and the SARs, which are the economic
equivalent of options, were valued as of the grant date at $15.61 using a
Black-Scholes model and a strike price of $28.82. The assumptions used in the
Black-Scholes model included a risk-free interest rate of 3.37%, a dividend
yield of 0%, an expected life of seven years and a volatility of 51.18%.
Our liability with regard to these awards will be remeasured for each quarterly
reporting period. The value of the phantom stock shares is determined by
comparing the closing stock price on our Class A common stock on the last day of
the quarter to the initial grant date value of $28.82. At September 30, the
closing stock price on our Class A common stock was $25.04. We measure the fair
value of each SAR, also on the last day of the quarter, using a Black-Scholes
model, and
Page 21
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION - ITEM 1
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
compare that result to the original calculated value of $15.61. At September 30,
this calculation yielded a value per SAR of $13.79.
As both the SARs and the phantom stock shares are settled in cash rather than by
issuing equity instruments, we record them as expense with a corresponding
liability on our balance sheet. The expense is based on the fair value of the
awards on the last day of the reporting period and represents an amortization of
that fair value over the three-year vesting period of the awards. Total
compensation expense related to the plan for the three and nine months ended
September 30, 2008 was $0.4 million and $1.9 million respectively. The balance
of the fair value that has not yet been recorded as expense is considered an
unrecognized liability. The total unrecognized liability as calculated at
September 30, 2008 was $7.8 million.
The SARs and phantom stock shares do not entitle recipients to receive any
shares of our common stock, nor do they provide recipients with any voting or
other stockholder rights. Similarly, since the awards are not paid out in the
form of equity, they do not change the number of shares we have available for
any future equity compensation we may elect to grant, and they do not create
stockholder dilution. However, because the value of the awards is tied to the
price of our Class A common stock, we believe they align employee and
stockholder interests, and provide retention benefits in much the same way as
would stock options and restricted stock awards.
Page 22
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Executive Summary
Until 2007, our business was focused upon three activities: hermetically sealed
compressors, small gasoline engine and power train products, and fractional
horsepower motors. Over the course of 2007 and 2008, we successfully executed a
strategy to divest operations that we did not consider to be core to our ongoing
business strategy. To that end, we sold the Residential & Commercial, Asia
Pacific and Automotive & Specialty portions of our Electrical Components
business, and also sold our Engine & Power Train business (with the exception of
TMT Motoco, our former Brazilian engine facility, which was subject to a
judicial restructuring and is in the process of finalizing its liquidation). The
remaining portion of our Electrical Components business is included with assets
held for sale. We also completed the sale of MP Pumps, a business not associated
with any of our major business segments. As a result of these initiatives, we
are now primarily focused on our global compressor business.
Our business is significantly influenced by several specific economic factors:
the strength of the overall global economy, which can have a significant impact
on our sales volumes; the drivers of product cost, especially the cost of copper
and steel; the relative value against the U.S. dollar of those foreign
currencies where we operate; and global weather conditions.
With respect to global economic activity, the recent decline, which may
ultimately become a global recession precipitated by the financial crisis, has
had a detrimental effect on our sales volumes. This decline has been marked by a
deterioration of credit availability for consumers and customers, increased
borrowing rates for those who are able to secure lines of credit, slowdowns in
the housing market, and double-digit inflation rates in some countries where our
business is concentrated. Any one of these factors, taken independently, would
have an adverse impact on our sales volumes; combined, the impact has been
significant. Although we are a global business, and declines in economic
activity that affect only certain regional markets are often balanced against
greater growth in other parts of the globe, the current slowdown is affecting
all of our global markets with nearly equal severity. In the first half of 2008,
consistent with our expectations, we began to see a slowdown when compared to
prior periods. As a result of the conditions described above, this trend
continued at an accelerated pace in the third quarter of the year, and based
upon customer actions we believe the fourth quarter will see an even greater
decline in activity. We do not currently expect market conditions to improve
before mid-2009. Accordingly, we have accelerated certain restructuring
activities which involve the idling of underutilized assets and reductions in
employment levels throughout the world.
Due to the high material content of copper and steel in compressor products, our
results of operations are very sensitive to the prices of these commodities.
Overall, commodity prices have been extremely volatile during 2007 and 2008,
increasing rapidly through July 2008, then dropping drastically in the final two
months of the recently completed quarter. The price of copper is representative
of this overall market volatility; from January 1, 2007 through July 31, 2008,
copper prices increased by over 30%; then, in the subsequent two months, the
price dropped by 22.3%. Copper prices have continued their rapid decline through
October 2008 as well. Such extreme volatilities create substantial challenges to
our ability to control the cost of our products, as the final product cost can
depend greatly on our ability to secure optimally priced forward and futures
contracts. Similarly, steel prices increased 77.8% from January 1, 2007 to
September 30, 2008. We currently expect that steel prices may stabilize at
current levels in the fourth quarter of the year, or decline in a manner
commensurate to other commodities. Due to competitive markets, we are typically
not able to quickly recover cost increases through price
Page 23
TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
increases or other cost savings. While we have been proactive in addressing the
volatility of these costs, including executing forward purchase contracts and
the purchase of futures contracts to cover in excess of 80% of our anticipated
copper requirements for the remainder of 2008, renewed rapid escalation of these
costs would nonetheless have an adverse affect on our results of operations both
in the near and long term. The rapid increase of steel prices has a particularly
negative impact, as there is currently no well-established market for hedging
against increases in the cost of steel. In addition, while the use of forwards
and futures can mitigate the risks of cost increases associated with these
commodities by "locking in" costs at a specific level, declines in the prices of
the underlying commodities can result in downward pressure in selling prices,
particularly if competitors have lesser future purchase positions, thus causing
a contraction of margins.
