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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2007
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 1-12387
TENNECO INC.
(Exact name of registrant as specified in its charter)
DELAWARE 76-0515284
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
500 NORTH FIELD DRIVE, LAKE FOREST, 60045
ILLINOIS
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (847) 482-5000
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [X] Accelerated filer [ ] Non-accelerated
filer [ ]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock as of the latest practicable date.
Common Stock, par value $.01 per share: 46,464,795 shares as of July 31,
2007.
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TABLE OF CONTENTS
PAGE
----
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited).............................. 4
Tenneco Inc. and Consolidated Subsidiaries --
Report of Independent Registered Public Accounting Firm.......... 4
Statements of Income............................................. 5
Balance Sheets................................................... 6
Statements of Cash Flows......................................... 7
Statements of Changes in Shareholders' Equity.................... 8
Statements of Comprehensive Income (Loss)........................ 9
Notes to Consolidated Financial Statements....................... 10
Item 2. Management's Discussion and Analysis of Financial Condition 38
and Results of Operations..........................................
Item 3. Quantitative and Qualitative Disclosures About Market Risk.... 62
Item 4. Controls and Procedures....................................... 62
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings............................................. *
Item 1A. Risk Factors.............................................. 64
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds... *
Item 3. Defaults Upon Senior Securities............................... *
Item 4. Submission of Matters to a Vote of Security Holders........... 64
Item 5. Other Information............................................. *
Item 6. Exhibits...................................................... 64
--------
* No response to this item is included herein for the reason that it is
inapplicable or the answer to such item is negative.
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR"
PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995
concerning, among other things, our prospects and business strategies. These
forward-looking statements are included in various sections of this report,
including "Management's Discussion and Analysis of Financial Condition and
Results of Operations" appearing in Part I, Item 2. The words "may," "will,"
"believe," "should," "could," "plans," "expect," "anticipated," "estimates," and
similar expressions (and variations thereof), identify these forward-looking
statements. Although we believe that the expectations reflected in these
forward-looking statements are based on reasonable assumptions, these
expectations may not prove to be correct. Because these forward-looking
statements are also subject to risks and uncertainties, actual results may
differ materially from the expectations expressed in the forward-looking
statements. Important factors that could cause actual results to differ
materially from the expectations reflected in the forward-looking statements
include:
- changes in consumer demand, prices and our ability to have our products
included on top selling vehicles, such as the recent shift in consumer
preferences from light trucks and SUVs to other vehicles in light of
higher fuel costs (because the percentage of our North American OE
revenues related to light trucks and SUVs is greater than the percentage
of the total North American light vehicle build rate represented by light
trucks and SUVs, our North American OE business is sensitive to this
change in consumer preferences), and other factors impacting the
cyclicality of automotive production and sales of automobiles which
include our products, and the potential negative impact on our revenues
and margins from such products;
1
- changes in automotive manufacturers' production rates and their actual
and forecasted requirements for our products;
- the overall highly competitive nature of the automotive parts industry,
and our resultant inability to realize the sales represented by our
awarded book of business (which is based on anticipated pricing for the
applicable program over its life, and is subject to increases or
decreases due to changes in customer requirements, customer and consumer
preferences, and the number of vehicles actually produced by customers);
- the loss of any of our large original equipment manufacturer ("OEM")
customers (on whom we depend for a substantial portion of our revenues),
or the loss of market shares by these customers if we are unable to
achieve increased sales to other OEMs;
- general economic, business and market conditions, including without
limitation the financial difficulties facing a number of companies in the
automotive industry and the potential impact thereof on labor unrest,
supply chain disruptions, weakness in demand and the collectibility of
any accounts receivable due us from such companies;
- labor disruptions at our facilities or any labor or other economic
disruptions at any of our significant customers or suppliers or any of
our customers' other suppliers;
- increases in the costs of raw materials, including our ability to
successfully reduce the impact of any such cost increases through
materials substitutions, cost reduction initiatives, low cost country
sourcing, and price recovery efforts with aftermarket and OE customers;
- the cyclical nature of the global vehicle industry, including the
performance of the global aftermarket sector and the longer product lives
of automobile parts;
- our continued success in cost reduction and cash management programs and
our ability to execute restructuring and other cost reduction plans and
to realize anticipated benefits from these plans;
- costs related to product warranties;
- the impact of consolidation among automotive parts suppliers and
customers on our ability to compete;
- operating hazards associated with our business;
- changes in distribution channels or competitive conditions in the markets
and countries where we operate, including the impact of changes in
distribution channels for aftermarket products on our ability to increase
or maintain aftermarket sales;
- the negative impact of higher fuel prices on discretionary purchases of
aftermarket products by consumers;
- the cost and outcome of existing and any future legal proceedings;
- economic, exchange rate and political conditions in the foreign countries
where we operate or sell our products;
- customer acceptance of new products;
- new technologies that reduce the demand for certain of our products or
otherwise render them obsolete;
- our ability to realize our business strategy of improving operating
performance;
- capital availability or costs, including changes in interest rates,
market perceptions of the industries in which we operate or ratings of
securities;
- our inability to successfully integrate any acquisitions that we
complete;
- changes by the Financial Accounting Standards Board or the Securities and
Exchange Commission of authoritative generally accepted accounting
principles or policies;
2
- potential legislation, regulatory changes and other governmental actions,
including the ability to receive regulatory approvals and the timing of
such approvals;
- the impact of changes in and compliance with laws and regulations,
including environmental laws and regulations, and environmental
liabilities in excess of the amount reserved;
- acts of war and/or terrorism, including, but not limited to, the events
taking place in the Middle East, the current military action in Iraq and
Afghanistan, the current situation in North Korea and the continuing war
on terrorism, as well as actions taken or to be taken by the United
States and other governments as a result of further acts or threats of
terrorism, and the impact of these acts on economic, financial and social
conditions in the countries where we operate; and
- the timing and occurrence (or non-occurrence) of other transactions,
events and circumstances which may be beyond our control.
The risks included here are not exhaustive. Refer to "Part I, Item
1A -- Risk Factors" in our annual report on Form 10-K/A for the year ended
December 31, 2006, for further discussion regarding our exposure to risks.
Additionally, new risk factors emerge from time to time and it is not possible
for us to predict all such risk factors, nor to assess the impact such risk
factors might have on our business or the extent to which any factor or
combination of factors may cause actual results to differ materially from those
contained in any forward-looking statements. Given these risks and
uncertainties, investors should not place undue reliance on forward-looking
statements as a prediction of actual results.
3
PART I.
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF
TENNECO INC.
We have reviewed the accompanying consolidated balance sheet of Tenneco
Inc. and consolidated subsidiaries (the "Company") as of June 30, 2007, and the
related consolidated statements of income, cash flows, comprehensive income
(loss) for the three-month and six-month periods ended June 30, 2007 and 2006,
and of changes in shareholders' equity for the six-month periods ended June 30,
2007 and 2006. These interim financial statements are the responsibility of
Tenneco Inc.'s management.
We conducted our reviews in accordance with the standards of the Public
Company Accounting Oversight Board (United States). A review of interim
financial information consists principally of applying analytical procedures and
making inquiries of persons responsible for financial and accounting matters. It
is substantially less in scope than an audit conducted in accordance with the
standards of the Public Company Accounting Oversight Board (United States), the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that
should be made to such consolidated interim financial statements for them to be
in conformity with accounting principles generally accepted in the United States
of America.
As discussed in Note 11, effective January 1, 2007, the Company adopted the
measurement date provisions of Statement of Financial Accounting Standards No.
158, Employers' Accounting for Defined Benefit Pension and Other Postretirement
Plans -- an amendment of FASB Statements No. 87, 88, 106 and 132(R).
As discussed in Note 2, the accompanying 2006 consolidated financial
statements have been restated.
We have previously audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated balance
sheet of Tenneco Inc. and consolidated subsidiaries as of December 31, 2006, and
the related consolidated statements of income, cash flows, changes in
shareholders' equity, and comprehensive income (loss) for the year then ended
(not presented herein); and in our report dated March 1, 2007 (August 14, 2007
as to the effects of the restatement discussed in Note 4), we expressed an
unqualified opinion on those consolidated financial statements and financial
statement schedule and included an explanatory paragraph regarding the Company's
adoption of Statement of Financial Accounting Standards No. 123(R), "Share-Based
Payment" on January 1, 2006, the Company's adoption of the recognition and
disclosure provisions of Statement of Financial Accounting Standards No. 158,
"Employers' Accounting for Defined Benefit Pension and Other Postretirement
Plans -- an amendment of FASB Statements No. 87, 88, 106 and 132(R)," and the
effects of the restatement discussed in Note 4. In our opinion, the information
set forth in the accompanying consolidated balance sheet as of December 31, 2006
is fairly stated, in all material respects, in relation to the consolidated
balance sheet from which it has been derived.
DELOITTE & TOUCHE LLP
Chicago, Illinois
August 14, 2007
4
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
STATEMENTS OF INCOME
(UNAUDITED)
AS RESTATED AS RESTATED
(NOTE 2) (NOTE 2)
------------ -----------
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
------------ ------------ ----------- -----------
2007 2006 2007 2006
------------ ------------ ----------- -----------
(MILLIONS EXCEPT SHARE AND PER SHARE AMOUNTS)
REVENUES
Net sales and operating revenues.... $ 1,663 $ 1,221 $ 3,063 $ 2,352
----------- ----------- ----------- -----------
COSTS AND EXPENSES
Cost of sales (exclusive of
depreciation and amortization
shown below)..................... 1,377 971 2,556 1,892
Engineering, research, and
development...................... 29 22 56 44
Selling, general, and
administrative................... 104 106 199 207
Depreciation and amortization of
other intangibles................ 50 47 98 91
----------- ----------- ----------- -----------
1,560 1,146 2,909 2,234
----------- ----------- ----------- -----------
OTHER INCOME (EXPENSE)
Loss on sale of receivables......... (3) (2) (5) (4)
Other income (loss)................. 3 -- 3 --
----------- ----------- ----------- -----------
-- (2) (2) (4)
----------- ----------- ----------- -----------
INCOME BEFORE INTEREST EXPENSE, INCOME
TAXES, AND MINORITY INTEREST........ 103 73 152 114
Interest expense (net of interest
capitalized)..................... 40 35 80 72
Income tax expense.................. 20 13 22 13
Minority interest................... 2 1 4 2
----------- ----------- ----------- -----------
NET INCOME............................ $ 41 $ 24 $ 46 $ 27
=========== =========== =========== ===========
EARNINGS PER SHARE
Weighted average shares of common
stock outstanding --
Basic............................... 45,828,992 44,496,640 45,609,875 44,194,107
Diluted............................. 47,680,883 47,175,205 47,415,922 46,874,751
Basic earnings per share of common
stock............................... $ 0.89 $ 0.55 $ 1.00 $ 0.62
Diluted earnings per share of common
stock............................... $ 0.85 $ 0.51 $ 0.96 $ 0.58
The accompanying notes to financial statements are an integral part of these
statements of income.
5
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
BALANCE SHEETS
(UNAUDITED)
AS RESTATED
(NOTE 2)
------------
JUNE 30, DECEMBER 31,
2007 2006
-------- ------------
(MILLIONS)
ASSETS
Current assets:
Cash and cash equivalents.................................... $ 168 $ 202
Receivables --
Customer notes and accounts, net........................ 908 578
Other................................................... 9 17
Inventories --
Finished goods.......................................... 211 193
Work in process......................................... 168 90
Raw materials........................................... 105 122
Materials and supplies.................................. 39 36
Deferred income taxes...................................... 57 51
Prepayments and other...................................... 154 126
------- -------
1,819 1,415
------- -------
Other assets:
Long-term notes receivable, net............................ 24 26
Goodwill................................................... 206 203
Intangibles, net........................................... 8 8
Deferred income taxes...................................... 412 397
Other...................................................... 136 132
------- -------
786 766
------- -------
Plant, property, and equipment, at cost...................... 2,767 2,643
Less -- Reserves for depreciation and amortization......... (1,663) (1,550)
------- -------
1,104 1,093
------- -------
$ 3,709 $ 3,274
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term debt (including current maturities of long-term
debt)................................................... $ 31 $ 28
Trade payables............................................. 1,049 781
Accrued taxes.............................................. 49 49
Accrued interest........................................... 30 33
Accrued liabilities........................................ 213 194
Other...................................................... 26 34
------- -------
1,398 1,119
------- -------
Long-term debt............................................... 1,419 1,357
------- -------
Deferred income taxes........................................ 121 107
------- -------
Postretirement benefits...................................... 335 350
------- -------
Deferred credits and other liabilities....................... 78 87
------- -------
Commitments and contingencies
Minority interest............................................ 32 28
------- -------
Shareholders' equity:
Common stock............................................... -- --
Premium on common stock and other capital surplus.......... 2,795 2,790
Accumulated other comprehensive loss....................... (197) (252)
Retained earnings (accumulated deficit).................... (2,032) (2,072)
------- -------
566 466
Less -- Shares held as treasury stock, at cost............. 240 240
------- -------
326 226
------- -------
$ 3,709 $ 3,274
======= =======
The accompanying notes to financial statements are an integral part of these
balance sheets.
6
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
STATEMENTS OF CASH FLOWS
(UNAUDITED)
AS RESTATED
(NOTE 2)
-----------
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
------------ ------------ ---------- -----------
2007 2006 2007 2006
------------ ------------ ---------- -----------
(MILLIONS)
OPERATING ACTIVITIES
Net income................................ $ 41 $ 24 $ 46 $ 27
Adjustments to reconcile net income to
cash provided (used) by operating
activities --
Depreciation and amortization of other
intangibles.......................... 50 47 98 91
Deferred income taxes................... (10) 2 (13) 7
Stock-based compensation................ 2 2 4 4
Loss on sale of assets, net............. 1 1 3 2
Changes in components of working
capital --
(Increase) decrease in receivables... (111) (16) (312) (100)
(Increase) decrease in inventories... 3 (13) (71) (40)
(Increase) decrease in prepayments
and other current assets........... (13) (14) (24) (37)
Increase (decrease) in payables...... 91 16 241 91
Increase (decrease) in accrued
taxes.............................. -- 2 (4) --
Increase (decrease) in accrued
interest........................... 2 1 (3) 1
Increase (decrease) in other current
liabilities........................ 13 14 19 5
Other..................................... (2) 7 (10) 9
----- ---- ----- -----
Net cash provided (used) by operating
activities.............................. 67 73 (26) 60
----- ---- ----- -----
INVESTING ACTIVITIES
Net proceeds from the sale of assets...... 1 2 1 2
Cash payments for plant, property, and
equipment............................... (36) (42) (75) (89)
Cash payments for software related
intangible assets....................... (4) (3) (11) (6)
Investments and other..................... 1 1 2 1
----- ---- ----- -----
Net cash used by investing activities..... (38) (42) (83) (92)
----- ---- ----- -----
FINANCING ACTIVITIES
Issuance of common shares................. 2 2 4 10
Issuance of long-term debt................ -- -- 150 --
Debt issuance cost of long-term debt...... -- -- (6) --
Retirement of long-term debt.............. (2) (1) (359) (2)
Net increase (decrease) in revolver
borrowings and short-term debt excluding
current maturities of long-term debt.... (7) (12) 273 (3)
Distributions to minority interest
partners................................ -- -- (1) (1)
Other..................................... (1) 2 -- 2
----- ---- ----- -----
Net cash provided (used) by financing
activities.............................. (8) (9) 61 6
----- ---- ----- -----
Effect of foreign exchange rate changes on
cash and cash equivalents............... 11 5 14 8
----- ---- ----- -----
Increase (decrease) in cash and cash
equivalents............................. 32 27 (34) (18)
Cash and cash equivalents, April 1 and
January 1, respectively................. 136 96 202 141
----- ---- ----- -----
Cash and cash equivalents, June 30
(Note).................................. $ 168 $123 $ 168 $ 123
===== ==== ===== =====
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the period for interest.. $ 35 $ 33 $ 77 $ 67
Cash paid during the period for income
taxes (net of refunds).................. $ 20 $ 7 $ 28 $ 7
NON-CASH INVESTING AND FINANCING
ACTIVITIES
Period ended balance of payable for plant,
property, and equipment................. $ 15 $ 23 $ 15 $ 23
NOTE: Cash and cash equivalents include highly liquid investments with a
maturity of three months or less at the date of purchase.