The compressor industry and our business in particular are characterized by
global and regional markets that are served by manufacturing locations
positioned throughout the world. An increasing portion of our manufacturing
presence is in international locations. From January 1 to September 30, 2008,
approximately 81% of our compressor manufacturing activity took place outside
the United States, primarily in Brazil, France, and India. Similarly,
approximately 80% of our sales through the first three quarters of 2008 were to
destinations outside North America. As a result, our consolidated financial
results are increasingly sensitive to changes in foreign currency exchange
rates. Because of our significant manufacturing and sales presence in Brazil,
changes in the Brazilian real have been especially adverse to our results of
operations when compared to prior periods; from January 1 to July 31, 2008, the
Brazilian real strengthened by 11.6%, and in the following two months the real
weakened by 22.2%. Our results of operations are substantially affected by
several types of foreign exchange risk. One type is balance sheet re-measurement
risk, which results when assets and liabilities are denominated in currencies
other than the functional currencies of the respective operations. This risk
applies for our Brazilian operation, which denominates certain of its borrowings
in U.S. dollars. The periodic re-measurement of these liabilities is recognized
in the income statement. In the quarter just ended, the abrupt weakening of the
Brazilian real against the U.S. dollar resulted in losses which were reported in
our results of operations. Another significant risk for our business is
transaction risk, which occurs when the foreign currency exchange rate changes
between the date that a transaction is expected and when it is executed, such as
collection of sales or purchase of goods. This risk affects our business
adversely when foreign currencies strengthen against the dollar, which until
recently has been the case for the last several years. We have developed
strategies to mitigate or partially offset these impacts, primarily hedging
against transactional exposure where the risk of loss is greatest. In
particular, we have entered into foreign currency forward purchases to hedge the
Brazilian export sales, some of which are denominated in U.S. dollars and some
in euros. To a lesser extent, we have also entered into foreign currency forward
purchases to mitigate the effect of fluctuations in the euro and the Indian
rupee. However, these hedging programs only reduce exposure to currency
movements over the limited time frame of three to fifteen months. Additionally,
if the currencies weaken against the dollar, any hedge contracts that have been
entered into at higher rates result in losses to our income statement when they
are settled. From January 1 to September 30, 2008, the euro weakened against the
dollar by 3.7%, while the rupee weakened by 18.8%. This resulted in losses to
our income statement for the settlement of currency contracts entered into in
India. In general, the strengthening of the U.S. dollar is favorable to our
overall results over time; however, the rapid and significant weakening of
foreign currencies in the third quarter of 2008 caused balance sheet
re-measurement losses to out-weigh the favorable impacts of transactional gains
in the period. Ultimately, long term changes in currency exchange rates have
lasting effects on the relative
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
competitiveness of operations located in certain countries versus competitors
located in different countries. Only one major competitor to our compressor
business faces similar exposure to the real. Other competitors, particularly
those with operations in countries where the currency has been substantially
pegged to the U.S. dollar, currently enjoy a cost advantage over our compressor
operations.
Our foreign manufacturing operations are subject to many other 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.
Aside from our efforts to manage increasing commodity costs and foreign exchange
risk with forward purchase contracts and futures, we have executed other
strategies to mitigate or partially offset the impact of rising costs and
declining volumes, which include aggressive cost reduction actions, cost
optimization engineering strategies, selective out-sourcing of components where
internal supplies are not cost competitive, continued consolidation of our
supply base and acceleration of low-cost country sourcing. In addition, the
sharing of increases in raw material costs has been, and will continue to be as
the situation warrants, 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 have 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 have raised prices to cover cost
increases, it is possible that customers may react by choosing to purchase their
requirements from alternative suppliers, or, in the case of certain customers,
to source more compressors utilizing internal capabilities. We may also need to
adjust prices downward if the economy contracts for an extended period of time.
Any 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.
Upon completion of the divestitures of the business operations discussed above,
we eliminated all our North American debt, and accumulated substantial net cash
on our balance sheet. This cash balance has become increasingly important in
light of recently constrained capital markets. In addition, consolidated
interest expense for our business, including amounts allocated to both
continuing and discontinued operations, in the foreseeable future will be
substantially reduced. We also expect our overall liquidity to increase through
the end of 2009, due primarily to the termination and reversion of our vastly
over-funded pension plans and collection of refundable non-income taxes in
Brazil. However, challenges remain with respect to our ability to generate
appropriate levels of liquidity via results of operations, particularly those
driven by global economic conditions, currency exchange and commodity pricing as
discussed above. With expected further volatility of the U.S. dollar versus key
currencies such as the Brazilian real and the euro we expect that we will
generate a limited amount of cash from normal operations until further
restructuring activities are implemented or economic conditions improve. As part
of our strategy to maintain sufficient liquidity, we have negotiated a new
financing arrangement for our North American based activities, although we have
not drawn upon that line due to our favorable liquidity position. While we
believe that this action combined with the cash generated by the pension plan
reversion and the recovery of non-income taxes will produce adequate liquidity
to implement our business strategy over a reasonable time horizon, there can be
no assurance that such improvements will ultimately be adequate if economic
conditions continue to deteriorate. We anticipate that we will continue to
maintain our cash balances as an effective source of liquidity given
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
the condition of current credit markets, low levels of cash production from
normal operations and uncertain conditions regarding the overall global economy.
In addition, while our business dispositions have improved our liquidity, many
of the sale agreements provide for certain retained liabilities, indemnities
and/or purchase price adjustments including liabilities that relate to
environmental issues and product warranties. While we believe we have adequately
provided for such contingent liabilities based on currently available
information, future events could result in the recognition of additional
liabilities that could consume available liquidity and management attention.
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 "Other Matters - Adequacy of Liquidity Sources,"
"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
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 SEPTEMBER 30,
(dollars in millions) 2008 % 2007 %
------- ----- ------ -----
Net sales $ 256.2 100.0% $278.4 100.0%
Cost of sales 238.7 93.2% 244.4 87.8%
------- ------
Gross margin 17.5 6.8% 34.0 12.2%
Selling and administrative expenses 33.7 13.1% 28.8 10.3%
Impairments, restructuring charges, and other items 16.2 6.3% (0.1) **
------- ------
Operating (loss) income (32.4) (12.6%) 5.3 1.9%
Interest expense (7.0) (2.7%) (6.6) (2.4%)
Interest income and other, net 2.7 1.0% 1.3 0.5%
------- ------
Loss from continuing operations before taxes (36.7) (14.3%) 0.0 **
Tax benefit (0.2) 0.1% (2.2) 0.8%
------- ------
(Loss) income from continuing operations ($36.5) (14.2%) $ 2.2 0.8%
======= ======
** less than 0.1%
Three Months Ended September 30, 2008 vs. Three Months Ended September 30, 2007
Consolidated net sales from continuing operations in the third quarter of 2008
decreased to $256.2 million from $278.4 million in 2007. After consideration for
the effect of currency translation, which increased sales in U.S. dollars by
$20.1 million, sales declined by $42.3 million. Sales of compressors for air
conditioning and other applications declined by $13.6 million, due to softer
economic conditions, higher customer inventory levels and cooler-than-normal
weather in many markets. Sales for refrigeration & freezer applications declined
by $9.6 million, associated primarily with a downturn in market volumes as well
as market share, most substantially in North America and India. Compressors for
commercial applications reported a slight increase in sales of $1.0 million. For
commercial applications, price increases and currency effects more than offset
declines in unit volumes, which were due to softer economic conditions and lower
shipments to customers in light of higher inventory balances. Expressed in unit
volumes, compressors for commercial and aftermarket applications (52% of sales
dollars) declined by 26.9% when compared to 2007, refrigeration & freezer
applications (33% of sales dollars) declined by 13.8%, and air conditioning
applications (15% of sales dollars) declined by 49.5%.
Cost of sales was $238.7 million in the three months ended September 30, 2008
compared to $244.4 million in the three months ended September 30, 2007. As a
percentage of net sales, cost of sales was 93.2% and 87.8% in the third quarters
of 2008 and 2007, respectively. In dollar terms, gross margin declined $16.5
million for 2008 operating profit when compared to the same period of 2007, from
$34.0 million in 2007 to $17.5 million in 2008.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Current year margin was favorably impacted by selling price advances of $7.0
million. However, as discussed above, volumes declined substantially when
compared to the third quarter of 2007, resulting in unfavorable overhead
absorption rates. These declines were partially offset by an improved mix of
higher-margin product, but the net impact of these factors resulted in a decline
of $11.1 million in 2008 when compared to 2007 results. The effect of foreign
currency exchange unfavorably impacted results for the current quarter by $8.6
million, which included $3.7 million for losses recognized in our income
statement from the re-measurement of foreign denominated assets & liabilities in
Brazil and the mark to market of ineffective hedges in India. Unfavorable
commodity costs of $3.7 million and unfavorable purchasing, productivity and
other costs of $0.1 million also affected gross margins in the quarter.
Selling, general and administrative ("SG&A") expenses were $33.7 million and
$28.8 million in the three months ended September 30, 2008 and 2007
respectively. As a percentage of net sales, SG&A expenses were 13.1% in the
third quarter of 2008 compared to 10.3% in the third quarter of 2007. We
recorded expenditures of approximately $5.1 million in the third quarter of 2008
for one-time professional fees, which included consulting services for strategic
planning and legal fees for corporate governance issues. This expenditure
constituted an increase of $2.7 million in professional fees incurred for
one-time projects when compared to the same period in 2007. The remaining $2.2
million increase in administrative cost was largely reflective of costs
recognized in continuing operations that were previously allocated to businesses
that are now discontinued operations.
We recorded expense of $16.2 million in impairments, restructuring charges, and
other items in the three months ended September 30, 2008. The majority of these
expenses were as a result of the acceleration of our plans for consolidating and
relocating certain of our global manufacturing capabilities in light of the
pronounced softening of demand resulting from the current global financial
conditions. These costs were recognized at our Brazilian ($11.9 million) North
American ($3.7 million) and Indian ($0.6 million) locations during the quarter.
Interest expense amounted to $7.0 million in the three months ended September
30, 2008 compared to $6.6 million in the same period of 2007. The higher
interest expense in the current quarter was attributable to increased interest
rates on our short-term borrowings in Brazil. Interest income and other, net was
$2.7 million in the third quarter of 2008 compared to $1.3 million in the third
quarter of 2007, reflecting the higher levels of cash and short-term investments
held in 2008.
Our results of operations reflect a $0.2 million income tax benefit from
continuing operations for the third quarter of 2008 and a $2.2 million income
tax benefit from continuing operations for the third quarter of 2007. Income
taxes are recorded pursuant to SFAS No. 109, "Accounting for Income Taxes," and
are applied on a jurisdiction by jurisdiction basis. For the three month period
ended September 30, 2008, we reported a loss from continuing operations and OCI
in U.S. jurisdictions, and net income in discontinued operations. Pursuant to
SFAS No. 109, Paragraph 140, we allocated income taxes between continuing
operations, discontinued operations and OCI.
In the U.S., Brazil, and India, we have substantial net operating losses
("NOL's"), for which valuation allowances have been recorded. As a result,
future taxable income in these jurisdictions will not result in tax expense for
the foreseeable future. The prior year reflects tax benefits in the statement of
operations and tax expense in other comprehensive income.
Since we pay taxes in various states there is also an expense recorded in the
U.S. that is related to state tax liabilities, including state tax expense that
is recorded in discontinued operations.
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PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
As a result of the factors described above, net loss from continuing operations
for the quarter ended September 30, 2008 was $36.5 million ($1.98 per share
basic and diluted) as compared to net income of $2.2 million ($0.12 per share
basic, $0.11 per share diluted) in the same period of 2007.
NINE MONTHS ENDED SEPTEMBER 30,
(dollars in millions) 2008 % 2007 %
------- ----- ------ -----
Net sales $ 805.2 100.0% $864.7 100.0%
Cost of sales 708.6 88.0% 760.5 87.9%
------- ------
Gross margin 96.6 12.0% 104.2 12.1%
Selling and administrative expenses 99.6 12.4% 97.7 11.3%
Impairments, restructuring charges, and other items 20.0 2.5% 1.6 0.2%
------- ------
Operating (loss) profit (23.0) (2.9%) 4.9 0.6%
Interest expense (20.5) (2.5%) (23.2) (2.7%)
Interest income and other, net 7.8 1.0% 4.6 0.5%
------- ------
Loss from continuing operations before taxes (35.7) (4.4%) (13.7) (1.6%)
Tax expense (benefit) 0.6 (0.1%) (5.5) 0.6%
------- ------
Loss from continuing operations ($36.3) 4.5% ($8.2) 1.0%
======= ======
Nine Months Ended September 30, 2008 vs. Nine Months Ended September 30, 2007
Consolidated net sales from continuing operations in the first three quarters of
2008 decreased to $805.2 million from $864.7 million in 2007. After
consideration for the effect of currency translation, which increased sales in
U.S. dollars by $80.4 million, sales declined by $139.9 million. Sales of
compressors used in commercial applications increased by $18.4 million; these
increases were primarily the result of pricing advances and currency impacts.
These increases in sales were offset by dollar volume declines in sales of
compressors used in refrigeration & freezer applications of $56.0 million,
associated primarily with a downturn in market volumes as well as market share,
predominantly in North America, India and Europe. Sales of compressors for air
conditioning applications and all other applications also declined by $21.9
million. Expressed in unit volumes, compressors for commercial and aftermarket
applications (52% of sales dollars) declined by 13.9% when compared to 2007,
refrigeration & freezer applications (32% of sales dollars) declined by 25.3%,
and air conditioning applications (16% of sales dollars) declined by 25.2%.
Cost of sales was $708.6 million in the nine months ended September 30, 2008, as
compared to $760.5 million in the same period of 2007. As a percentage of net
sales, cost of sales was 88.0% and 87.9% in the first nine months of 2008 and
2007, respectively. Gross margin declined by $7.6 million in 2008 when compared
to the same period of 2007, from $104.2 million in 2007 to $96.6 million in
2008.