The accompanying notes to financial statements are an integral part of these
statements of cash flows.
7
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(UNAUDITED)
AS RESTATED (NOTE 2)
--------------------
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2007 JUNE 30, 2006
-------------------- --------------------
SHARES AMOUNT SHARES AMOUNT
---------- ------- ---------- -------
(MILLIONS EXCEPT SHARE AMOUNTS)
COMMON STOCK
Balance January 1............................ 47,085,274 $ -- 44,544,668 $ --
Issued pursuant to benefit plans........... 228,036 -- 1,173,248 --
Stock options exercised.................... 383,660 -- 966,583 --
---------- ------- ---------- -------
Balance June 30.............................. 47,696,970 -- 46,684,499 --
========== ==========
PREMIUM ON COMMON STOCK AND OTHER CAPITAL
SURPLUS
Balance January 1............................ 2,790 2,776
Premium on common stock issued pursuant to
benefit plans........................... 5 9
------- -------
Balance June 30.............................. 2,795 2,785
------- -------
ACCUMULATED OTHER COMPREHENSIVE LOSS
Balance January 1............................ (252) (281)
Other comprehensive income................. 55 53
------- -------
Balance June 30.............................. (197) (228)
------- -------
RETAINED EARNINGS (ACCUMULATED DEFICIT)
Balance January 1............................ (2,072) (2,118)
Net income................................. 46 27
Measurement date implementation of SFAS No.
158, net of tax......................... (5) --
Other...................................... (1) (1)
------- -------
Balance June 30.............................. (2,032) (2,092)
------- -------
LESS -- COMMON STOCK HELD AS TREASURY STOCK,
AT COST
Balance January 1 and June 30................ 1,294,692 240 1,294,692 240
========== ------- ========== -------
Total................................... $ 326 $ 225
======= =======
The accompanying notes to financial statements are an integral part
of these statements of changes in shareholders' equity.
8
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
AS RESTATED (NOTE 2)
-----------------------------
THREE MONTHS ENDED JUNE 30, THREE MONTHS ENDED JUNE 30,
2007 2006
----------------------------- -----------------------------
ACCUMULATED ACCUMULATED
OTHER OTHER
COMPREHENSIVE COMPREHENSIVE COMPREHENSIVE COMPREHENSIVE
INCOME INCOME INCOME INCOME
(LOSS) (LOSS) (LOSS) (LOSS)
------------- ------------- ------------- -------------
(MILLIONS)
NET INCOME.......................... $41 $24
--- ---
ACCUMULATED OTHER COMPREHENSIVE
INCOME (LOSS)
CUMULATIVE TRANSLATION ADJUSTMENT
Balance April 1..................... $ (41) $(132)
Translation of foreign currency
statements..................... 29 29 36 36
----- -----
Balance June 30..................... (12) (96)
----- -----
ADDITIONAL LIABILITY FOR PENSION
BENEFITS
Balance April 1 and June 30......... (185) (132)
----- -----
Balance June 30..................... $(197) $(228)
===== --- ===== ---
OTHER COMPREHENSIVE INCOME (LOSS)... 29 36
--- ---
COMPREHENSIVE INCOME................ $70 $60
=== ===
AS RESTATED (NOTE 2)
-----------------------------
SIX MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
2007 2006
----------------------------- -----------------------------
ACCUMULATED ACCUMULATED
OTHER OTHER
COMPREHENSIVE COMPREHENSIVE COMPREHENSIVE COMPREHENSIVE
INCOME INCOME INCOME INCOME
(LOSS) (LOSS) (LOSS) (LOSS)
------------- ------------- ------------- -------------
(MILLIONS)
NET INCOME.......................... $ 46 $27
---- ---
ACCUMULATED OTHER COMPREHENSIVE
INCOME (LOSS)
CUMULATIVE TRANSLATION ADJUSTMENT
Balance January 1................... $ (53) $(149)
Translation of foreign currency
statements..................... 41 41 53 53
----- -----
Balance June 30..................... (12) (96)
----- -----
ADDITIONAL LIABILITY FOR PENSION
BENEFITS
Balance January 1................... (199) (132)
-----
Measurement date implementation of
SFAS No. 158, net of tax.......... 14 14
-----
Balance June 30..................... (185)
-----
Balance June 30..................... $(197) $(228)
===== ---- ===== ---
OTHER COMPREHENSIVE INCOME (LOSS)... 55 53
---- ---
COMPREHENSIVE INCOME................ $101 $80
==== ===
The accompanying notes to financial statements are an integral part
of these statements of comprehensive income (loss).
9
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) As you read the accompanying financial statements and Management's
Discussion and Analysis you should also read our Annual Report on Form 10-K/A
for the year ended December 31, 2006.
In our opinion, the accompanying unaudited financial statements contain all
adjustments (consisting of normal recurring adjustments) necessary to present
fairly Tenneco Inc.'s financial position, results of operations, cash flows,
changes in shareholders' equity, and comprehensive income (loss) for the periods
indicated. We have prepared the unaudited interim consolidated financial
statements pursuant to the rules and regulations of the U.S. Securities and
Exchange Commission. Accordingly, they do not include all of the information and
footnotes required by accounting principles generally accepted in the United
States of America ("GAAP") for annual financial statements.
Our consolidated financial statements include all majority-owned
subsidiaries. We carry investments in 20 percent to 50 percent owned companies
at cost plus equity in undistributed earnings and cumulative translation
adjustments from the date of acquisition since we have the ability to exert
significant influence over operating and financial policies.
Certain reclassifications have been made to prior year amounts to conform
to the current year presentation. We have reclassified in the statement of cash
flows the net change in payables for acquisitions of plant, property and
equipment (PP&E) from the increase (decrease) in payables included in operating
activities into cash payments for PP&E included in investing activities and
disclosed the period end balance of payables for PP&E in non-cash investing and
financing activities. We do not believe these changes in presentation are
material to the financial statements.
(2) Subsequent to the issuance of our consolidated financial statements for
the year ended December 31, 2006, we determined that an error existed in our
financial statements relating to our accounting for three interest rate swaps.
The error did not change the underlying economics of the transaction and had no
effect on our cash flow or liquidity.
In April 2004, we entered into three separate fixed-to-floating interest
rate swaps with two financial institutions. These agreements swapped a total of
$150 million of our fixed 10.25% senior secured notes to floating interest rate
debt at LIBOR plus an average spread of 5.68 percentage points. From the
inception of the interest rate swaps, we applied the so-called "short-cut"
method of fair value hedge accounting under Statement of Financial Accounting
Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities." To qualify for the short-cut method of hedge accounting, the terms
of an interest rate swap must be an exact match, or "mirror image," of the terms
of the debt it is hedging. When these conditions are met, a company can assume
the changes in the value of the hedges and the underlying debt offset each
other. Any unrealized gains and losses in fair value of the swap agreements are
recorded as an offset to long-term debt thereby having no effect on earnings.
While we believed we had appropriately matched the terms of the swaps and
the underlying debt, differences have subsequently been identified. One
difference is between the 30-day notice period to terminate the swaps and the 30
to 60 day notice period to redeem the notes. Another difference relates to the
fact that while the debt and swaps can both be redeemed before their maturity
dates, the notes allow us to make redemptions in increments of $1,000 while the
interest rate swap agreements imply that they can only be redeemed in their full
amounts.
As a result, we have determined that these transactions do not meet the
requirements for hedge accounting treatment under SFAS No. 133 and we are
correcting our past accounting for the swaps as hedges. Therefore, we are
recording the changes in the fair value of the interest rate swaps as increases
or decreases to interest expense in each period since we entered into them,
instead of recording the changes in fair value as an offset to the underlying
debt.
In connection with the restatement, we requested and received from the
lenders under the senior credit facility a waiver of any default or event of
default that would otherwise have arisen because our prior financial statements
could no longer be relied upon.
10
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
Other restatement adjustments
In addition, we are correcting other errors as part of this restatement
that we originally determined to be immaterial, individually and in the
aggregate, to our consolidated financial statements. The corrections include:
Fees on Receivables Sold -- We corrected the classification of costs
associated with our European receivables sale program. These costs were recorded
in interest expense and selling, general and administrative expense and should
have been recorded in other income and expense. This change reduced interest
expense by less than one million dollars in the three month period ended June
30, 2006 and by $1 million in the six month period ended June 30, 2006. Selling,
general and administrative expense was also reduced by less than one million
dollars in the three month period ended June 30, 2006 and by $1 million in the
six month period ended June 30, 2006. This represents the discount from book
values at which these receivables were sold to the third party. This adjustment
did not impact net income.
As a result, the accompanying consolidated financial statements for the
three and six month periods ending June 30, 2006 and the accompanying
consolidated balance sheet as of December 31, 2006 have been restated from the
amounts previously reported. In connection with this restatement, the following
Notes to the Consolidated
11
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
Financial Statements have been restated: 1, 4, 7, 9, 10, 13 and 14. The
following tables reflect the effects of the restatement.
AS PREVIOUSLY AS PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED
------------- ----------- ------------- -----------
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- ---------------------------
2006 2006 2006 2006
------------- ----------- ------------- -----------
REVENUE
Net sales and operating
revenues..................... $ 1,222 $ 1,221 $ 2,354 $ 2,352
----------- ----------- ----------- -----------
COSTS AND EXPENSES
Costs and expenses (exclusive of
depreciation and amortization
shown below)................. 972 971 1,893 1,892
Engineering, research, and
development.................. 22 22 44 44
Selling, general, and
administrative............... 107 106 208 207
Depreciation and amortization of
other intangibles............ 47 47 91 91
----------- ----------- ----------- -----------
1,148 1,146 2,236 2,234
----------- ----------- ----------- -----------
OTHER INCOME (EXPENSE)
Loss on sale of receivables..... (1) (2) (2) (4)
Other income (expense).......... -- -- (1) --
----------- ----------- ----------- -----------
(1) (2) (3) (4)
----------- ----------- ----------- -----------
INCOME BEFORE INTEREST EXPENSE,
INCOME TAXES, AND MINORITY
INTEREST........................ 73 73 115 114
Interest expense (net of
interest capitalized)........ 33 35 67 72
Income tax expense (benefit).... 15 13 15 13
Minority interest............... 1 1 2 2
----------- ----------- ----------- -----------
NET INCOME........................ $ 24 $ 24 $ 31 $ 27
=========== =========== =========== ===========
EARNINGS PER SHARE
Average shares of common stock
outstanding --
Basic........................... 44,496,640 44,496,640 44,194,107 44,194,107
Diluted......................... 47,175,205 47,175,205 46,874,751 46,874,751
Basic earnings per share of common
stock........................... $ 0.56 $ 0.55 $ 0.71 $ 0.62
Diluted earnings per share of
common stock.................... $ 0.53 $ 0.51 $ 0.67 $ 0.58
12
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
AS PREVIOUSLY
REPORTED AS RESTATED
------------- -----------
DECEMBER 31,
---------------------------
2006 2006
------------- -----------
ASSETS
Current assets:
Cash, and cash equivalents............................... $ 202 $ 202
Receivables -
Customer notes and accounts, net...................... 579 578
Other................................................. 25 17
Inventories -
Finished Goods........................................ 191 193
Work in process....................................... 90 90
Raw Materials......................................... 122 122
Materials & Supplies.................................. 36 36
Deferred income taxes.................................... 52 51
Prepayments and other.................................... 125 126
------- -------
1,422 1,415
------- -------
Other assets:
Long-term notes receivable, net.......................... 26 26
Goodwill................................................. 203 203
Intangibles, net......................................... 9 8
Deferred income taxes.................................... 376 397
Other.................................................... 134 132
------- -------
748 766
------- -------
Plant, property, and equipment, at cost.................... 2,643 2,643
Less -- Accumulated depreciation and amortization........ (1,550) (1,550)
------- -------
1,093 1,093
------- -------
$ 3,263 $ 3,274
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term debt (including current maturities of long-
term debt)............................................ $ 28 28
Trade payables........................................... 782 781
Accrued taxes............................................ 49 49
Accrued interest......................................... 40 33
Accrued liabilities...................................... 200 194
Other.................................................... 34 34
------- -------
1,133 1,119
Long-term debt............................................. 1,350 1,357
Deferred income taxes...................................... 107 107
Postretirement benefits.................................... 349 350
Deferred credits and other liabilities..................... 75 87
Commitments and contingencies
Minority interest.......................................... 28 28
Shareholders' equity:
Common stock............................................. -- --
Premium on common stock and other capital surplus........ 2,790 2,790
Accumulated other comprehensive loss..................... (253) (252)
Retained earnings (accumulated deficit).................. (2,076) (2,072)
------- -------
461 466
Less -- Shares held as treasury stock, at cost............. 240 240
------- -------
221 226
------- -------
$ 3,263 $ 3,274
======= =======
13
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
AS PREVIOUSLY
REPORTED AS RESTATED
------------- -----------
SIX MONTHS ENDED JUNE 30,
---------------------------
2006 2006
------------- -----------
(MILLIONS)
OPERATING ACTIVITIES
Net income................................................. $ 31 $ 27
Adjustments to reconcile net income to cash provided by
operating activities --
Depreciation and amortization of other intangibles......... 91 91
Deferred income taxes...................................... 8 7
Stock-based compensation................................... 2 4
Loss on sale of assets, net................................ 2 2
Changes in components of working capital --
(Increase) decrease in receivables....................... (102) (100)
(Increase) decrease in inventories....................... (40) (40)
(Increase) decrease in prepayments and other current
assets................................................ (27) (37)
Increase (decrease) in payables.......................... 90 91
Increase (decrease) in accrued taxes..................... -- --
Increase (decrease) in accrued interest.................. 1 1
Increase (decrease) in other current liabilities......... (4) 5
Other...................................................... 5 9
----- -----
Net cash provided by operating activities.................. 57 60
----- -----
INVESTING ACTIVITIES
Net proceeds from the sale of assets....................... 2 2
Cash payments for plant, property, and equipment........... (87) (89)
Cash payments for software related intangible assets....... (6) (6)
Investments and other...................................... 1 1
----- -----
Net cash used by investing activities...................... (90) (92)
----- -----
FINANCING ACTIVITIES
Issuance of common shares.................................. 10 10
Issuance of long-term debt................................. -- --
Debt issuance costs on long-term debt...................... -- --
Retirement of long-term debt............................... (2) (2)
Net decrease in revolver borrowings and short-term debt
excluding current maturities of long-term debt........... (3) (3)
Distribution to minority interest partners................. -- (1)
Other...................................................... 2 2
----- -----
Net cash provided by financing activities.................. 7 6
----- -----
Effect of foreign exchange rate changes on cash and cash
equivalents.............................................. 8 8
Increase (decrease) in cash and cash equivalents........... (18) (18)
Cash and cash equivalents, January 1....................... 141 141
----- -----
Cash and cash equivalents, June 30......................... $ 123 $ 123
===== =====
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the year for interest..................... $ 67 $ 67
Cash paid during the year for income taxes (net of
refunds)................................................. $ 7 $ 7
NON-CASH INVESTING AND FINANCING ACTIVITIES
Period ended balance of payables for plant, property, and
equipment................................................ -- $ 23
14
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
(3) Equity Plans -- In December 1996, we adopted the 1996 Stock Ownership
Plan, which permitted the granting of a variety of awards, including common
stock, restricted stock, performance units, stock equivalent units, stock
appreciation rights ("SARs"), and stock options to our directors, officers,
employees and consultants. The plan, which terminated as to new awards on
December 31, 2001, was renamed the "Stock Ownership Plan." In December 1999, we
adopted the Supplemental Stock Ownership Plan, which permitted the granting of a
variety of similar awards to our directors, officers, employees and consultants.
We were authorized to deliver up to about 1.1 million treasury shares of common
stock under the Supplemental Stock Ownership Plan, which also terminated as to
new awards on December 31, 2001. In March 2002, we adopted the 2002 Long-Term
Incentive Plan which permitted the granting of a variety of similar awards to
our officers, directors, employees and consultants. Up to 4 million shares of
our common stock were authorized for award under the 2002 Long-Term Incentive
Plan. In March 2006, we adopted the 2006 Long-Term Incentive Plan which replaced
the 2002 Long-Term Incentive Plan and permits the granting of a variety of
similar awards to directors, officers, employees and consultants. Up to 2
million shares of our common stock plus the shares remaining for issuance under
the 2002 Long-Term Incentive Plan are authorized for award under the 2006 Long-
Term Incentive Plan. As of June 30, 2007, up to 1,301,144 shares of our common
stock remain authorized for award under the 2006 Long-Term Incentive Plan. Our
nonqualified stock options have 7 to 20 year terms and vest equally over a three
year service period from the date of the grant.
We have granted restricted common stock to our directors and certain key
employees. These awards generally require, among other things, that the award
holder remains in service to our company during the restriction period. We have
also granted stock equivalent units and long term performance units to certain
key employees that are payable in cash. For 2007, the awards contain an annual
stub-year grant payable in the first quarter of 2008 and a three-year grant
payable in the first quarter of 2010. Payment is based on the attainment of
specified performance goals. The grant value is indexed to the stock price. Each
employee granted long term performance units will (based on the achievement of
the applicable goals) receive a percentage of the total grant's value. In
addition, we have granted SARs to certain key employees in our Asian operations
that are payable in cash after a three year service period. The grant value is
indexed to the stock price.
Accounting Methods -- Effective January 1, 2006, we adopted SFAS No.
123(R), "Share-Based Payment," using the modified prospective application
method. Under this transition method, compensation cost recognized for the six
months ended June 30, 2007 and 2006, respectively, includes the applicable
amounts of: (1) compensation cost of all unvested stock-based awards granted
prior to January 1, 2006, based upon the grant date fair value estimated in
accordance with the original provisions of SFAS No. 123 and previously presented
in pro forma footnote disclosures, and (2) compensation cost for all stock-based
awards granted on or after January 1, 2006, based upon the grant date fair value
estimated in accordance with the new provisions of SFAS No. 123(R).
The impact of recognizing compensation expense related to nonqualified
stock options is contained in the table below.
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2007 2006
---------------- ----------------
(MILLIONS) (MILLIONS)
Selling, general and administrative.................. $ 2 $ 2
------ ------
Loss before interest expense, income taxes and
minority interest.................................. (2) (2)
Income tax benefit................................... 1 1
------ ------
Net loss............................................. $ (1) $ (1)
====== ======
Decrease in basic earnings per share................. $(0.04) $(0.03)
Decrease in diluted earnings per share............... $(0.04) $(0.03)
15
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
For stock options awarded to retirement eligible employees we immediately
accelerate the recognition of any outstanding compensation cost when employees
become retiree eligible before the end of the explicit vesting period.
As of June 30, 2007, there was approximately $5 million, net of tax, of
total unrecognized compensation costs related to these stock-based awards that
we expect to recognize over a weighted average period of 1.2 years.
Compensation expense for restricted stock, stock equivalent units, long
term performance units and SARs, net of tax, was approximately $3 million for
the six months ended June 30, 2007 and 2006, and was recorded in selling,
general, and administrative expense on the statement of income.
SFAS No. 109, "Accounting for Income Taxes," discusses the deductibility of
transactions. We are allowed a tax deduction for compensation cost which is
calculated as the difference between the value of the stock at the date of grant
and the price upon exercise of a stock option. Under SFAS No. 123(R), excess tax
benefits, which are tax benefits we may realize upon the exercise of stock
options that are greater than the tax benefit recognized on the compensation
cost recorded in our income statement, are recorded as an addition to paid-in
capital. We would present cash retained as a result of excess tax benefits as
financing cash flows. Any write-offs of deferred tax assets related to
unrealized tax benefits associated with the recognized compensation cost would
be reported as income tax expense.
Cash received from option exercises for the six months ended June 30, 2007,
was approximately $3 million. Stock option exercises during the first six months
of 2007 generated an excess tax benefit of approximately $3 million. Pursuant to
footnote 82 of SFAS No. 123(R), this benefit was not recorded as we have federal
and state net operating losses which are not currently being utilized. As a
result, the excess tax benefit had no impact on our financial position or
statement of cash flows.
Assumptions -- We calculated the fair values of stock option awards using
the Black-Scholes option pricing model with the weighted average assumptions
listed below. Determining the fair value of share-based awards requires judgment
in estimating employee and market behavior. If actual results differ
significantly from these estimates, stock-based compensation expense and our
results of operations could be materially impacted.
SIX MONTHS
ENDED
JUNE 30,
-------------
2007 2006
----- -----
Stock Options
Weighted average grant date fair value, per share................ $9.91 $9.27
Weighted average assumptions used:
Expected volatility.............................................. 38.4% 42.6%
Expected lives................................................... 4.1 5.1
Risk-free interest rates......................................... 4.7% 4.2%
Dividend yields.................................................. 0.0% 0.0%
Effective January 1, 2006, we changed our method of determining volatility
on all new options granted after that date to implied volatility rather than an
analysis of historical volatility. We believe the market-based measures of
implied volatility are currently the best available indicators of the expected
volatility used in these estimates. The effect of this change did not have a
material impact to our results of operations.
Expected lives of options are based upon the historical and expected time
to post-vesting forfeiture and exercise. We believe this method is the best
estimate of the future exercise patterns currently available.
The risk-free interest rates are based upon the Constant Maturity Rates
provided by the U.S. Treasury. For our valuations, we used the continuous rate
with a term equal to the expected life of the options.
16
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
On January 10, 2001, we announced that our Board of Directors eliminated
the quarterly dividend on our common stock. As a result, there is no dividend
yield.
Stock Options -- The following table reflects the status and activity for
all options to purchase common stock for the period indicated:
SIX MONTHS ENDED JUNE 30, 2007
------------------------------------------------------
WEIGHTED AVG.
SHARES WEIGHTED AVG. REMAINING AGGREGATE
UNDER EXERCISE LIFE IN INTRINSIC
OPTION PRICES YEARS VALUE
--------- ------------- ------------- ----------
(MILLIONS)
Outstanding Stock Options
Outstanding, January 1, 2007.............. 3,074,173 $10.13
Granted................................. 589,681 26.68
Canceled................................ -- --
Forfeited............................... (54,730) 23.67
Exercised............................... (192,563) 7.31 $ 3
---------
Outstanding, March 31, 2007............... 3,416,561 $12.93 5.2 $42
Granted................................. 33,039 13.86
Canceled................................ (159,800) --
Forfeited............................... (31,317) 23.27
Exercised............................... (191,097) 6.58 $ 5
---------
Outstanding, June 30, 2007................ 3,067,386 $12.65 5.2 $55
=========
Vested or expected to vest, June 30,
2007.................................... 3,065,875 $12.65 5.2 $55
=========
Exercisable, June 30, 2007................ 2,272,539 $ 8.38 4.8 $51
=========
Restricted Stock -- The following table reflects the status for all
nonvested restricted shares for the period indicated:
SIX MONTHS ENDED
JUNE 30, 2007
------------------------
WEIGHTED AVG.
GRANT DATE
SHARES FAIR VALUE
-------- -------------
Nonvested Restricted Shares
Nonvested balance at January 1, 2007....................... 386,507 $17.10
Granted.................................................. 364,018 26.73
Vested................................................... (222,040) 15.39
Forfeited................................................ (35,972) 22.49
--------
Nonvested balance at March 31, 2007........................ 492,513 $24.60
Granted.................................................. 6,527 30.22
Vested................................................... (833) 13.28
Forfeited................................................ (17,199) 22.35
--------
Nonvested balance at June 30, 2007......................... 481,008 $24.77
========
17
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
The fair value of restricted stock grants is equal to the average market
price of our stock at the date of grant. As of June 30, 2007, approximately $10
million of total unrecognized compensation costs related to restricted stock
awards is expected to be recognized over a weighted-average period of
approximately 2.2 years.
Long Term Performance Units and SARs -- Long term performance units and
SARs are paid in cash and recognized as a liability based upon their fair value.
As of June 30, 2007, approximately $8 million of total unrecognized compensation
costs is expected to be recognized over the weighted-average period of
approximately 1.5 years.
(4) In March 2007 we refinanced our $831 million senior credit facility.
This transaction reduced the interest rates we pay on all portions of the
facility. While the total amount of the new senior credit facility is $830
million, approximately the same as the previous facility, we changed the
components of the facility to enhance our financial flexibility. We increased
the amount of commitments under our revolving loan facility from $320 million to
$550 million, reduced the amount of commitments under our tranche B-1 letter of
credit/revolving loan facility from $155 million to $130 million and replaced
the $356 million term loan B with a $150 million term loan A. As of June 30,
2007, the senior credit facility consisted of a five-year, $150 million term
loan A maturing in March 2012, a five-year, $550 million revolving credit
facility maturing in March 2012, and a seven-year $130 million tranche B-1
letter of credit/revolving loan facility maturing in March 2014.
The refinancing of the prior facility allowed us to: (i) amend the
consolidated net debt to EBITDA ratio, (ii) eliminate the fixed charge coverage
ratio, (iii) eliminate the restriction on capital expenditures, (iv) increase
the amount of acquisitions permitted to $250 million, (v) improve the
flexibility to repurchase and retire higher cost junior debt, (vi) increase our
ability to enter into capital leases, (vii) increase the ability of our foreign
subsidiaries to incur debt, (viii) increase our ability to pay dividends and
repurchase common stock, (ix) increase our ability to invest in joint ventures,
(x) allow for the increase in the existing tranche B-1 facility and/or the term
loan A or the addition of a new term loan of up to $275 million in order to
reduce our 10.25 percent senior secured notes, and (xi) make other
modifications.
Following the refinancing, the term loan A facility is payable in twelve
consecutive quarterly installments, commencing June 30, 2009 as follows: $6
million due each of June 30, September 30, December 31, 2009 and March 31, 2010,
$15 million due each of June 30, September 30, December 31, 2010 and March 31,
2011, and $17 million due each of June 30, September 30, December 31, 2011 and
March 16, 2012. The revolving credit facility requires that any amounts drawn,
be repaid by March 2012. Prior to that date, funds may be borrowed, repaid and
reborrowed under the revolving credit facility without premium or penalty.
Letters of credit may be issued under the revolving credit facility.
The tranche B-1 letter of credit/revolving loan facility requires that it
be repaid by March 2014. We can borrow revolving loans and issue letters of
credit under the $130 million tranche B-1 letter of credit/revolving loan
facility. The tranche B-1 letter of credit/revolving loan facility lenders have
deposited $130 million with the administrative agent, who has invested that
amount in time deposits. We do not have an interest in any of the funds on
deposit. When we draw revolving loans under this facility, the loans are funded
from the $130 million on deposit with the administrative agent. When we make
repayments, the repayments are redeposited with the administrative agent.
The tranche B-1 letter of credit/revolving loan facility is reflected as
debt on our balance sheet only if we borrow money under this facility or if we
use the facility to make payments for letters of credit. We will not be liable
for any losses to or misappropriation of any (i) return due to the
administrative agent's failure to achieve the return described above or to pay
all or any portion of such return to any lender under such facility or (ii)
funds on deposit in such account by such lender (other than the obligation to
repay funds released from such accounts and provided to us as revolving loans
under such facility).
We have three fixed-to-floating interest rate swaps that effectively
convert $150 million of our 10.25 percent fixed interest rate senior secured
notes into floating interest rate debt at an annual rate of LIBOR plus 5.68
percent.
18
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
Based upon the current LIBOR rate of 5.39 percent (which is in effect until
January 15, 2008) these swaps are expected to increase our interest expense by
$1 million in 2007 excluding any impact from marking the swaps to market. Since
entering into these swaps, we have realized a net cumulative benefit of $3
million through June 30, 2007, in reduced interest payments. The change in the
market value of these swaps is recorded as part of interest expense with an
offset to other long-term liabilities. As of June 30, 2007, the fair value of
the interest rate swaps was a liability of approximately $9 million which has
been recorded in other long-term liabilities.
(5) In June 2006, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes, an
Interpretation of FASB Statement No. 109 ("FIN 48")". FIN 48 is a new
interpretation of SFAS No. 109 establishing a new model in accounting for
uncertainty in income taxes recognized in financial statements. FIN 48
prescribes a recognition threshold and measurement attributes for financial
statement disclosure of tax positions taken or expected to be taken on tax
returns. Under FIN 48, the impact of an uncertain income tax position on the
income tax return must be recognized at the largest amount that is more-likely-
than-not to be sustained upon audit by the relevant taxing authority. An
uncertain income tax position will not be recognized if it has less than a 50%
likelihood of being sustained. In addition, FIN 48 provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. FIN 48 is effective for fiscal years
beginning after December 15, 2006. In May 2007, the FASB issued Interpretation
No. 48-1, "Definition of Settlement in FASB Interpretation No. 48". FIN 48-1 is
effective for fiscal years beginning after December 15, 2006 and provides
guidance on how a reporting entity should determine when a tax position is
effectively settled.
We adopted the provisions of FIN 48 on January 1, 2007. The total amount of
unrecognized tax benefits as of the date of adoption was $42 million. As a
result of the implementation of FIN 48, we recognized an increase to retained
earnings in an amount less than $1 million and a decrease to our accruals for
uncertain tax positions and related interest and penalties by a corresponding
amount.
Included in the balance of unrecognized tax benefits at January 1, 2007,
are $26 million of tax benefits that, if recognized, would impact the effective
tax rate. Also included in the balance of the unrecognized tax benefits at
January 1, 2007, are $14 million of tax benefits that, if recognized, would
result in adjustments to other tax accounts, primarily deferred taxes.
We recognize interest related to unrecognized tax benefits in interest
expense and penalties in the provision for income taxes. Upon adoption of FIN 48
on January 1, 2007, we have an accrual for interest and penalties of $3 million.
Included in the balance of unrecognized tax benefits at January 1, 2007,
are $1 million of unrecognized tax benefits that are expected to settle or for
which the statute of limitations will expire within the next twelve months.
We are subject to taxation in the U.S. and various states and foreign
jurisdictions. Canada and Germany are our significant tax jurisdictions where we
have had recent audit activity. A Canadian tax examination for years ended 2002-
2004 has just been initiated. In 2006 we concluded a German tax examination for
years ended 1998-2001. We have accrued the appropriate amounts and have made the
required cash payments to the German tax authorities. With few exceptions, we
are no longer subject to U.S. federal, state, local or foreign examinations by
tax authorities for years before 2002. However, in certain jurisdictions tax
authorities generally have the right, without regard to whether the year is
open, to examine years in which a loss carryover originates in the year the loss
carryover is used.