Current year margin was favorably impacted by selling price advances of $32.7
million. However, although an improved mix of higher-margin product contributed
favorably to 2008 year-to-date results, this favorable mix was not sufficient to
fully offset volume declines and lower overhead absorption, resulting in a net
reduction to 2008 margin of $23.6 million. The effect of foreign currency
exchange unfavorably impacted results for 2008 by $23.5 million when compared to
the prior year, including $5.7 million for losses from the re-measurement of
foreign denominated assets & liabilities in Brazil and the
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
mark to market of ineffective hedges in India. Increased commodity costs
accounted for $13.1 million of the gross margin decline. These unfavorable
trends were somewhat offset by gains in productivity, purchasing costs and other
improvements of $15.6 million, as well as gains on the sale of an airplane and
our former airport facility of $4.2 million.
Selling, general and administrative ("SG&A") expenses were $99.6 million or
12.4% of net sales in the first three quarters of 2008 as compared to $97.7
million or 11.3% of sales in the nine months ended September 30, 2007. While we
incurred approximately $11.1 million in 2008 for one-time professional fees,
which included consulting services for strategic planning and legal fees for
corporate governance issues, this figure represented a $6.2 million reduction in
professional fees incurred for one-time projects when compared to 2007. This
improvement was offset by $8.1 million in increased administrative costs, which
was primarily reflective of costs recognized in continuing operations that were
previously allocated to businesses that are now discontinued operations.
We recorded expense of $20.0 million in impairments, restructuring charges, and
other items in the nine months ended September 30, 2008. This included $20.0
million in excise tax expense on the proceeds received from the reversion of our
former salaried retirement plan, and a curtailment loss on our hourly pension
plan of $3.9 million. In addition, we recorded $15.2 million in charges for
impairment of buildings and machinery in the third quarter of 2008, as a result
of the consolidation and relocation of global manufacturing capabilities. These
expenses were recognized in Brazil ($11.0 million), North America ($3.6
million), and India ($0.6 million). We also recorded expense of $6.9 million
related to severance costs for previously announced on-going restructuring
activities at our North American ($3.1 million) Brazilian ($2.9 million) and
European ($0.9 million) locations. Offsetting these expenses were a curtailment
gain related to our hourly OPEB plans ($19.1 million) due to reductions in
future service cost related to the closure of our manufacturing operations in
Tecumseh, Michigan, a settlement gain on the sale of annuity contracts for our
former salaried retirement plan ($6.3 million), and a gain on the sale of our
facility in Dundee, Michigan ($0.6 million). We recorded $1.6 million in
impairments, restructuring charges, and other items in the nine months ended
September 30, 2007; these charges were the result of reductions in force at
multiple locations.
Interest expense of $20.5 million was recorded through September 30, 2008
compared to $23.2 million in the nine months ended September 30, 2007. Lower
average levels of short-term borrowings in 2008 as well as lower levels of
discounted accounts receivable in the current year contributed to the reduction
in interest costs.
Interest income and other, net was $7.8 million in the first nine months of 2008
compared to $4.6 million in the same period of 2007. The increase was due to the
higher levels of cash and short-term investments held in 2008, primarily in the
second and third quarters.
Our results of operations reflect a $0.6 million income tax expense from
continuing operations for the nine months ended September 30, 2008 and a $5.5
million income tax benefit from continuing operations for the nine months ended
September 30, 2007. Income taxes are recorded pursuant to SFAS No. 109,
"Accounting for Income Taxes," and are applied on a jurisdiction by jurisdiction
basis. Through September 30, 2008, we reported loss from continuing operations
and OCI in U.S. jurisdictions, and income in discontinued operations. Pursuant
to SFAS No. 109, Paragraph 140, we allocated income taxes between continuing
operations, discontinued operations and OCI. The tax expense for the nine month
period ended September 30, 2008 related primarily to state and foreign income
taxes. A U.S. tax benefit was reported in continuing operations resulting from
the allocation of
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
taxes between continuing operations, discontinued operations and OCI. The
foreign income tax expense includes expense in several jurisdictions.
In the U.S., Brazil, and India, we have substantial NOL's, for which valuation
allowances have been recorded. As a result, future taxable income in these
jurisdictions will not result in tax expense for the foreseeable future. The
prior year reflects tax benefits in the statement of operations and tax expense
in other comprehensive income.
Since we pay taxes in various states there is also an expense recorded in the
U.S. that is related to state tax liabilities, including state tax expense that
is recorded in discontinued operations.
After considering the factors outlined above, net loss from continuing
operations for the nine months ended September 30, 2008 was $36.3 million ($1.96
per share basic and diluted) as compared to net loss from continuing operations
of $8.2 million ($0.44 per share basic and diluted) for the same period of 2007.
OTHER MATTERS
LIQUIDITY AND CAPITAL RESOURCES
Our primary liquidity needs are to fund capital expenditures, service
indebtedness and support working capital requirements. In general, our principal
current sources of liquidity are cash flows from operating activities, when
available, borrowings under available credit facilities, and cash on hand
representing proceeds from sales of non-core businesses and over-funded pension
plan reversions. For the remainder of 2008 and 2009, we also expect the recovery
of non-income taxes in Brazil and the reversion of another pension plan to
generate substantial liquidity, as is further discussed in Note 6 to the
financial statements and in "Adequacy of Liquidity Sources" below.
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,
although there are tax consequences to such activities.
Cash Flow
In the third quarter of 2008, cash used by operations amounted to $55.6 million.
The most significant uses of cash during the quarter involved working capital
requirements, particularly payables and accrued expenses (a use of $33.1
million) as well as accounts receivable (a use of $13.2 million). In the case of
payables, we accelerated payments to many cash- and credit-constrained suppliers
during the period, in order to avoid interest rate charges on outstanding
balances. With regard to accounts receivable, we reduced the amount of
discounted receivables by $31.0 million during the period, which increased the
net receivables recorded on our balance sheet, also to avoid unnecessary
interest expense. The remaining cash use was primarily attributable to cash net
losses, which were a result of the economic downturn adversely affecting our
sales volumes combined with higher steel costs. In each of these instances, our
favorable cash position allowed us to address unfavorable market conditions
without incurring the cost of escalating interest rates or drawing upon lines of
credit. These
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
uses of cash were somewhat offset by our aggressive efforts to reduce inventory
balances, which yielded cash of $16.5 million during the quarter.
For the first nine months of 2008, cash provided by operations amounted to $24.1
million. The $80 million in net proceeds realized from the reversion of our
salaried retirement plan was the most significant element of this increase in
cash. Accounts receivable increased by $36.9 million from the beginning of the
year; this was primarily reflective of a reduction of $39.8 million in the
amount of discounted receivables across the two periods, which increased the net
receivables recorded on our balance sheet at September 30. When evaluating days
to collection for outstanding receivables, there was an improvement of two days
to collection as of September 30, 2008 when compared to the end of 2007. The
days sales outstanding ("DSO") for compressors decreased from 57 at the end of
the year to 55 at September 30 (before consideration for discounted accounts
receivable), due to a change in the composition of customer sales in outstanding
receivables.
Inventories decreased by $8.0 million since the beginning of the year. The lower
levels reflect a decrease in days inventory on hand of four days. Accounts
payable and other accrued expenses and liabilities decreased since December 31,
2007 (down $2.8 million). Trade payables declined in the third quarter of the
year; many of our customers accelerated demands for payment as a result of their
inability to obtain normal lines of credit.
In evaluating balance sheet metrics, we consider 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. When comparing sales
patterns for the compressor business, average days sales outstanding were 55
days at September 30, 2008 versus 54 days at September 30, 2007, before giving
effect to receivables sold. Compressor days inventory on hand were 52 days at
September 30, 2008, down from 58 days at September 30, 2007, largely due to
concerted efforts to reduce excess balances and the elimination of inventory
bank builds as we complete the consolidation of certain manufacturing
facilities.
Cash provided by investing activities was $9.5 million in the first nine months
of 2008 versus cash provided by investing activities of $200.0 million for the
same period of 2007. $22.6 million in proceeds were received from the sale of
assets during 2008, while $205.9 million in proceeds were recorded in 2007.
Asset sales in 2008 included MP Pumps for net initial cash proceeds of $14.2
million ($14.6 million less up-front expenses of $0.4 million), an airplane for
$3.4 million, our Dundee, Michigan facility for $1.6 million, our Shannon,
Mississippi facility for $1.2 million, excess equipment for $1.4 million, and
our airport facility for $0.8 million. In 2007, asset sales included the sale of
our Residential & Commercial product lines for $199.0 million in net proceeds,
the sale of an aircraft for $3.4 million, the sale of other fixed assets for
$2.5 million, and the sale of Manufacturing Data Systems, Inc. for $1.0 million.
Cash used in financing activities was $1.1 million in the first nine months of
2008 as compared to cash used of $201.8 million in the comparable period of
2007. The change in 2008 was due to fluctuations in borrowing at foreign
facilities. During the third quarter of 2007, we used the proceeds from the sale
of our Residential & Commercial product lines to pay off the entire balance of
our Second Lien Credit Agreement and the majority of the balance under our First
Lien Credit Agreement.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Credit Facilities and Cash on Hand
In addition to cash provided by operating activities when available, we use a
combination of our revolving credit arrangement under our North American credit
agreement and foreign bank debt to fund our capital expenditures and working
capital requirements. For the nine months ended September 30, 2008 and the full
year ended December 31, 2007, our average outstanding debt balance was $67.8
million and $210.2 million, respectively. The weighted average long-term
interest rate was 9.3% and 8.9% at September 30, 2008 and December 31, 2007,
respectively.
On March 20, 2008, we terminated our previous First Lien Credit Agreement and
entered into a $50 million First Lien Credit Agreement with JPMorgan Chase Bank,
N.A. as administrative agent and J.P. Morgan Securities Inc. as sole lead
arranger. The agreement provides us with a $50 million revolving line of credit
expiring on March 20, 2013. The agreement contains certain covenants, including
a minimum fixed charge ratio, which would apply only if liquidity, as defined by
the credit agreement, were to fall below a specified level. As of September 30,
2008, we had no borrowings outstanding against this agreement, and our level of
liquidity was such that the covenants did not apply.
Although we have terminated our former Second Lien Credit Agreement, the former
lender still possesses 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 as of the date of issuance at $7.3 million or $5.29 per share,
expires in April of 2012. The costs associated with this warrant, while
originally accounted for as additional interest to be expensed over the
remaining terms of the credit agreement, were expensed upon full repayment of
the debt in the third quarter of 2007.
In addition to our North American credit agreement, we have various borrowing
arrangements at our foreign subsidiaries to support working capital needs and
government sponsored borrowings which provide advantageous lending rates. Our
borrowings under these arrangements totaled $56.7 million at September 30, 2008.
Any cash we hold that is not utilized for day-to-day working capital
requirements is primarily invested in secure, institutional money market funds,
the majority of which are with the holder of our domestic credit agreement,
JPMorgan Chase Bank, N.A. Money market funds are strictly regulated by the U.S.
Securities and Exchange Commission and operate under tight requirements for the
liquidity, creditworthiness, and diversification of their assets.
At September 30, 2008, we had cash and short-term investments in North America
of approximately $97.9 million, outstanding letters of credit of $6.4 million
and the capacity for borrowings under the borrowing base formula of $30.8
million in the U.S. and $68.8 million in foreign jurisdictions under our U.S.
credit agreement.
Accounts Receivable Sales
Our Brazilian, European, and Indian subsidiaries periodically sell their
accounts receivable with financial institutions. Such receivables are factored
both without and with limited recourse to us and are excluded from accounts
receivable in our consolidated balance sheets. The amount of sold receivables
excluded from our balance sheet was $39.4 million and $79.2 million as of
September 30, 2008 and December 31, 2007, respectively. We cannot provide any
assurances that these facilities will be available or utilized in the future. In
fact, such programs have been adversely affected by the recent global financial
crises both in terms of availability and cost. We expect to reduce our need for
such
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
facilities or other higher-cost forms of financing in Brazil upon receipt of
non-income tax receivables as is further discussed in Note 6 to the financial
statements.
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 2007 cash flows from operations were negative and we had to rely on
existing cash balances, proceeds from credit facilities and asset sales to fund
our needs.
As a result of the sale of the majority of the Electrical Components business
and the Engine & Power Train business, we completely eliminated our North
American debt in the fourth quarter of 2007. Accordingly, we expect our
consolidated interest expense in the future to be substantially reduced. Based
on the amount of our North American debt prior to the sale of those businesses,
we expect that its elimination will reduce our annualized interest expense,
including amounts recognized in both continuing and discontinued operations, by
approximately $22 million. However, challenges will remain with respect to our
ability to generate appropriate levels of liquidity from operations,
particularly those driven by currency exchange and commodity pricing. With
expected further volatility of the U.S. dollar versus key currencies such as the
Brazilian real and the euro we expect that we will generate a limited amount of
cash until further restructuring activities are implemented, or economic
conditions improve. As part of our strategy to maintain sufficient liquidity, we
have negotiated a new financing arrangement for our North American based
activities. In addition, we are generating other sources of cash through various
activities as noted below.
We are in the process of finalizing the tax audit of our 2003 year, the
resolution of which is expected to result in the refund of federal income taxes
previously paid of approximately $13.9 million. Receipt of such proceeds is
dependent upon final resolution of this audit, the principal issue in which is
the timing of a deduction. Given that the IRS is currently disputing the timing
of the deduction, the timing of the expected refund is uncertain. We continue to
believe that we will prevail in this matter and we have hired legal counsel to
pursue this refund.