(6) Over the past several years we have adopted plans to restructure
portions of our operations. These plans were approved by the Board of Directors
and were designed to reduce operational and administrative overhead costs
throughout the business. Prior to the change in accounting required for exit or
disposal activities, we recorded charges to income related to these plans for
costs that did not benefit future activities in the period in which the plans
were finalized and approved, while actions necessary to affect these
restructuring plans occurred over future periods in accordance with established
plans.
19
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
Our recent restructuring activities began in the fourth quarter of 2001,
when our Board of Directors approved a restructuring plan, a project known as
Project Genesis, which was designed to lower our fixed costs, relocate capacity,
reduce our work force, improve efficiency and utilization, and better optimize
our global footprint. We have subsequently engaged in various other
restructuring projects related to Project Genesis. We incurred $27 million in
restructuring and restructuring-related costs during 2006, of which $23 million
was recorded in cost of sales and $4 million was recorded in selling, general
and administrative expense. In the second quarter of 2007, we incurred $2
million in restructuring and restructuring-related costs which was recorded in
cost of sales. For the first six months of 2007, we incurred $4 million in
restructuring and restructuring-related costs of which $3 million was recorded
in cost of sales and $1 million in selling, general and administrative expense.
Since Project Genesis was initiated, we have incurred costs of $134 million
through June 30, 2007.
Under the terms of our amended and restated senior credit agreement that
took effect on March 16, 2007, we are allowed to exclude $80 million of cash
charges and expenses, before taxes, related to cost reduction initiatives
incurred after March 16, 2007 from the calculation of the financial covenant
ratios required under our senior credit facility. As of June 30, 2007, we have
excluded $4 million in allowable charges relating to restructuring initiatives
against the $80 million available under the terms of the March 2007 amended and
restated senior credit facility.
In addition to the announced actions, we will continue to evaluate
additional opportunities and expect that we will initiate actions that will
reduce our costs through implementing the most appropriate and efficient
logistics, distribution and manufacturing footprint for the future. We expect to
continue to undertake additional restructuring actions as deemed necessary,
however, there can be no assurances we will undertake such actions. Actions that
we take, if any, will require the approval of our Board of Directors, or its
authorized committee. We plan to conduct any workforce reductions that result in
compliance with all legal and contractual requirements including obligations to
consult with workers' councils, union representatives and others.
(7) We are subject to a variety of environmental and pollution control laws
and regulations in all jurisdictions in which we operate. We expense or
capitalize, as appropriate, expenditures for ongoing compliance with
environmental regulations that relate to current operations. We expense costs
related to an existing environmental condition caused by past operations that do
not contribute to current or future revenue generation. We record liabilities
when environmental assessments indicate that remedial efforts are probable and
the costs can be reasonably estimated. Estimates of the liability are based upon
currently available facts, existing technology, and presently enacted laws and
regulations taking into consideration the likely effects of inflation and other
societal and economic factors. We consider all available evidence including
prior experience in remediation of contaminated sites, other companies' cleanup
experiences and data released by the United States Environmental Protection
Agency or other organizations. These estimated liabilities are subject to
revision in future periods based on actual costs or new information. Where
future cash flows are fixed or reliably determinable, we have discounted the
liabilities. All other environmental liabilities are recorded at their
undiscounted amounts. We evaluate recoveries separately from the liability and,
when they are assured, recoveries are recorded and reported separately from the
associated liability in our financial statements.
As of June 30, 2007, we are designated as a potentially responsible party
in one Superfund site. Including the Superfund site, we may have the obligation
to remediate current or former facilities, and we estimate our share of
environmental remediation costs at these facilities to be approximately $9
million. For the Superfund site and the current and former facilities, we have
established reserves that we believe are adequate for these costs. Although we
believe our estimates of remediation costs are reasonable and are based on the
latest available information, the cleanup costs are estimates and are subject to
revision as more information becomes available about the extent of remediation
required. At some sites, we expect that other parties will contribute to the
remediation costs. In addition, at the Superfund site, the Comprehensive
Environmental Response, Compensation and Liability Act provides that our
liability could be joint and several, meaning that we could be required to pay
in excess of our share of remediation costs. Our understanding of the financial
strength of other potentially responsible parties at the
20
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
Superfund site, and of other liable parties at our current and former
facilities, has been considered, where appropriate, in our determination of our
estimated liability. We believe that any potential costs associated with our
current status as a potentially responsible party in the Superfund site, or as a
liable party at our current or former facilities, will not be material to our
results of operations or consolidated financial position.
We also from time to time are involved in legal proceedings, claims or
investigations that are incidental to the conduct of our business. Some of these
proceedings allege damages against us relating to environmental liabilities
(including toxic tort, property damage and remediation), intellectual property
matters (including patent, trademark and copyright infringement, and licensing
disputes), personal injury claims (including injuries due to product failure,
design or warnings issues, and other product liability related matters), taxes,
employment matters, and commercial or contractual disputes, sometimes related to
acquisitions or divestitures. We vigorously defend ourselves against all of
these claims. In future periods, we could be subjected to cash costs or non-cash
charges to earnings if any of these matters is resolved on unfavorable terms.
However, although the ultimate outcome of any legal matter cannot be predicted
with certainty, based on current information, including our assessment of the
merits of the particular claim, we do not expect that these legal proceedings or
claims will have any material adverse impact on our future consolidated
financial position or results of operations.
In addition, we are subject to a number of lawsuits initiated by a
significant number of claimants alleging health problems as a result of exposure
to asbestos. A small percentage of claims have been asserted by railroad workers
alleging exposure to asbestos products in railroad cars manufactured by The
Pullman Company, one of our subsidiaries. Nearly all of the claims are related
to alleged exposure to asbestos in our automotive emission control products.
Only a small percentage of these claimants allege that they were automobile
mechanics and a significant number appear to involve workers in other industries
or otherwise do not include sufficient information to determine whether there is
any basis for a claim against us. We believe, based on scientific and other
evidence, it is unlikely that mechanics were exposed to asbestos by our former
muffler products and that, in any event, they would not be at increased risk of
asbestos-related disease based on their work with these products. Further, many
of these cases involve numerous defendants, with the number of each in some
cases exceeding 200 defendants from a variety of industries. Additionally, the
plaintiffs either do not specify any, or specify the jurisdictional minimum,
dollar amount for damages. As major asbestos manufacturers continue to go out of
business or file for bankruptcy, we may experience an increased number of these
claims. We vigorously defend ourselves against these claims as part of our
ordinary course of business. In future periods, we could be subject to cash
costs or non-cash charges to earnings if any of these matters is resolved
unfavorably to us. To date, with respect to claims that have proceeded
sufficiently through the judicial process, we have regularly achieved favorable
resolution. Accordingly, we presently believe that these asbestos-related claims
will not have a material adverse impact on our future financial condition or
results of operations.
We provide warranties on some of our products. The warranty terms vary but
range from one year up to limited lifetime warranties on some of our premium
aftermarket products. Provisions for estimated expenses related to product
warranty are made at the time products are sold or when specific warranty issues
are identified on OE products. These estimates are established using historical
information about the nature, frequency, and average cost of warranty claims. We
actively study trends of our warranty claims and take action to improve product
quality and minimize warranty claims. We believe that the warranty reserve is
appropriate; however, actual claims incurred could differ from the original
estimates, requiring adjustments to the reserve. The reserve is included in both
current and long-term liabilities on the balance sheet.
21
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
Below is a table that shows the activity in the warranty accrual accounts:
SIX MONTHS
ENDED
JUNE 30,
-----------
2007 2006
---- ----
(MILLIONS)
Beginning Balance January 1,....................................... $25 $22
Accruals related to product warranties............................. 7 9
Reductions for payments made....................................... (5) (9)
--- ---
Ending Balance June 30,............................................ $27 $22
=== ===
The current year increase in the warranty accrual is primarily driven by
higher unit pricing and product mix in the North American aftermarket.
(8) In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurement." This statement defines fair value, establishes a framework for
measuring fair value in generally accepted accounting principles and expands
disclosures about fair value measurements. This statement applies under other
accounting pronouncements that require or permit fair value measurements. The
statement is effective for financial statements issued for fiscal years
beginning after November 15, 2007, and interim periods within those fiscal
years. We do not expect the adoption of this statement to have a material impact
to our financial statements.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB
Statements No. 87, 88, 106, and 132(R)." Part of this Statement was effective as
of December 31, 2006, and requires companies that have defined benefit pension
plans and other postretirement benefit plans to recognize the funded status of
those plans on the balance sheet on a prospective basis from the effective date.
The funded status of these plans is determined as of the plans' measurement
dates and represents the difference between the amount of the obligations owed
to participants under each plan (including the effects of future salary
increases for defined benefit plans) and the fair value of each plan's assets
dedicated to paying those obligations. To record the funded status of those
plans, unrecognized prior service costs and net actuarial losses experienced by
the plans will be recorded in the Accumulated Other Comprehensive Loss section
of shareholders' equity on the balance sheet. The initial adoption as of
December 31, 2006 resulted in a reduction of Accumulated Other Comprehensive
Loss in shareholders' equity of $59 million.
In addition, SFAS No. 158 requires that companies using a measurement date
for their defined benefit pension plans and other postretirement benefit plans
other than their fiscal year end, change the measurement date to the fiscal year
end effective for fiscal years ending after December 15, 2008. Effective January
1, 2007, we elected to early adopt the measurement date provision of SFAS No.
158. Adoption of this part of the statement was not material to our financial
position and results of operations. See Note 11.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities." This statement permits companies to
choose to measure at fair value many financial instruments and certain other
items that are not currently required to be measured at fair value. SFAS No. 159
is effective for financial statements issued for fiscal years beginning on or
after November 15, 2007. We do not believe the statement will have a material
effect on our financial statements and related disclosures.
In April 2007, the FASB issued Interpretation No. 39-1, "Amendment of FASB
Interpretation No. 39". This amendment allows a reporting entity to offset fair
value amounts recognized for derivative instruments with fair value amounts
recognized for the right to reclaim or realize cash collateral. Additionally,
this amendment requires disclosure of the accounting policy on the reporting
entity's election to offset or not offset amounts for derivative instruments.
FIN 39-1 is effective for fiscal years beginning after November 15, 2007. We do
not expect the adoption of FIN 39-1 to have a material impact on our financial
statements.
22
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
In May 2007, the FASB issued Interpretation No. 48-1, "Definition of
Settlement in FASB Interpretation No. 48". FIN 48-1 is effective for fiscal
years beginning after December 15, 2006 and provides guidance on how a reporting
entity should determine when a tax position is effectively settled. We have
applied FIN 48-1 in the current quarter. The adoption of FIN 48-1 did not have a
material impact to our financial statements and related disclosures. See Note 5.
In June 2007, the Emerging Issues Task Force ("EITF") issued EITF 06-11,
"Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards".
EITF 06-11 provides the final consensus on the application of paragraphs 62 and
63 of SFAS 123(R) on the accounting for income tax benefits relating to the
payment of dividends on equity-classified employee share-based payment awards
that are charged to retained earnings. EITF 06-11 affirms that the realized
income tax benefit from dividends or dividend equivalents that are charged to
retained earnings for equity classified nonvested equity shares, nonvested
equity share units, and outstanding equity share options should be recognized as
an increase in additional paid-in-capital. Additionally, EITF 06-11 provides
guidance on the amount of tax benefits from dividends that are reclassified from
additional paid-in-capital to the income statement when an entity's estimate of
forfeitures changes. EITF 06-11 is effective prospectively for the income tax
benefits that result from dividends on equity-classified employee share-based
payment awards that are declared in fiscal years beginning after December 15,
2007. Because we currently do not pay dividends on our common stock, we do not
expect the adoption of EITF 06-11 to have an impact on our financial statements.
In June 2007, the EITF issued EITF 07-3, "Accounting for Nonrefundable
Advance Payments for Goods or Services Received for Use in Future Research and
Development Activities". EITF 07-3 requires the deferral and capitalization of
nonrefundable advance payments for goods and services that an entity will use in
research and development activities pursuant to an executory contractual
agreement. Expenditures which are capitalized under EITF 07-3 should be expensed
as the goods are delivered or the related services are performed. EITF 07-3 is
effective prospectively for fiscal years beginning after December 15, 2007 and
interim periods within those fiscal years. EITF 07-3 is applicable to new
contracts entered into on or after the effective date of this Issue. We do not
expect the adoption of EITF 07-3 to have a material impact on our financial
statements.
(9) We have an agreement to sell an interest in some of our U.S. trade
accounts receivable to a third party. Receivables become eligible for the
program on a daily basis, at which time the receivables are sold to the third
party, net of a factoring discount, through a wholly-owned subsidiary. Under
this agreement, as well as individual agreements with third parties in Europe,
we have sold accounts receivable of $148 million at June 30, 2007 and 2006. We
recognized a loss of approximately $5 million for the six months ended June 30,
2007, and approximately $4 million for the six months ended June 30, 2006, on
these sales of trade accounts, representing the discount from book values at
which these receivables were sold to the third party. The discount rate varies
based on funding cost incurred by the third party, which has averaged
approximately six percent during 2007. We retain ownership of the remaining
interest in the pool of receivables not sold to the third party. The retained
interest represents a credit enhancement for the program. We value the retained
interest based upon the amount we expect to collect from our customers, which
approximates book value.
23
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
(10) Earnings per share of common stock outstanding were computed as
follows:
AS RESTATED AS RESTATED
(NOTE 2) (NOTE 2)
------------ -----------
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
2007 2006 2007 2006
------------ ------------ ----------- -----------
(MILLIONS EXCEPT SHARE AND PER SHARE AMOUNTS)
Basic earnings per share --
Net Income.......................... $ 41 $ 24 $ 46 $ 27
=========== =========== =========== ===========
Average shares of common stock
outstanding...................... 45,828,992 44,496,640 45,609,875 44,194,107
=========== =========== =========== ===========
Earnings per average share of common
stock............................ $ 0.89 $ 0.55 $ 1.00 $ 0.62
=========== =========== =========== ===========
Diluted earnings per share --
Net Income.......................... $ 41 $ 24 $ 46 $ 27
=========== =========== =========== ===========
Average shares of common stock
outstanding...................... 45,828,992 44,496,640 45,609,875 44,194,107
Effect of dilutive securities:
Restricted stock................. 139,897 452,586 203,090 458,619
Stock options.................... 1,711,994 2,225,979 1,602,957 2,222,025
----------- ----------- ----------- -----------
Average shares of common stock
outstanding including dilutive
securities....................... 47,680,883 47,175,205 47,415,992 46,874,751
=========== =========== =========== ===========
Earnings per average share of common
stock............................ $ 0.85 $ 0.51 $ 0.96 $ 0.58
=========== =========== =========== ===========
Options to purchase 530,581 and 611,492 shares of common stock were
outstanding at June 30, 2007 and 2006, respectively, but were not included in
the computation of diluted EPS because the options were anti-dilutive for the
quarters ended June 30, 2007 and 2006, respectively.