We have successfully executed a conversion of our salaried retirement plan to a
new retirement program, which includes both defined benefit and defined
contribution plans. This conversion yielded net cash to the Company in 2008 of
approximately $80 million. The net proceeds were higher than we previously
expected because the old plan was able to purchase annuities to fund its future
obligations for a lower premium than we had estimated, due in part to the final
actuarial assumptions being more favorable than those we used for purposes of
our original estimate. The arrangements we have made will fully secure the
benefits payable under the old plan and will also fund the new plans, without
additional annual contributions, for approximately six to seven future years.
In the fourth quarter of 2007 we announced the relocation of the manufacturing
operations at our Tecumseh, Michigan facility to other locations in North
America. As a result of this consolidation, we will also be executing a
reversion of our hourly pension plan. At December 31, 2007, this plan reported
approximately $90 million in overfunding. We expect that the conversion of this
plan will make net cash available of approximately $35 to $45 million. The
timing of the distribution is dependent on the length of time needed to meet IRS
distribution requirements, and is currently expected to take place in 2009.
As is further discussed in Note 6 to the financial statements, we have begun to
receive the expected
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
refunds of the outstanding refundable Brazilian non-income taxes. As of October
27, 2008, and based upon the exchange rate between the U.S. dollar and the
Brazilian real as of September 30, we had received approximately $53.5 million
in refunds, and we currently expect to receive approximately $5.6 million in
further refunds by the end of 2008. Due to the recent volatility in the exchange
rate between the U.S. dollar and the Brazilian real, the actual amounts received
as expressed in U.S. dollars will vary depending on the exchange rate at the
time of receipt or future reporting date.
As part of addressing our liquidity needs, we made substantially lower levels of
capital expenditures in 2007, and are continuing that trend in 2008. Looking
ahead, we expect capital expenditures in 2008 and beyond to remain at levels far
less than historical averages, due to the elimination of non-core businesses and
due to a shift away from capital intensive vertical integration to higher levels
of outside sourcing of components from suppliers located in low cost countries.
We expect capital expenditures to average $20 to $25 million annually for the
foreseeable future, although the timing of expenditures may result in higher
investment in some years and lower amounts in others. We currently estimate that
capital expenditures for 2008 will run in the $10 to $15 million dollar range,
but with a carryover into the upcoming year may be as high as $35 million in
2009. These expenditures will be carefully managed and will be dependent upon
economic conditions throughout the year.
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 13 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 $2.9 million at September 30, 2008 and $3.0 million at December
31, 2007 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.
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, 2007.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In the first quarter of 2008, we adopted a share-based cash compensation plan.
This plan requires us to begin applying FASB Statement 123R, "Share Based
Payments" ("SFAS 123R"). SFAS 123R requires all share-based payments to
employees, including our grants of SARs, which are the economic equivalents of
employee stock options, to be recognized in the financial statements as
compensation expense based upon the fair value on the date of grant. We
determined the fair value of these awards using the Black-Scholes option pricing
model. The Black-Scholes option pricing model incorporates certain assumptions,
such as risk-free interest rate, expected volatility, expected dividend yield
and expected life of the SARs, in order to arrive at a fair value estimate.
Expected volatilities are based on the historical volatility of our common stock
and that of an index of companies in our industry group. The risk free interest
rate is based upon quoted market yields for United States Treasury debt
securities. The expected dividend yield is based upon our history of not having
issued a dividend since the second quarter of 2005 and management's current
expectation of future action surrounding dividends. We believe that the
assumptions selected by management are reasonable; however, significant changes
could materially impact the results of the calculation of fair value. For
further discussion of this share-based compensation plan, see Note 18,
"Share-Based Compensation Arrangements," to the consolidated condensed financial
statements.
In the third quarter of 2008, we initiated the use of commodity futures
contracts. The intent of these contracts is to enable us to minimize the impact
of market fluctuations in commodity prices on our financial results.
Accordingly, we now manage our exposure to the volatility in the prices of
commodities, particularly copper, through a combination of commodity forward
contracts and commodity futures. The commodity futures contracts qualify for
hedge accounting under SFAS 133, "Accounting for Derivative Instruments and
Hedging Activities," and are discussed further in Note 7 to the financial
statements.
Recently Issued Accounting Pronouncements
Derivative Instruments and Hedging Activities
In March 2008, the FASB issued Statement No. 161, "Disclosures about Derivative
Instruments and Hedging Activities," ("SFAS 161"), which revised the disclosure
requirements of Statement No. 133, "Accounting for Derivative Instruments and
Hedging Activities." Among other things, SFAS 161 requires enhanced qualitative
disclosures about an entity's objectives and strategies for using derivatives,
requires tabular quantitative disclosures about 1) the fair value of derivative
instruments and 2) gains and losses on derivatives during the reporting period,
and requires disclosures about contingent features in derivative instruments
that relate to credit risk. SFAS 161 is effective for fiscal years and interim
periods beginning on or after November 15, 2008, and we are currently evaluating
the impact of adopting the statement.
OUTLOOK
Information in this "Outlook" section should be read in conjunction with the
cautionary statements and discussion of risk factors included elsewhere in this
report and in our Annual Report on Form 10-K for the year ended December 31,
2007.
The outlook for the fourth quarter of 2008 is subject to many of the same
variables that negatively impacted us in the first three quarters of the year.
The condition of the global economy, commodity costs, key currency rates and
weather are all important to future performance. While we have seen
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
commodities and currencies generally move in directions favorable to the Company
over the past two months, our practice of mitigating our exposure to such
movements will result in little to no benefit being realized in the fourth
quarter of 2008 and only limited amounts in the first half of 2009. In addition,
these movements have been the result of very rapid fluctuations precipitated by
an event that the former U.S. Federal Reserve Chairman described as a "once in a
hundred year financial tsunami." Whether such movements will reverse quickly or
be sustained is unknown. In either event, we will continue our approach of
mitigating the effect of short term swings through the appropriate use of
hedging instruments.
Mostly, we are concerned about maintaining our expected level of sales volumes,
particularly in light of current global economic conditions. Volumes in the
first half of 2008 were consistent with our expectations; as anticipated, we
began to see a slowdown when compared to prior periods. This trend continued at
an accelerated pace in the third quarter, and current evidence indicates that
the trend could become even more pronounced in the fourth quarter of the year.
We do not currently expect market conditions to improve before mid-2009. If a
greater-than-expected decline in volume occurs in our key markets, this could
have a further adverse effect on our current outlook.