(11) Net periodic pension costs (income) and postretirement benefit costs
(income) consist of the following components:
THREE MONTHS ENDED JUNE 30,
---------------------------------------------
POSTRETIRE-
PENSION MENT
----------------------------- -------------
2007 2006 2007 2006
------------- ------------- ---- ----
US FOREIGN US FOREIGN US US
--- ------- --- ------- ---- ----
(MILLIONS)
Service cost -- benefits earned during the
period...................................... $ 1 $ 2 $ 4 $ 2 $-- $ 1
Interest cost................................. 5 5 4 4 3 2
Expected return on plan assets................ (6) (6) (5) (4) -- --
Net amortization:
Actuarial loss.............................. -- 2 1 2 2 1
Prior service cost.......................... -- -- 1 -- (2) (1)
--- --- --- --- --- ---
Net pension and postretirement costs.......... $-- $ 3 $ 5 $ 4 $ 3 $ 3
=== === === === === ===
24
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
SIX MONTHS ENDED JUNE 30,
-----------------------------------------------
POSTRETIRE-
PENSION MENT
------------------------------- -------------
2007 2006 2007 2006
-------------- -------------- ---- ----
US FOREIGN US FOREIGN US US
---- ------- ---- ------- ---- ----
(MILLIONS)
Service cost -- benefits earned during the
period.................................... $ 1 $ 4 $ 8 $ 4 $ 1 $ 2
Interest cost............................... 10 9 9 8 5 4
Expected return on plan assets.............. (11) (10) (10) (8) -- --
Net amortization:
Actuarial loss............................ 1 3 2 3 3 3
Prior service cost........................ -- -- 2 -- (3) (3)
---- ---- ---- --- --- ---
Net pension and postretirement costs........ $ 1 $ 6 $ 11 $ 7 $ 6 $ 6
==== ==== ==== === === ===
Effective January 1, 2007, we froze our defined benefit plans and replaced
them with additional contributions under defined contribution plans for nearly
all U.S.-based salaried and non-union hourly employees.
In September 2006, the FASB issued Statement No. 158 "Employers' Accounting
for Defined Benefit and Other Postretirement Plans." Effective January 1, 2007,
Tenneco elected to early-adopt the measurement date provisions of SFAS No. 158.
As a result, during the first quarter of 2007, the following adjustments were
made to retained earnings (accumulated deficit) and other comprehensive income
(both net of tax effects):
US FOREIGN
--- -------
Retained earnings (accumulated deficit)........................... (3) (2)
Accumulated other comprehensive income............................ 8 6
For the six months ended June 30, 2007, we made pension contributions of
approximately $4 million for our domestic pension plans and $8 million for our
foreign pension plans. Based on current actuarial estimates, we believe we will
be required to make approximately $17 million in contributions for the remainder
of 2007.
We made postretirement contributions of approximately $5 million during the
first six months of 2007. Based on current actuarial estimates, we believe we
will be required to make approximately $5 million in contributions for the
remainder of 2007.
(12) We occasionally provide guarantees that could require us to make
future payments in the event that the third party primary obligor does not make
its required payments. We have not recorded a liability for any of these
guarantees. The only third party guarantee we have made is the performance of
lease obligations by a former affiliate. Our maximum liability under this
guarantee was less than $1 million at June 30, 2007 and 2006, respectively. We
have no recourse in the event of default by the former affiliate. However, we
have not been required to make any payments under this guarantee.
Additionally, we have from time to time issued guarantees for the
performance of obligations by some of our subsidiaries, and some of our
subsidiaries have guaranteed our debt. All of our existing and future material
domestic wholly-owned subsidiaries fully and unconditionally guarantee our
senior credit facility, our senior secured notes and our senior subordinated
notes on a joint and several basis. The arrangement for the senior credit
facility is also secured by first-priority liens on substantially all our
domestic assets and pledges of 66 percent of the stock of certain first-tier
foreign subsidiaries. The arrangement for the $475 million senior secured notes
is also secured by second-priority liens on substantially all our domestic
assets, excluding some of the stock of our domestic subsidiaries. No assets or
capital stock of our direct or indirect foreign subsidiaries secure these notes.
You should also read Note 13 where we present the Supplemental Guarantor
Condensed Consolidating Financial Statements.
25
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
We have issued guarantees through letters of credit in connection with some
obligations of our affiliates. We have issued $18 million in letters of credit
to support some of our subsidiaries' insurance arrangements. In addition, we
have issued $6 million in guarantees through letters of credit to guarantee
other obligations of subsidiaries primarily related to environmental remediation
activities.
Negotiable Financial Instruments -- One of our European subsidiaries
receives payment from one of its OE customers whereby the account receivables
are satisfied through the delivery of negotiable financial instruments. These
financial instruments are then sold at a discount to a European bank. The sales
of these financial instruments are not included in the account receivables sold.
Any of these financial instruments which were not sold as of June 30, 2007 and
2006 are classified as other current assets and are excluded from our definition
of cash equivalents. We had sold approximately $21 million of these instruments
at June 30, 2007 and $36 million at June 30, 2006.
In certain instances several of our Chinese subsidiaries receive payment
from OE customers and satisfy vendor payments through the receipt and delivery
of negotiable financial instruments. Financial instruments used to satisfy
vendor payables and not redeemed totaled $11 million and $5 million at June 30,
2007 and 2006, respectively, and were classified as notes payable. Financial
instruments received from OE customers and not redeemed totaled $6 million and
$11 million at June 30, 2007 and 2006, respectively, and were classified as
other current assets. One of our Chinese subsidiaries is required to maintain a
cash balance at a financial institution issuing the financial instruments which
are used to satisfy vendor payments. The balance was less than $1 million
dollars at June 30, 2007 and 2006, respectively, and was classified as cash and
cash equivalents.
(13) We are a global manufacturer with three geographic reportable
segments: (1) North America, (2) Europe, South America and India ("Europe"), and
(3) Asia Pacific. Each segment manufactures and distributes ride control and
emission control products primarily for the automotive industry. We have not
aggregated individual operating segments within these reportable segments. We
evaluate segment performance based primarily on income before interest expense,
income taxes, and minority interest. Products are transferred between segments
and geographic areas on a basis intended to reflect as nearly as possible the
"market value" of the products.
26
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
The following table summarizes certain Tenneco segment information:
AS RESTATED (NOTE 2)
-----------------------------------------------------
SEGMENT
-----------------------------------------------------
NORTH ASIA RECLASS &
AMERICA EUROPE PACIFIC ELIMS CONSOLIDATED
------- ------ ------- --------- ------------
(MILLIONS)
AT JUNE 30, 2007 AND FOR THE THREE MONTHS
THEN ENDED
Revenues from external customers........... $ 810 $ 718 $135 $ -- $1,663
Intersegment revenues...................... 2 93 4 (99) --
Income before interest expense, income
taxes, and minority interest............. 50 45 8 -- 103
AT JUNE 30, 2006 AND FOR THE THREE MONTHS
THEN ENDED
Revenues from external customers........... $ 523 $ 596 $102 $ -- $1,221
Intersegment revenues...................... 1 16 4 (21) --
Income before interest expense, income
taxes, and minority interest............. 37 34 2 -- 73
AT JUNE 30, 2007 AND FOR THE SIX MONTHS
THEN ENDED
Revenues from external customers........... $1,453 $1,362 $248 $ -- $3,063
Intersegment revenues...................... 4 192 7 (203) --
Income before interest expense, income
taxes, and minority interest............. 80 58 14 -- 152
Total assets............................... 1,634 1,609 345 121 3,709
AT JUNE 30, 2006 AND FOR THE SIX MONTHS
THEN ENDED
Revenues from external customers........... $1,037 $1,123 $192 $ -- $2,352
Intersegment revenues...................... 3 32 7 (42) --
Income before interest expense, income
taxes, and minority interest............. 70 42 2 -- 114
Total assets............................... 1,446 1,415 268 51 3,180
(14) Supplemental guarantor condensed financial statements are presented
below:
Basis of Presentation
Subject to limited exceptions, all of our existing and future material
domestic wholly owned subsidiaries (which are referred to as the Guarantor
Subsidiaries) fully and unconditionally guarantee our senior subordinated notes
due 2014 and our senior secured notes due 2013 on a joint and several basis. We
have not presented separate financial statements and other disclosures
concerning each of the Guarantor Subsidiaries because management has determined
that such information is not material to the holders of the notes. Therefore,
the Guarantor Subsidiaries are combined in the presentation below.
These condensed consolidating financial statements are presented on the
equity method. Under this method, our investments are recorded at cost and
adjusted for our ownership share of a subsidiary's cumulative results of
operations, capital contributions and distributions, and other equity changes.
You should read the condensed consolidating financial statements of the
Guarantor Subsidiaries in connection with our consolidated financial statements
and related notes of which this note is an integral part.
Distributions
There are no significant restrictions on the ability of the Guarantor
Subsidiaries to make distributions to us.
27
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
STATEMENT OF INCOME (LOSS)
FOR THE THREE MONTHS ENDED JUNE 30, 2007
---------------------------------------------------------------------
TENNECO INC.
GUARANTOR NONGUARANTOR (PARENT RECLASS &
SUBSIDIARIES SUBSIDIARIES COMPANY) ELIMS CONSOLIDATED
------------ ------------ ------------ --------- ------------
(MILLIONS)
REVENUES
Net sales and operating
revenues --
External..................... $783 $ 880 $ -- $ -- $1,663
Affiliated companies......... 30 223 -- (253) --
---- ------ ---- ----- ------
813 1,103 -- (253) 1,663
---- ------ ---- ----- ------
COSTS AND EXPENSES
Cost of sales (exclusive of
depreciation shown below).... 719 911 -- (253) 1,377
Engineering, research, and
development.................. 15 14 -- -- 29
Selling, general, and
administrative............... 39 63 2 -- 104
Depreciation and amortization of
other intangibles............ 19 31 -- -- 50
---- ------ ---- ----- ------
792 1,019 2 (253) 1,560
---- ------ ---- ----- ------
OTHER INCOME (EXPENSE)
Loss on sale of receivables..... -- (3) -- -- (3)
Other income (loss)............. 2 3 3 (5) 3
---- ------ ---- ----- ------
2 -- 3 (5) --
---- ------ ---- ----- ------
INCOME BEFORE INTEREST EXPENSE,
INCOME TAXES, MINORITY INTEREST,
AND EQUITY IN NET INCOME FROM
AFFILIATED COMPANIES............ 23 84 1 (5) 103
---- ------ ---- ----- ------
Interest expense --
External (net of interest
capitalized)............... -- 2 38 -- 40
Affiliated companies (net of
interest income)........... 47 (5) (42) -- --
Income tax expense (benefit).... (12) 25 1 6 20
Minority interest............... -- 2 -- -- 2
---- ------ ---- ----- ------
(12) 60 4 (11) 41
Equity in net income from
affiliated companies......... 60 -- 37 (97) --
---- ------ ---- ----- ------
NET INCOME........................ $ 48 $ 60 $ 41 $(108) $ 41
==== ====== ==== ===== ======
28
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
STATEMENT OF INCOME (LOSS)
AS RESTATED (NOTE 2)
---------------------------------------------------------------------
FOR THE THREE MONTHS ENDED JUNE 30, 2006
---------------------------------------------------------------------
TENNECO INC.
GUARANTOR NONGUARANTOR (PARENT RECLASS &
SUBSIDIARIES SUBSIDIARIES COMPANY) ELIMS CONSOLIDATED
------------ ------------ ------------ --------- ------------
(MILLIONS)
REVENUES
Net sales and operating
revenues --
External..................... $503 $718 $ -- $ -- $1,221
Affiliated companies......... 23 126 -- (149) --
---- ---- ---- ----- ------
526 844 -- (149) 1,221
---- ---- ---- ----- ------
COSTS AND EXPENSES
Cost of sales (exclusive of
depreciation shown below).... 418 702 -- (149) 971
Engineering, research, and
development.................. 9 13 -- -- 22
Selling, general, and
administrative............... 48 57 1 -- 106
Depreciation and amortization of
other intangibles............ 18 29 -- -- 47
---- ---- ---- ----- ------
493 801 1 (149) 1,146
---- ---- ---- ----- ------
OTHER INCOME (EXPENSE)
Loss on sale of receivables..... -- (2) -- -- (2)
Other income (loss)............. 2 (2) 2 (2) --
---- ---- ---- ----- ------
2 (4) 2 (2) (2)
---- ---- ---- ----- ------
INCOME (LOSS) BEFORE INTEREST
EXPENSE, INCOME TAXES, MINORITY
INTEREST, AND EQUITY IN NET
INCOME FROM AFFILIATED
COMPANIES....................... 35 39 1 (2) 73
---- ---- ---- ----- ------
Interest expense --
External (net of interest
capitalized)............... (2) -- 37 -- 35
Affiliated companies (net of
interest income)........... 41 (3) (38) -- --
Income tax expense (benefit).... 1 8 14 (10) 13
Minority interest............... -- 1 -- -- 1
---- ---- ---- ----- ------
(5) 33 (12) 8 24
Equity in net income (loss) from
affiliated companies......... 23 -- 36 (59) --
---- ---- ---- ----- ------
NET INCOME (LOSS)................. $ 18 $ 33 $ 24 $ (51) $ 24
==== ==== ==== ===== ======
29
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
STATEMENT OF INCOME (LOSS)
FOR THE SIX MONTHS ENDED JUNE 30, 2007
---------------------------------------------------------------------
TENNECO INC.
GUARANTOR NONGUARANTOR (PARENT RECLASS &
SUBSIDIARIES SUBSIDIARIES COMPANY) ELIMS CONSOLIDATED
------------ ------------ ------------ --------- ------------
(MILLIONS)
REVENUES
Net sales and operating
revenues --
External..................... $1,398 $1,665 $ -- $ -- $3,063
Affiliated companies......... 58 429 -- (487) --
------ ------ ---- ----- ------
1,456 2,094 -- (487) 3,063
------ ------ ---- ----- ------
COSTS AND EXPENSES
Cost of sales (exclusive of
depreciation shown below).... 1,279 1,764 -- (487) 2,556
Engineering, research, and
development.................. 26 30 -- -- 56
Selling, general, and
administrative............... 76 121 2 -- 199
Depreciation and amortization of
other intangibles............ 37 61 -- -- 98
------ ------ ---- ----- ------
1,418 1,976 2 (487) 2,909
------ ------ ---- ----- ------
OTHER INCOME (EXPENSE)
Loss on sale of receivables..... -- (5) -- -- (5)
Other income (loss)............. 3 1 3 (4) 3
------ ------ ---- ----- ------
3 (4) 3 (4) (2)
------ ------ ---- ----- ------
INCOME BEFORE INTEREST EXPENSE,
INCOME TAXES, MINORITY INTEREST,
AND EQUITY IN NET INCOME FROM
AFFILIATED COMPANIES............ 41 114 1 (4) 152
------ ------ ---- ----- ------
Interest expense --
External (net of interest
capitalized)............... (1) 3 78 -- 80
Affiliated companies (net of
interest income)........... 92 (8) (84) -- --
Income tax expense (benefit).... (24) 34 1 11 22
Minority interest............... -- 4 -- -- 4
------ ------ ---- ----- ------
(26) 81 6 (15) 46
Equity in net income (loss) from
affiliated companies......... 81 -- 40 (121) --
------ ------ ---- ----- ------
NET INCOME (LOSS)................. $ 55 $ 81 $ 46 $(136) $ 46
====== ====== ==== ===== ======
30
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
STATEMENT OF INCOME (LOSS)
AS RESTATED (NOTE 2)
---------------------------------------------------------------------
FOR THE SIX MONTHS ENDED JUNE 30, 2006
---------------------------------------------------------------------
TENNECO INC.
GUARANTOR NONGUARANTOR (PARENT RECLASS &
SUBSIDIARIES SUBSIDIARIES COMPANY) ELIMS CONSOLIDATED
------------ ------------ ------------ --------- ------------
(MILLIONS)
REVENUES
Net sales and operating
revenues --
External..................... $1,006 $1,346 $ -- $ -- $2,352
Affiliated companies......... 44 248 -- (292) --
------ ------ ---- ----- ------
1,050 1,594 -- (292) 2,352
------ ------ ---- ----- ------
COSTS AND EXPENSES
Cost of sales (exclusive of
depreciation shown below).... 837 1,347 -- (292) 1,892
Engineering, research, and
development.................. 17 27 -- -- 44
Selling, general, and
administrative............... 91 114 2 -- 207
Depreciation and amortization of
other intangibles............ 35 56 -- -- 91
------ ------ ---- ----- ------
980 1,544 2 (292) 2,234
------ ------ ---- ----- ------
OTHER INCOME (EXPENSE)
Loss on sale of receivables..... -- (4) -- -- (4)
Other income (loss)............. 5 (5) 2 (2) --
------ ------ ---- ----- ------
5 (9) 2 (2) (4)
------ ------ ---- ----- ------
INCOME BEFORE INTEREST EXPENSE,
INCOME TAXES, MINORITY INTEREST,
AND EQUITY IN NET INCOME FROM
AFFILIATED COMPANIES............ 75 41 -- (2) 114
------ ------ ---- ----- ------
Interest expense --
External (net of interest
capitalized)............... (2) 1 73 -- 72
Affiliated companies (net of
interest income)........... 78 (6) (72) -- --
Income tax expense (benefit).... 4 11 26 (28) 13
Minority interest............... -- 2 -- -- 2
------ ------ ---- ----- ------
(5) 33 (27) 26 27
Equity in net income (loss) from
affiliated companies......... 26 -- 54 (80) --
------ ------ ---- ----- ------
NET INCOME (LOSS)................. $ 21 $ 33 $ 27 $ (54) $ 27
====== ====== ==== ===== ======
31
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
BALANCE SHEET
JUNE 30, 2007
-----------------------------------------------------------------
TENNECO INC.
GUARANTOR NONGUARANTOR (PARENT RECLASS &
SUBSIDIARIES SUBSIDIARIES COMPANY) ELIMS CONSOLIDATED
------------ ------------ ------------ --------- ------------
(MILLIONS)
ASSETS
Current assets:
Cash and cash equivalents........ $ 9 $ 159 $ -- $ -- $ 168
Receivables, net................. 531 1,233 24 (871) 917
Inventories...................... 195 328 -- -- 523
Deferred income taxes............ 34 17 36 (30) 57
Prepayments and other............ 21 133 -- -- 154
------ ------ ------ -------- ------
790 1,870 60 (901) 1,819
------ ------ ------ -------- ------
Other assets:
Investment in affiliated
companies..................... 664 -- 1,169 (1,833) --
Notes and advances receivable
from affiliates............... 3,472 222 5,112 (8,806) --
Long-term notes receivable, net.. 2 22 -- -- 24
Goodwill......................... 135 71 -- -- 206
Intangibles, net................. -- 9 -- (1) 8
Deferred income taxes............ 347 64 197 (196) 412
Other............................ 39 70 27 -- 136
------ ------ ------ -------- ------
4,659 458 6,505 (10,836) 786
------ ------ ------ -------- ------
Plant, property, and equipment, at
cost............................. 965 1,802 -- -- 2,767
Less -- Reserves for depreciation
and amortization.............. 643 1,020 -- -- 1,663
------ ------ ------ -------- ------
322 782 -- -- 1,104
------ ------ ------ -------- ------
$5,771 $3,110 $6,565 $(11,737) $3,709
====== ====== ====== ======== ======
LIABILITIES AND SHAREHOLDERS'
EQUITY
Current liabilities:
Short-term debt (including
current maturities of long-
term debt)
Short-term debt -- non-
affiliated.................. $ -- $ 29 $ 2 $ -- $ 31
Short-term
debt -- affiliated.......... 272 463 10 (745) --
Trade payables................... 390 783 -- (124) 1,049
Accrued taxes.................... 44 31 -- (26) 49
Other............................ 120 121 30 (2) 269
------ ------ ------ -------- ------
826 1,427 42 (897) 1,398
------ ------ ------ -------- ------
Long-term debt -- non-affiliated... -- 9 1,410 -- 1,419
Long-term debt -- affiliated....... 3,989 38 4,779 (8,806) --
Deferred income taxes.............. 208 103 -- (190) 121
Postretirement benefits and other
liabilities...................... 294 104 8 7 413
Commitments and contingencies
Minority interest.................. -- 32 -- -- 32
Shareholder's equity............... 454 1,397 326 (1,851) 326
------ ------ ------ -------- ------
$5,771 $3,110 $6,565 $(11,737) $3,709
====== ====== ====== ======== ======
32
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
BALANCE SHEET
AS RESTATED (NOTE 2)
-----------------------------------------------------------------
DECEMBER 31, 2006
-----------------------------------------------------------------
TENNECO INC.
GUARANTOR NONGUARANTOR (PARENT RECLASS &
SUBSIDIARIES SUBSIDIARIES COMPANY) ELIMS CONSOLIDATED
------------ ------------ ------------ --------- ------------
(MILLIONS)
ASSETS
Current assets:
Cash and cash equivalents........ $ 57 $ 146 $ (1) $ -- $ 202
Receivables, net................. 333 828 23 (589) 595
Inventories...................... 138 303 -- -- 441
Deferred income taxes............ 34 12 7 (2) 51
Prepayments and other............ 24 102 -- -- 126
------ ------ ------ -------- ------
586 1,391 29 (591) 1,415
------ ------ ------ -------- ------
Other assets:
Investment in affiliated
companies..................... 587 -- 1,108 (1,695) --
Notes and advances receivable
from affiliates............... 3,442 215 5,012 (8,669) --
Long-term notes receivable, net.. 2 27 (3) -- 26
Goodwill......................... 135 68 -- -- 203
Intangibles, net................. -- 9 (1) -- 8
Deferred income taxes............ 327 67 200 (197) 397
Other............................ 34 70 28 -- 132
------ ------ ------ -------- ------
4,527 456 6,344 (10,561) 766
------ ------ ------ -------- ------
Plant, property, and equipment, at
cost............................. 949 1,694 -- -- 2,643
Less -- Accumulated depreciation
and amortization.............. 621 929 -- -- 1,550
------ ------ ------ -------- ------
328 765 -- -- 1,093
------ ------ ------ -------- ------
$5,441 $2,612 $6,373 $(11,152) $3,274
====== ====== ====== ======== ======
LIABILITIES AND SHAREHOLDERS'
EQUITY
Current liabilities:
Short-term debt (including
current maturities of long-
term debt)
Short-term debt -- non-
affiliated.................. $ -- $ 26 $ 2 $ -- $ 28
Short-term
debt -- affiliated.......... 211 281 10 (502) --
Trade payables................... 248 618 (1) (84) 781
Accrued taxes.................... 16 33 1 (1) 49
Other............................ 119 114 32 (4) 261
------ ------ ------ -------- ------
594 1,072 44 (591) 1,119
------ ------ ------ -------- ------
Long-term debt-non-affiliated...... -- 10 1,347 -- 1,357
Long-term debt-affiliated.......... 3,872 49 4,748 (8,669) --
Deferred income taxes.............. 212 92 -- (197) 107
Postretirement benefits and other
liabilities...................... 311 111 8 7 437
Commitments and contingencies
Minority interest.................. -- 28 -- -- 28
Shareholders' equity............... 452 1,250 226 (1,702) 226
------ ------ ------ -------- ------
$5,441 $2,612 $6,373 $(11,152) $3,274
====== ====== ====== ======== ======
33
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
STATEMENT OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2007
---------------------------------------------------------------------
TENNECO INC.
GUARANTOR NONGUARANTOR (PARENT RECLASS &
SUBSIDIARIES SUBSIDIARIES COMPANY) ELIMS CONSOLIDATED
------------ ------------ ------------ --------- ------------
(MILLIONS)
OPERATING ACTIVITIES
Net cash provided (used) by operating
activities......................... $ 118 $ 10 $(158) $ 4 $ (26)
----- ---- ----- ----- -----
INVESTING ACTIVITIES
Net proceeds from the sale of
assets............................. 1 1 -- (1) 1
Expenditures for plant, property, and
equipment.......................... (27) (45) -- (3) (75)
Expenditures for software related
intangible assets.................. (6) (4) -- (1) (11)
Acquisition of businesses............ -- -- -- -- --
Investments and other................ -- 2 -- -- 2
----- ---- ----- ----- -----
Net cash used by investing
activities......................... (32) (46) -- (5) (83)
----- ---- ----- ----- -----
FINANCING ACTIVITIES
Issuance of common stock............. -- -- 4 -- 4
Issuance of long-term debt........... 150 150
Debt issuance cost of long-term
debt............................... -- -- (6) -- (6)
Retirement of long -- term debt...... -- (2) (470) 113 (359)
Net increase (decrease) in revolver
borrowings and short-term debt
excluding current maturities of
long-term debt..................... -- 2 383 (112) 273
Intercompany dividends and net
increase (decrease) in intercompany
obligations........................ (133) 36 97 -- --
Distribution to minority interest
partners........................... -- (1) -- -- (1)
Other................................ -- -- --
----- ---- ----- ----- -----
Net cash provided (used) by financing
activities......................... (133) 35 158 1 61
----- ---- ----- ----- -----
Effect of foreign exchange rate
changes on cash and cash
equivalents........................ -- 14 -- -- 14
----- ---- ----- ----- -----
Increase (decrease) in cash and cash
equivalents........................ (47) 13 -- -- (34)
Cash and cash equivalents, January
1.................................. 56 146 -- -- 202
----- ---- ----- ----- -----
Cash and cash equivalents, June 30
(Note)............................. $ 9 $159 $ -- $ -- $ 168
===== ==== ===== ===== =====
NOTE: Cash and cash equivalents include highly liquid investments with a
maturity of three months or less at the date of purchase.
34
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
STATEMENT OF CASH FLOWS
AS RESTATED (NOTE 2)
---------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, 2006
---------------------------------------------------------------------
TENNECO INC.
GUARANTOR NONGUARANTOR (PARENT RECLASS &
SUBSIDIARIES SUBSIDIARIES COMPANY) ELIMS CONSOLIDATED
------------ ------------ ------------ --------- ------------
(MILLIONS)
OPERATING ACTIVITIES
Net cash provided (used) by operating
activities......................... $ 188 $ 10 $(138) $-- $ 60
----- ---- ----- --- ----
INVESTING ACTIVITIES
Net proceeds from the sale of
assets............................. -- 2 -- -- 2
Expenditures for plant, property, and
equipment.......................... (45) (44) -- -- (89)
Expenditures for software related
intangible assets.................. (4) (2) -- -- (6)
Acquisition of businesses............ -- -- -- -- --
Investments and other................ -- 1 -- -- 1
----- ---- ----- --- ----
Net cash used by investing
activities......................... (49) (43) -- -- (92)
----- ---- ----- --- ----
FINANCING ACTIVITIES
Issuance of common shares............ -- -- 10 -- 10
Retirement of long-term debt......... -- (1) (1) -- (2)
Net decrease in revolver borrowings
and short-term debt excluding
current maturities of long-term
debt............................... -- (3) -- -- (3)
Intercompany dividends and net
increase (decrease) in intercompany
obligations........................ (158) 29 129 -- --
Distribution to minority interest
partners........................... -- (1) -- -- (1)
Other................................ -- 2 -- -- 2
----- ---- ----- --- ----
Net cash provided (used) by financing
activities......................... (158) 26 138 -- 6
----- ---- ----- --- ----
Effect of foreign exchange rate
changes on cash and cash
equivalents........................ -- 8 -- -- 8
----- ---- ----- --- ----
Increase (decrease) in cash and cash
equivalents........................ (19) 1 -- -- (18)
Cash and cash equivalents, January
1.................................. 31 110 -- -- 141
----- ---- ----- --- ----
Cash and cash equivalents, June 30
(Note)............................. $ 12 $111 $ -- $-- $123
===== ==== ===== === ====
NOTE: Cash and cash equivalents include highly liquid investments with a
maturity of three months or less at the date of purchase.
35
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
STATEMENT OF CASH FLOWS
THREE MONTHS ENDED JUNE 30, 2007
---------------------------------------------------------------------
TENNECO INC.
GUARANTOR NONGUARANTOR (PARENT RECLASS &
SUBSIDIARIES SUBSIDIARIES COMPANY) ELIMS CONSOLIDATED
------------ ------------ ------------ --------- ------------
(MILLIONS)
OPERATING ACTIVITIES
Net cash provided (used) by
operating activities............ $ 94 $ 43 $ (76) $ 6 $ 67
---- ----- ----- ---- ----
INVESTING ACTIVITIES
Net proceeds from the sale of
assets.......................... 1 1 -- (1) 1
Expenditures for plant, property,
and equipment................... (11) (21) -- (4) (36)
Expenditures for intangible
assests......................... (1) (2) -- (1) (4)
Acquisition of businesses......... -- -- -- -- --
Investments and other............. -- 2 -- (1) 1
---- ----- ----- ---- ----
Net cash used by investing
activities...................... (11) (20) -- (7) (38)
---- ----- ----- ---- ----
FINANCING ACTIVITIES
Issuance of common shares......... -- -- 2 -- 2
Retirement of long-term debt...... -- (2) (113) 113 (2)
Net decrease in revolver
borrowings and short-term debt
excluding current maturities of
long-term debt.................. -- (104) 165 (68) (7)
Intercompany dividends and net
increase (decrease) in
intercompany obligations........ (74) 95 23 (44) --
Other............................. -- -- (1) -- (1)
---- ----- ----- ---- ----
Net cash provided (used) by
financing activities............ (74) (11) 76 1 (8)
---- ----- ----- ---- ----
Effect of foreign exchange rate
changes on cash and cash
equivalents..................... -- 11 -- -- 11
---- ----- ----- ---- ----
Increase (decrease) in cash and
cash equivalents................ 9 23 -- -- 32
Cash and cash equivalents, April
1............................... -- 136 -- -- 136
---- ----- ----- ---- ----
Cash and cash equivalents, June 30
(Note).......................... $ 9 $ 159 $ -- $ -- $168
==== ===== ===== ==== ====
NOTE: Cash and cash equivalents include highly liquid investments with a
maturity of three months or less at the date of purchase.
36
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
STATEMENT OF CASH FLOWS
THREE MONTHS ENDED JUNE 30, 2006
---------------------------------------------------------------------
TENNECO INC.
GUARANTOR NONGUARANTOR (PARENT RECLASS &
SUBSIDIARIES SUBSIDIARIES COMPANY) ELIMS CONSOLIDATED
------------ ------------ ------------ --------- ------------
(MILLIONS)
OPERATING ACTIVITIES
Net cash provided (used) by
operating activities............ $ 150 $ (7) $(70) $-- $ 73
----- ---- ---- --- ----
INVESTING ACTIVITIES
Net proceeds from the sale of
assets.......................... -- 2 -- -- 2
Expenditures for plant, property,
and equipment................... (19) (23) -- -- (42)
Expenditures for software related
intangible assets............... (3) -- -- -- (3)
Acquisition of businesses......... -- -- -- -- --
Investments and other............. -- 1 -- -- 1
----- ---- ---- --- ----
Net cash used by investing
activities...................... (22) (20) -- -- (42)
----- ---- ---- --- ----
FINANCING ACTIVITIES
Issuance of common shares......... -- -- 2 -- 2
Retirement of long-term debt...... -- -- (1) -- (1)
Net decrease in revolver
borrowings and short-term debt
excluding current maturities of
long-term debt.................. -- -- (12) -- (12)
Intercompany dividends and net
increase (decrease) in
intercompany obligations........ (116) 35 81 -- --
Other............................. -- 2 -- -- 2
----- ---- ---- --- ----
Net cash provided (used) by
financing activities............ (116) 37 70 -- (9)
----- ---- ---- --- ----
Effect of foreign exchange rate
changes on cash and cash
equivalents..................... -- 5 -- -- 5
----- ---- ---- --- ----
Increase (decrease) in cash and
cash equivalents................ 12 15 -- -- 27
Cash and cash equivalents, April
1............................... -- 96 -- -- 96
----- ---- ---- --- ----
Cash and cash equivalents, June 30
(Note).......................... $ 12 $111 $ -- $-- $123
===== ==== ==== === ====
NOTE: Cash and cash equivalents include highly liquid investments with a
maturity of three months or less at the date of purchase.