Certain key commodities, including copper, have seen significant fluctuations in
pricing since the beginning of the year; copper prices increased by over 30%
through July and then dropped 22.3% in August and September. As of September 30,
2008, we held more than 80% of our total projected copper requirements for the
remainder of 2008 in the form of forward purchase contracts and futures, which
will provide us with substantial (though not total) protection from any
resurgence in price during the remainder of the year but also will detract from
our ability to benefit from any price decreases. In addition, we expect the cost
of steel and other purchased materials to be more costly in 2008 versus 2007. As
of September 30, 2008, steel costs had risen by 65.5% since the beginning of
this year and by 77.8% when compared to January 1, 2007. Increases in the price
of steel are particularly detrimental to our profitability, as there is
currently no well-established market for hedging the cost of steel. In the
aggregate and after consideration for the recent rapid escalation in steel
costs, we expect the total 2008 cost of our purchased materials for the full
year, including the impact of our hedging activities, to be approximately $48
million more than the prior year, depending on commodity cost levels in the
remaining three months of 2008. As a partial means of addressing the escalating
costs of commodities, we have implemented price increases, most of which have
already taken effect with the remainder becoming effective over the final
quarter of this year.
The Brazilian real, the euro and the Indian rupee continue significant
volatility against the U.S. dollar. While we have considerable forward purchase
contracts to cover our exposure to additional fluctuations in value during the
year, we expect the changes in foreign currency exchange rates, after giving
consideration to our contracts and including the impact of balance sheet
re-measurement, to have a negative financial impact totaling approximately $37
million when compared to 2007; however, further strengthening of the dollar
against the real could result in additional re-measurement losses.
As part of our efforts to offset these worsening conditions, to improve
profitability and reduce the consumption of capital resources, our plans for the
remainder of 2008 include price increases if needed to cover our increased input
costs, additional cost reduction activities including, but not limited to,
further employee headcount reductions, consolidation of productive capacity and
rationalization of product platforms, and revised sourcing plans. During the
third quarter, our total global headcount was reduced by approximately 1200
people. We also expect that we will initiate further actions in the fourth
quarter of the year, which we estimate will result in severance costs of $5 to
$7 million. We have also
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
recently completed our initiative to close one of our U.S. operating facilities
located in Tecumseh, Michigan. The closure is expected to reduce annualized
costs by $5.6 million. We are continuing to evaluate our corporate
infrastructure in relation to the level of business activity that remains now
that the majority of our restructuring programs are completed and in light of
current sales volumes. Such actions could result in further 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.
We incurred approximately $11.1 million through the first nine months of 2008
for one-time professional fees, which included consulting services for strategic
planning, legal fees for corporate governance issues and preparation for our
upcoming special meeting of shareholders. Due to these expenses, many of which
were unforeseeable earlier in the year, we currently estimate a decrease of $6.0
million in one-time professional fees in 2008 compared to 2007. For further
discussion of issues impacting our liquidity and cash flows, refer to "Adequacy
of Liquidity" elsewhere in Part 1, Item 2.
After giving recognition to these factors, we believe it is highly unlikely that
we will match 2007 operating profit levels in 2008. As discussed above, we also
remain concerned about the general health of the global economy and the
possibility of recession in the United States, which could also expand to other
global economies.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAUTIONARY STATEMENTS RELATING TO FORWARD-LOOKING STATEMENTS
This 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 success of our ongoing effort to bring costs in line with
projected production levels and product mix; ii) financial market changes,
including fluctuations in foreign currency exchange rates and interest rates;
iii) availability and cost of materials, particularly commodities, including
steel and copper, whose cost can be subject to significant variation; iv)
changes in business conditions and the economy in general in both foreign and
domestic markets, the condition of which may magnify other risk factors; v)
weather conditions affecting demand for replacement products; vi) actions of
competitors; vii) our ability to maintain adequate liquidity in total and within
each foreign operation; 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) increased or
unexpected warranty claims; 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, commodity forward purchase
contracts and commodity futures. 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 2007 Annual Report on Form 10-K in Item 7A and
in Notes 1 and 13 of the Notes to the Consolidated Financial Statements, and an
update is provided in "Significant Accounting Policies and Critical Accounting
Estimates" in Part 1, Item 2 of this Report on Form 10-Q. We do not utilize
financial instruments for trading or other speculative purposes.
Our results of operations are substantially affected by several types of foreign
exchange risk. One type is balance sheet re-measurement risk, which results when
assets and liabilities are denominated in currencies other than the functional
currencies of the respective operations. This risk applies for our Brazilian
operation, which denominates certain of its borrowings in U.S. dollars. The
periodic re-measurement of these liabilities is recognized in the income
statement. In the quarter just ended, the abrupt weakening of the Brazilian real
against the U.S. dollar resulted in losses which were reported in our results of
operations. Further weakening of the real against the dollar could result in
additional re-measurement losses. Another significant risk for our business is
transaction risk, which occurs when the foreign currency exchange rate changes
between the date that a transaction is expected and when it is executed, such as
collection of sales or purchase of goods. This risk affects our business
adversely when foreign currencies strengthen against the dollar, which until
recently has been the case for the last several years. We have developed
strategies to mitigate or partially offset these impacts, primarily hedging
against transactional exposure where the risk of loss is greatest. This involves
entering into short-term forward exchange contracts to sell or purchase foreign
currencies at specified rates based on estimated foreign currency cash flows. In
particular, we have entered into foreign currency forward purchases to hedge the
Brazilian export sales, some of which are denominated in U.S. dollars and some
in euros. To a lesser extent, we have also entered into foreign currency forward
purchases to mitigate the effect of fluctuations in the euro and the Indian
rupee. However, these hedging programs only reduce exposure to currency
movements over the limited time frame of three to fifteen months. Additionally,
if the currencies weaken against the dollar, any hedge contracts that have been
entered into at higher rates result in losses to our income statement when they
are settled. From January 1 to September 30, 2008, the euro weakened against the
dollar by 3.7%, while the rupee weakened by 18.8%. This resulted in losses to
our income statement for the settlement of currency contracts entered into in
India. In general, the strengthening of the U.S. dollar is favorable to our
overall results over time; however, the rapid and significant weakening of
foreign currencies in the third quarter of 2008 caused balance sheet
re-measurement losses to out-weigh the favorable impacts of transactional gains
in the period. A third type of foreign currency exchange exposure affects
operations whose assets and liabilities are denominated in currencies other than
U.S. dollars. On a normal basis, we do not attempt to hedge the foreign currency
translation fluctuations in the net investments in our foreign subsidiaries. It
is also our policy not to purchase financial and/or derivative instruments for
speculative purposes. 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. Only one
major competitor to our compressor business faces similar exposure to
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
the real. Other competitors, particularly those with operations in countries
where the currency has been substantially pegged to the U.S. dollar, currently
enjoy a cost advantage over our compressor operations.