37
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
EXECUTIVE SUMMARY
We are one of the world's leading manufacturers of automotive emission
control and ride control products and systems. We serve both original equipment
(OE) vehicle designers and manufacturers and the repair and replacement markets,
or aftermarket, globally through leading brands, including Monroe(R), Rancho(R),
Clevite(R) Elastomers and Fric Rot(TM) ride control products and Walker(R),
Fonos(TM) and Gillet(TM) emission control products. Worldwide we serve more than
35 different original equipment manufacturers, and our products or systems are
included on nine of the top 10 passenger car models produced for sale in Europe
and nine of the top 10 light truck and SUV models produced for sale in North
America for 2006. Our aftermarket customers are comprised of full-line and
specialty warehouse distributors, retailers, jobbers, installer chains and car
dealers. We operate more than 80 manufacturing facilities worldwide and employ
approximately 19,000 people to service our customers' demands.
Factors that are critical to our success include winning new business
awards, managing our overall global manufacturing footprint to ensure proper
placement and workforce levels in line with business needs, maintaining
competitive wages and benefits, maximizing efficiencies in manufacturing
processes, fixing or eliminating unprofitable businesses and reducing overall
costs. In addition, our ability to adapt to key industry trends, such as the
consolidation of OE customers, a shift in consumer preferences to other vehicles
in response to higher fuel costs and other economic and social factors,
increasing technologically sophisticated content, changing aftermarket
distribution channels, increasing environmental standards and extended product
life of automotive parts, also play a critical role in our success. Other
factors that are critical to our success include adjusting to industry and
economic challenges such as increases in the cost of raw materials and our
ability to successfully reduce the impact of any such cost increases through
material substitutions, cost reduction initiatives and other methods.
We have a substantial amount of indebtedness. As such, our ability to
generate cash -- both to fund operations and service our debt -- is also a
significant area of focus for our company. See "Liquidity and Capital Resources"
below for further discussion of cash flows.
The numbers reported as of June 30, 2006 and for the three and six months
then ended have been restated. See Note 2.
Total revenues for the second quarter of 2007 were $1,663 million, compared
to $1,221 million in the second quarter of 2006. Excluding the impact of
currency and substrate sales, revenue was up $156 million, from $1,008 million
to $1,164 million, driven primarily by large North American OE emission control
platform launches, as well as continued new business and higher OE production
rates in European OE businesses and expanding markets like China. In addition to
the benefit of the new launches, our geographic balance, broad platform
diversity and wide customer base helped offset the overall North American
industry production decline.
Gross margin in the second quarter of 2007 was 17.2 percent, down 3.3
percentage points from 20.5 percent in 2006. Substantially higher substrate
sales, which typically carry lower margins, primarily from newly launched diesel
truck platforms in North America, reduced OE ride control sales for commercial
vehicles due to the significant production decline in that industry, and a shift
toward a lower percentage of total revenue generated by higher margin
aftermarket business all negatively impacted overall gross margin. Increased
steel and other material costs were offset by cost reduction initiatives,
material substitutions, low cost country sourcing, steel price recovery efforts
with aftermarket and OE customers, as well as improved efficiencies from Lean
manufacturing and Six Sigma programs.
We reported selling, general, administrative and engineering expenses in
the second quarter of 2007 at 8.0 percent of revenues, as compared to 10.5
percent of revenues for the second quarter of 2006. The improvement was due to
leveraging our higher revenues and keeping our SG&A expenses relatively flat to
last year, while continuing to invest in engineering and technology development
for OE emission control and ride control businesses globally.
38
Earnings before interest expense, taxes and minority interest ("EBIT") was
$103 million for the second quarter of 2007, up $30 million from the $73 million
reported in the second quarter of 2006. Global sales growth on OE platforms
featuring advanced technology content, operational efficiencies and lower costs
for restructuring and new aftermarket customer changeovers drove the year-over-
year improvement.
Total revenues for the first six months of 2007 were $3,063 million,
compared to $2,352 million for the first six months of 2006. Excluding the
impact of currency and substrate sales, revenue was up $241 million, from $1,943
million to $2,184 million, driven primarily by new launches in North America and
strong OE volumes in Europe. In addition to the benefit of the new launches, our
geographic balance and diverse customer base helped offset the overall North
American industry production decline.
Gross margin in the first half of 2007 was 16.6 percent, down 3.0
percentage points from 19.6 percent in 2006. Higher substrate sales, which
typically carry lower margins, driven by significant diesel platform launches in
North America diluted gross margin. As these high volume new platforms launched,
we also saw our revenue mix shift from higher-margin aftermarket revenues to OE
revenues. Increased steel and other material costs were more than offset by cost
reduction initiatives, material substitutions, low cost country sourcing, steel
price recovery efforts with aftermarket and OE customers, as well as improved
efficiencies from Lean manufacturing and Six Sigma programs.
We reported selling, general, administrative and engineering expenses in
the first six months of 2007 at 8.3 percent of revenues, as compared to 10.7
percent of revenues for the first six months of 2006. The improvement was due to
leveraging our higher revenues and reducing our SG&A expenses, while continuing
to increase our investment in engineering and technology development to prepare
to meet customer needs for more stringent environmental regulations.
EBIT was $152 million for the first half of 2007, up $38 million from the
$114 million for 2006. Global sales growth on OE platforms, benefits from the
company's ongoing manufacturing efficiency programs, favorable currency and
lower restructuring charges and aftermarket customer changeover costs more than
offset higher material costs and reduced North American industry production
volumes.
RESULTS FROM OPERATIONS
NET SALES AND OPERATING REVENUES FOR THE THREE MONTHS ENDED JUNE 30, 2007 AND
2006
The following tables reflect our revenues for the second quarters of 2007
and 2006. We present these reconciliations of revenues in order to reflect the
trend in our sales in various product lines and geographic regions separately
from the effects of doing business in currencies other than the U.S. dollar. We
have not reflected any currency impact in the 2006 table since this is the base
period for measuring the effects of currency during 2007 on our operations. We
believe investors find this information useful in understanding period-to-period
comparisons in our revenues.
Additionally, we show the component of our revenue represented by substrate
sales in the following table. While we generally have primary design,
engineering and manufacturing responsibility for OE emission control systems, we
do not manufacture substrates. Substrates are porous ceramic filters coated with
a catalyst -- precious metals such as platinum, palladium and rhodium. These are
supplied to us by Tier 2 suppliers and directed by our OE customers. We
generally earn a small margin on these components of the system. As the need for
more sophisticated emission control solutions increases to meet more stringent
environmental regulations, and as we capture more diesel aftertreatment
business, these substrate components have been increasing as a percentage of our
revenue. While these substrates dilute our gross margin percentage they are a
necessary component of an emission control system. We view the growth of
substrates as a key indicator that our value add content in an emission control
system is moving toward the higher technology hot-end gas and diesel business.
Our value-add content in an emission control system includes designing the
system to meet environmental regulations through integration of the substrates
into the system, maximizing use of thermal energy to heat up the catalyst
quickly, efficiently managing airflow to reduce back pressure as the exhaust
stream moves past the catalyst, managing the expansion and contraction of the
emission control system components due to temperature extremes experienced by an
emission control system, using advanced acoustic engineering tools to design the
desired exhaust
39
sound, minimizing the opportunity for the fragile components of the substrate to
be damaged when we integrate it into the emission control system and reducing
unwanted noise, vibration and harshness transmitted through the emission control
system.
We present these substrate sales separately in the following table because
we believe investors utilize this information to understand the impact of this
portion of our revenues on our overall business and because it removes the
impact of potentially volatile precious metals pricing from our revenues. While
our original equipment customers generally assume the risk of precious metals
pricing volatility, it impacts our reported revenues. Excluding "substrate"
catalytic converter and diesel particulate filter sales removes this impact.
THREE MONTHS ENDED JUNE 30, 2007
----------------------------------------------------------
SUBSTRATE REVENUES
SALES EXCLUDING
REVENUES EXCLUDING CURRENCY AND
CURRENCY EXCLUDING CURRENCY SUBSTRATE
REVENUES IMPACT CURRENCY IMPACT SALES
-------- -------- --------- --------- ------------
(MILLIONS)
North America Original Equipment
Ride Control........................ $ 132 $-- $ 132 $ -- $ 132
Emission Control.................... 529 -- 529 266 263
------ --- ------ ---- ------
Total North America Original
Equipment...................... 661 -- 661 266 395
North America Aftermarket
Ride Control........................ 110 -- 110 -- 110
Emission Control.................... 39 -- 39 -- 39
------ --- ------ ---- ------
Total North America Aftermarket.. 149 -- 149 -- 149
Total North America............ 810 -- 810 266 544
Europe Original Equipment
Ride Control........................ 107 6 101 -- 101
Emission Control.................... 406 23 383 137 246
------ --- ------ ---- ------
Total Europe Original Equipment.. 513 29 484 137 347
Europe Aftermarket
Ride Control........................ 61 4 57 -- 57
Emission Control.................... 63 4 59 -- 59
------ --- ------ ---- ------
Total Europe Aftermarket......... 124 8 116 -- 116
South America & India................. 81 6 75 10 65
Total Europe, South America &
India.......................... 718 43 675 147 528
Asia.................................. 85 -- 85 30 55
Australia............................. 50 6 44 7 37
------ --- ------ ---- ------
Total Asia Pacific............... 135 6 129 37 92
------ --- ------ ---- ------
Total Tenneco......................... $1,663 $49 $1,614 $450 $1,164
====== === ====== ==== ======
40
AS RESTATED
----------------------------------------------------------
THREE MONTHS ENDED JUNE 30, 2006
----------------------------------------------------------
SUBSTRATE REVENUES
SALES EXCLUDING
REVENUES EXCLUDING CURRENCY AND
CURRENCY EXCLUDING CURRENCY SUBSTRATE
REVENUES IMPACT CURRENCY IMPACT SALES
-------- -------- --------- --------- ------------
(MILLIONS)
North America Original Equipment
Ride Control........................ $ 131 $-- $ 131 $ -- $ 131
Emission Control.................... 236 -- 236 61 175
------ --- ------ ---- ------
Total North America Original
Equipment...................... 367 -- 367 61 306
North America Aftermarket
Ride Control........................ 112 -- 112 -- 112
Emission Control.................... 44 -- 44 -- 44
------ --- ------ ---- ------
Total North America Aftermarket.. 156 -- 156 -- 156
Total North America............ 523 -- 523 61 462
Europe Original Equipment
Ride Control........................ 98 -- 98 -- 98
Emission Control.................... 314 -- 314 120 194
------ --- ------ ---- ------
Total Europe Original Equipment.. 412 -- 412 120 292
Europe Aftermarket
Ride Control........................ 54 -- 54 -- 54
Emission Control.................... 64 -- 64 -- 64
------ --- ------ ---- ------
Total Europe Aftermarket......... 118 -- 118 -- 118
South America & India................. 66 -- 66 8 58
Total Europe, South America &
India.......................... 596 -- 596 128 468
Asia.................................. 58 -- 58 19 39
Australia............................. 44 -- 44 5 39
------ --- ------ ---- ------
Total Asia Pacific............... 102 -- 102 24 78
------ --- ------ ---- ------
Total Tenneco......................... $1,221 $-- $1,221 $213 $1,008
====== === ====== ==== ======
Revenues from our North American operations increased $287 million in the
second quarter of 2007 compared to the same period last year. Higher sales from
new North American OE platform launches more than offset lower aftermarket
revenues. North American OE emission control revenues were up $293 million in
the second quarter of 2007. Excluding substrate sales, revenues were up $88
million compared to last year. This increase was primarily due to significant
new OE platform launches which included the Ford Super Duty gas and diesel pick
up trucks, GM's three-quarter ton gasoline powered pick-up trucks, GM's light
duty pick-up trucks and vans with the Duramax diesel engines, GM's new Lambda
crossover, the International Truck and Engine medium duty diesel platform,
Toyota's Tundra gasoline pick-up truck and the Dodge Ram three-quarter ton
diesel pick-up truck. North American OE ride control revenues for the second
quarter of 2007 were up $1 million from the prior year. Increased ride-control
content on the GMT900 platform and strong sales on Ford's Super Duty truck
offset lower heavy duty and commercial vehicle volumes. Our total North American
OE revenues, excluding substrate sales and currency, increased 29 percent in the
second quarter of 2007 compared to second quarter of 2006 despite the North
American light vehicle production rate decrease of three percent. Aftermarket
revenues for North America were $149 million in the second quarter of 2007, a
decrease of $7 million compared to the prior year, driven by lower volumes in
both product lines due to soft market conditions. These volume decreases were
partially offset by price increases to recover steel costs. Aftermarket ride
control revenues decreased three percent in the second quarter of 2007 while
aftermarket emission control revenues decreased 11 percent in the second quarter
of 2007.
Our European, South American and Indian segment's revenues increased $122
million, or 20 percent, in the second quarter of 2007 compared to last year. The
second quarter total European light vehicle industry production increased four
percent from the second quarter of 2006. Europe OE emission control revenues of
$406 million in the
41
second quarter of 2007 were up 29 percent as compared to the second quarter of
last year. Excluding a $17 million increase in substrate sales and $23 million
due to the impact of currency, Europe OE emission control revenues increased 27
percent over 2006, due to a growing position on the hot-end of exhaust
platforms. In addition, higher volumes on the BMW 3-Series, Volvo C30 hatchback,
PSA Picasso, Mercedes Benz E - Class and Ford Mondeo drove the improvement.
Europe OE ride control revenues of $107 million in the second quarter of 2007
were up nine percent year-over-year. Excluding currency, revenues increased by
two percent in the 2007 second quarter due to favorable volumes on the Ford
Focus, VW Transporter and Renault's Dacia Logan, partially offset by lower
volumes on the Renault Scenic and Audi A6. European aftermarket revenues
increased $6 million in the second quarter of 2007 compared to last year. When
adjusted for currency, aftermarket revenues were relatively flat year over year.
Excluding the $4 million impact of currency, ride control aftermarket revenues
were up six percent due to strong volumes and improved pricing. Emission control
aftermarket revenues were down six percent, excluding $4 million in currency
benefit, due to lower volumes which more than offset improved pricing. South
American and Indian revenues were $81 million during the second quarter of 2007,
compared to $66 million in the prior year. Stronger OE and aftermarket sales and
currency appreciation drove this increase.
Revenues from our Asia Pacific segment increased $33 million to $135
million in the second quarter of 2007 compared to the same period last year.
Excluding the impact of substrate sales and currency, revenues increased to $92
million from $78 million in the prior year. Asian revenues for the second
quarter of 2007 were $85 million, up 48 percent from last year. This increase
was primarily due to higher OE sales in China driven by new launches and higher
emission control volumes on existing platforms. Second quarter revenues for
Australia increased 14 percent to $50 million. Excluding higher substrate sales
and favorable currency of $6 million, Australian revenue was down $2 million due
to lower volumes.