At September 30, 2008 and December 31, 2007, we held foreign currency forward
contracts with a total notional value of $186.5 million and $232.7 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.
Our exposure to commodity cost risk is related primarily to the cost of copper
and steel, as these are major components of our product cost. The rapid increase
of steel prices has a particularly negative impact, as there is currently no
well-established market for hedging against increases in the cost of steel. We
use commodity forward purchasing contracts as well as commodity futures to help
control the cost of other traded commodities, primarily copper. Company policy
allows management to contract commodity forwards or futures for a limited
percentage of projected raw material requirements up to 18 months in advance.
Commodity forward contracts at our divisions and subsidiaries are essentially
purchase contracts designed to fix the price of the commodities during the
operating cycle. Our practice with regard to forward contracts has been to
accept delivery of the commodities and consume them in manufacturing activities.
At September 30, 2008 and December 31, 2007, we held a total notional value of
$50.2 million and $64.4 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. As discussed above, we have also
initiated the purchase of commodity futures contracts in the third quarter of
2008, as these contracts provide us with greater flexibility in managing the
substantial volatility in copper pricing. These futures are designated as hedges
against the price of copper, and are accounted for as hedges on our balance
sheet in accordance with SFAS 133. While we have been proactive in addressing
the volatility of copper costs, including executing forward purchase contracts
and the purchase of futures contracts to cover in excess of 80% of our
anticipated copper requirements for the remainder of 2008, renewed rapid
escalation of these costs would nonetheless have an adverse affect on our
results of operations both in the near and long term. In addition, while the use
of forwards and futures can mitigate the risks of cost increases associated with
these commodities by "locking in" costs at a specific level, we do not realize
the full benefit of a rapid decrease in commodity prices. As a result, if market
pricing becomes deflationary, our level of commodity hedging could result in
lower operating margins and reduced profitability. Based on our current level of
activity, and before consideration for commodity forward purchases and futures
contracts, an increase in the price of copper of $100 per metric ton (an
increase of 1.5% from 2007 year-end pricing) would adversely affect our annual
operating profit by $1.6 million.
We are subject to interest rate risk, primarily associated with our borrowings
of $56.7 million at September 30, 2008. Our $50 million North American credit
agreement, if we had borrowings against it, would be variable-rate debt. Our
current debt consists 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.
Based on our debt balances at September 30, 2008, a 1% increase in interest
rates would increase interest expense for the year by approximately $0.6
million.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 4
CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
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 management,
including the President and Chief Executive 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 Executive
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 September 30, 2008.
Disclosure controls and procedures are our controls and other procedures that
are designed to ensure that information required to be disclosed by us in the
reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported, within the time periods specified in the Securities and
Exchange Commission's rules and forms. Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that
information required to be disclosed by us in the reports that we file or submit
under the Exchange Act is accumulated and communicated to our management,
including our principal executive and principal financial officers, as
appropriate to allow timely decisions regarding required disclosure.
Internal control over financial reporting is a process designed by, or under the
supervision of, our President & Chief Executive Officer and Chief Financial
Officer, and effected by our board of directors, management and other personnel,
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles and includes those policies and
procedures that: 1) pertain to the maintenance of records that in reasonable
detail accurately and fairly reflect our transactions and dispositions of
assets, 2) provide in reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and expenditures are
being made only in accordance with authorizations of management and directors,
and 3) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisitions, use or disposition of our assets that could have a
material effect on the financial statements.
Changes In Internal Control Over Financial Reporting
During the three months ended September 30, 2008, there have been no changes
that have materially affected, or are reasonably likely to materially affect,
our internal control over financial reporting.
Limitations On The Effectiveness Of Controls And Procedures
Management, including our Chief Executive 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.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION - ITEM 4
CONTROLS AND PROCEDURES
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
ITEM1. LEGAL PROCEEDINGS
A nationwide class-action lawsuit filed against us and other defendants (Ronnie
Phillips et al v. Sears Roebuck Corporation et al., No. 04-L-334 (20th Judicial
Circuit, St. Clair County, IL)) alleged that the horsepower labels on the
products the plaintiffs purchased, which included products manufactured by our
former Engine & Power Train business, were inaccurate. The plaintiffs sought
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. On March 30, 2007, the Court issued an order
granting the defendants' motion to dismiss, and on May 8, 2008 the Court issued
an opinion that (i) dismissed all the claims made under the Racketeer Influenced
and Corrupt Organization (RICO) Act with prejudice; (ii) dismissed all claims of
the 93 non-Illinois plaintiffs with instructions to refile amended claims in
individual state courts; and (iii) ordered that any amended complaint for the
three Illinois plaintiffs be refiled by May 30, 2008. Since that time, three
legal firms have filed numerous class action matters in over twenty states,
asserting claims on behalf of consumers in each of those states with respect to
lawnmower purchases from January 1, 1994 to the present. 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.
On June 13, 2008, Herrick Foundation, then the owner of 25% of our Class B
shares (later reduced to 15.2%), sued Tecumseh Products Company in the Circuit
Court for the County of Lenawee, Michigan. The directors of Herrick Foundation
are Kent B. Herrick, who is a Tecumseh Products Company director, his father,
Todd W. Herrick, and their lawyer, Michael A. Indenbaum. The complaint alleged
that the April 4, 2008 amendment to our bylaws, which increased the percentage
of Class B shares required to call a special meeting from 50% to 75%, violated
Michigan law. Herrick Foundation sought to have the amendment set aside and also
requested the court to order a special meeting of shareholders for the purpose
of removing Dr. Peter Banks and Mr. David Risley from our board of directors. We
filed a counterclaim against Herrick Foundation alleging that Herrick
Foundation's actions violate the settlement agreed to by it and others to end
litigation in April 2007.
On August 11, 2008, we reached an agreement with Herrick Foundation with respect
to its request to schedule the special meeting, which was entered by the Circuit
Court on that date. As a result of this agreement, there will be a special
meeting of voting shareholders on Friday, November 21, 2008. The record date for
the special meeting was October 17. The proposal by Herrick Foundation to remove
Dr. Banks and Mr. Risley from our board of directors will be included in the
agenda for the special meeting and, to the extent that removal is approved, the
election of directors to replace them will also take place. The Company strongly
supports Dr. Banks and Mr. Risley as members of its board and opposes their
removal. The Circuit Court postponed its ruling regarding the amendment to our
bylaws until after the special meeting takes place.
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TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS
(a) Exhibit
Number Description
------- ----------
31.1 Certification of the President and Chief Executive 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 Executive 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: November 6, 2008 BY: /s/ JAMES S. NICHOLSON
------------------------------------
James S. Nicholson
Vice President, Treasurer and
Chief Financial Officer (on behalf
of the Registrant and as principal
financial officer)
Page 46