NET SALES FOR THE SIX MONTHS ENDED JUNE 30, 2007 AND 2006
SIX MONTHS ENDED JUNE 30, 2007
------------------------------------------------------------
SUBSTRATE REVENUES
SALES EXCLUDING
REVENUES EXCLUDING CURRENCY AND
CURRENCY EXCLUDING CURRENCY SUBSTRATE
REVENUES IMPACT CURRENCY IMPACT SALES
---------- -------- --------- --------- ------------
(MILLIONS)
North America Original Equipment
Ride Control........................ $ 265 $-- $ 265 $ -- $ 265
Emission Control.................... 905 -- 905 432 473
------ --- ------ ---- ------
Total North America Original
Equipment...................... 1,170 -- 1,170 432 738
North America Aftermarket
Ride Control........................ 208 -- 208 -- 208
Emission Control.................... 75 -- 75 -- 75
------ --- ------ ---- ------
Total North America Aftermarket.. 283 -- 283 -- 283
Total North America............ 1,453 -- 1,453 432 1,021
Europe Original Equipment
Ride Control........................ 214 16 198 -- 198
Emission Control.................... 793 52 741 263 478
------ --- ------ ---- ------
Total Europe Original Equipment.. 1,007 68 939 263 676
Europe Aftermarket
Ride Control........................ 100 6 94 -- 94
Emission Control.................... 104 8 96 -- 96
------ --- ------ ---- ------
Total Europe Aftermarket......... 204 14 190 -- 190
South America & India................. 151 7 144 18 126
Total Europe, South America &
India.......................... 1,362 89 1,273 281 992
Asia.................................. 155 -- 155 56 99
Australia............................. 93 9 84 12 72
------ --- ------ ---- ------
Total Asia Pacific............... 248 9 239 68 171
------ --- ------ ---- ------
Total Tenneco......................... $3,063 $98 $2,965 $781 $2,184
====== === ====== ==== ======
42
AS RESTATED
----------------------------------------------------------
SIX MONTHS ENDED JUNE 30, 2006
----------------------------------------------------------
SUBSTRATE REVENUES
SALES EXCLUDING
REVENUES EXCLUDING CURRENCY AND
CURRENCY EXCLUDING CURRENCY SUBSTRATE
REVENUES IMPACT CURRENCY IMPACT SALES
-------- -------- --------- --------- ------------
(MILLIONS)
North America Original Equipment
Ride Control........................ $ 262 $-- $ 262 $ -- $ 262
Emission Control.................... 479 -- 479 127 352
------ --- ------ ---- ------
Total North America Original
Equipment...................... 741 -- 741 127 614
North America Aftermarket
Ride Control........................ 212 -- 212 -- 212
Emission Control.................... 84 -- 84 -- 84
------ --- ------ ---- ------
Total North America Aftermarket.. 296 -- 296 -- 296
Total North America............ 1,037 -- 1,037 127 910
Europe Original Equipment
Ride Control........................ 193 -- 193 -- 193
Emission Control.................... 606 -- 606 222 384
------ --- ------ ---- ------
Total Europe Original Equipment.. 799 -- 799 222 577
Europe Aftermarket
Ride Control........................ 90 -- 90 -- 90
Emission Control.................... 103 -- 103 -- 103
------ --- ------ ---- ------
Total Europe Aftermarket......... 193 -- 193 -- 193
South America & India................. 131 -- 131 15 116
Total Europe, South America &
India.......................... 1,123 -- 1,123 237 886
Asia.................................. 108 -- 108 36 72
Australia............................. 84 -- 84 9 75
------ --- ------ ---- ------
Total Asia Pacific............... 192 -- 192 45 147
------ --- ------ ---- ------
Total Tenneco......................... $2,352 $-- $2,352 $409 $1,943
====== === ====== ==== ======
Revenues from our North American operations increased $416 million in the
first six months of 2007 compared to the same period last year. Higher sales
from new North American OE platform launches more than offset lower aftermarket
revenues. North American OE emission control revenues were up $426 million in
the first six months of 2007. Excluding substrate sales, revenues were up $121
million compared to last year. This increase was primarily due to significant
new OE platform launches as discussed in the three month discussion above. North
American OE ride control revenues for the first six months of 2007 were up $3
million from the prior year. Increased ride-control content on the GMT900
platform more than offset lower heavy duty and commercial vehicle volumes. Our
total North American OE revenues, excluding substrate sales and currency,
increased 20 percent in the first six months of 2007 compared to the first six
months of 2006 despite the North American light vehicle production rate decrease
of five percent. Aftermarket revenues for North America were $283 million in the
first six months of 2007, a decrease of $13 million compared to the prior year,
driven by lower volumes in both product lines due to soft market conditions.
These volume decreases were partially offset by price increases to recover steel
costs. Aftermarket ride control revenues decreased two percent in the first six
months of 2007 while aftermarket emission control revenues decreased 11 percent
in the first six months of 2007.
Our European, South American and Indian segment's revenues increased $239
million, or 21 percent, in the first six months of 2007 compared to last year.
The first six months total European light vehicle industry production increased
five percent from the first six months of 2006. Europe OE emission control
revenues of $793 million in the
43
first six months of 2007 were up 31 percent as compared to the first six months
of last year. Excluding a $41 million increase in substrate sales and $52
million due to the impact of currency, Europe OE emission control revenues
increased 24 percent over 2006, due to a growing position on the hot-end of
exhaust platforms, new launches and higher OE production levels as discussed in
the three month discussion above. Europe OE ride control revenues of $214
million in the first six months of 2007 were up 11 percent year-over-year.
Excluding currency, revenues increased by three percent in the the first six
months of 2007 due to improved volumes on the Ford Focus and the Audi A6 for
both conventional and electronic shocks, and the Ford Galaxy and Mondeo for
electronic shocks. European aftermarket revenues increased $11 million in the
first six months of 2007 compared to last year. When adjusted for currency,
aftermarket revenues were down one percent. Excluding the $6 million impact of
currency, ride control aftermarket revenues were up four percent due to strong
volumes and improved pricing. Emission control aftermarket revenues were down
six percent, excluding $8 million in currency benefit, due to lower volumes
which more than offset improved pricing. South American and Indian revenues were
$151 million during the first six months of 2007, compared to $131 million in
the prior year. Stronger OE and aftermarket sales and currency appreciation
drove this increase.
Revenues from our Asia Pacific segment, increased $56 million to $248
million in the first six months of 2007 compared to the same period last year.
Excluding the impact of substrate sales and currency, revenues increased to $171
million from $147 million in the prior year. Asian revenues for the first six
months of 2007 were $155 million, up 44 percent from last year. This increase
was primarily due to higher OE sales in China driven by new launches and higher
emission control volumes on existing platforms. Revenues for the first six
months of 2007 for Australia increased 10 percent to $93 million. Excluding
higher substrate sales and favorable currency of $9 million, Australian revenue
was down $3 million due to lower volumes.
EARNINGS BEFORE INTEREST EXPENSE, INCOME TAXES AND MINORITY INTEREST ("EBIT")
FOR THE THREE MONTHS ENDED JUNE 30, 2007 AND 2006
AS RESTATED
------------
THREE MONTHS THREE MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
2007 2006 CHANGE
------------ ------------ ------
(MILLIONS)
North America...................................... $ 50 $37 $13
Europe, South America & India...................... 45 34 11
Asia Pacific....................................... 8 2 6
---- --- ---
$103 $73 $30
==== === ===
The EBIT results shown in the preceding table include the following items,
certain of which are discussed below under "Restructuring and Other Charges",
which have an effect on the comparability of EBIT results between periods:
THREE MONTHS
ENDED JUNE 30,
--------------
2007 2006
---- ----
(MILLIONS)
North America
Restructuring and restructuring-related expenses................ $-- $4
Changeover costs for a major new aftermarket customer(1).......... -- 6
Europe, South America & India
Restructuring and restructuring-related expenses................ 2 3
Asia Pacific
Restructuring and restructuring-related expenses................ -- 1
--------
(1) Represents costs associated with changing new aftermarket customers from
their prior suppliers to an inventory of our products. Although our
aftermarket business regularly incurs changeover costs, we specifically
identify
44
in the table above those changeover costs that, based on the size or
number of customers involved, we believe are of an unusual nature for the
quarter in which they were incurred.
EBIT for North American operations increased to $50 million in the second
quarter of 2007, from $37 million one year ago. Strong OE emission control
volumes impacted EBIT by $11 million, particularly the efficient ramp-up on key
emission control truck platforms, lower selling, general, and administrative
expenses, manufacturing efficiencies driven by Lean and Six Sigma and reduced
restructuring charges of $4 million drove the increase. These improvements were
partially offset by higher steel costs of $11 million, increased spending on
engineering of $4 million and a softer aftermarket. Included in North America's
second quarter 2006 EBIT was $4 million in restructuring and restructuring-
related costs and $6 million of changeover costs for new aftermarket customers.
Our European, South American and Indian segment's EBIT was $45 million for
the second quarter of 2007 compared to $34 million during the same period last
year. Higher European OE volumes on existing business and new platform launches
combined for an EBIT increase of $8 million, manufacturing efficiencies, as well
as favorable currency of $3 million drove the increase. These increases were
partially offset by $6 million of higher steel costs. Restructuring and
restructuring-related expenses of $2 million were included in second quarter of
2007 compared to $3 million in the second quarter of 2006.
EBIT for our Asia Pacific segment in the second quarter of 2007 was $8
million compared to $2 million in the second quarter of 2006. Increased OE
production and new launches in China, reduced head count in Australia due to our
2006 restructuring activities and favorable currency of $1 million was partially
offset by $1 million of increased steel costs and reduced light vehicle
production in Australia. Included in the second quarter of 2006's EBIT was $1
million in restructuring and restructuring related expenses.
Currency had a $5 million favorable impact on overall company EBIT for the
three months ended June 30, 2007, as compared to the prior year.
EBIT AS A PERCENTAGE OF REVENUE
THREE MONTHS
ENDED JUNE
30,
-------------
2007 2006
---- ----
North America..................................................... 6% 7%
Europe, South America & India..................................... 6% 6%
Asia Pacific...................................................... 6% 2%
Total Tenneco................................................... 6% 6%
In North America, EBIT as a percentage of revenue for the second quarter of
2007 was one percentage point less than last year. The benefits from our new
platform launches, lower selling, general, and administrative expenses and
manufacturing efficiencies were more than offset by the margin impact from an
increase in lower margin substrate sales, lower OE industry volumes, higher
material costs, increased investments in engineering and soft aftermarket
conditions. During the second quarter of 2007, North American results also
included lower restructuring and restructuring-related charges and aftermarket
customer changeover costs. In Europe, South America and India, EBIT margin for
the second quarter of 2007 was even with prior year. Higher European OE volumes
on existing business, new platform launches, favorable currency and
manufacturing efficiencies were offset by higher material costs. Restructuring
and restructuring-related expenses were $1 million less than the prior year.
EBIT as a percentage of revenue for our Asia Pacific segment increased four
percentage points in the second quarter of 2007 versus the prior year. Volume
increases in China, favorable currency and benefits from last year's
restructuring activities drove the improvement. Lower restructuring and
restructuring-related expenses also benefited EBIT margin.
45
EBIT FOR THE SIX MONTHS ENDED JUNE 30, 2007 AND 2006
AS RESTATED
-----------
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
2007 2006 CHANGE
---------- ----------- ------
(MILLIONS)
North America......................................... $ 80 $ 70 $10
Europe, South America & India......................... 58 42 16
Asia Pacific.......................................... 14 2 12
---- ---- ---
$152 $114 $38
==== ==== ===
The EBIT results shown in the preceding table include the following items,
certain of which are discussed below under "Restructuring and Other Charges",
which have an effect on the comparability of EBIT results between periods:
SIX MONTHS
ENDED
JUNE 30,
-----------
2007 2006
---- ----
(MILLIONS)
North America
Restructuring and restructuring-related expenses................. $ 1 $7
Changeover costs for a major new aftermarket customer(1)........... -- 6
Europe, South America & India
Restructuring and restructuring-related expenses................. 3 4
Asia Pacific
Restructuring and restructuring-related expenses................. -- 3
--------
(1) Represents costs associated with changing new aftermarket customers from
their prior suppliers to an inventory of our products. Although our
aftermarket business regularly incurs changeover costs, we specifically
identify in the table above those changeover costs that, based on the
size or number of customers involved, we believe are of an unusual nature
for the quarter in which they were incurred.
EBIT for North American operations increased to $80 million in the first
six months of 2007, from $70 million one year ago. Volumes on new platform
launches, lower selling, general, and administrative expenses and manufacturing
efficiencies driven by Lean and Six Sigma of $12 million drove the improvement.
These increases were partially offset by higher steel costs of $19 million,
incremental launch costs, increased spending on engineering and a softer
aftermarket. Included in North America's first six months 2007 EBIT was $1
million in restructuring and restructuring-related expenses compared to $7
million in the first six months of 2006. Also included in 2006 EBIT was $6
million of new aftermarket customer changeover cost.
Our European, South American and Indian segment's EBIT was $58 million for
the first six months of 2007 compared to $42 million during the same period last
year. Higher European OE volumes on existing business, new platform launches,
favorable currency of $5 million and manufacturing efficiencies of $17 million
gained through Lean manufacturing and Six Sigma programs drove the improvement.
These increases were partially offset by higher material costs which included
$11 million of higher steel costs. Restructuring and restructuring-related
expenses of $3 million were included in first six months EBIT of 2007, a
decrease of $1 million from the same period last year.
EBIT for our Asia Pacific segment in the first six months of 2007 was $14
million compared to $2 million in the first six months of 2006. Increased OE
production and new launches in China of $6 million, reduced head count in
Australia due to our 2006 restructuring activities and favorable currency of $1
million was partially offset by $2 million of increased steel costs and reduced
light vehicle production in Australia. Included in the first six months of
2006's EBIT was $3 million in restructuring and restructuring-related expenses.
46
Currency had a $7 million favorable impact on overall company EBIT for the
six months ended June 30, 2007, as compared to the prior year.
EBIT AS A PERCENTAGE OF REVENUE
SIX MONTHS
ENDED
JUNE 30,
-----------
2007 2006
---- ----
North America...................................................... 6% 7%
Europe, South America & India...................................... 4% 4%
Asia Pacific....................................................... 6% 1%
Total Tenneco.................................................... 5% 5%
In North America, EBIT as a percentage of revenue for the first six months
of 2007 was one percentage point less than last year. The benefits from our new
platform launches, lower selling, general, and administrative expenses and
manufacturing efficiencies were more than offset by the margin impact from an
increase in lower margin substrate sales, lower OE industry volumes, higher
material costs, incremental launch costs, increased investments in engineering,
and soft aftermarket conditions. During the first six months of 2007, North
American results included lower restructuring and restructuring-related charges
and aftermarket changeover costs. In Europe, South America and India, EBIT
margin for the first six months of 2007 was even with prior year. Higher
European OE volumes on existing business, new platform launches, favorable
currency and manufacturing efficiencies were offset by higher material costs.
Restructuring and restructuring-related expenses were less than prior year. EBIT
as a percentage of revenue for our Asia Pacific segment increased five
percentage points in the first six months of 2007 versus the prior year. OE
production increases in China, favorable currency and benefits from last year's
restructuring activities drove the improvement. Lower restructuring and
restructuring-related expenses also benefited EBIT margin.
INTEREST EXPENSE, NET OF INTEREST CAPITALIZED
We reported interest expense for the second quarter of 2007 of $40 million,
up from $35 million a year ago. Higher borrowing levels in the quarter drove a
majority of the interest expense increase. The requirement to mark the fixed to
floating interest rate swaps to market also increased interest expense by $3
million in the second quarter 2007, versus an expense of $2 million in the
second quarter 2006.
We reported interest expense for the first half of 2007 of $80 million, up
from $72 million in the first six months of a year ago. Higher borrowing levels
for the first six months of the year drove a majority of the interest expense
increase. The requirement to mark the fixed to floating interest rate swaps to
market also increased interest expense by $2 million for the first six months of
2007, versus an increased expense of $5 million in the first half of 2006.
Included in the first six months of 2007 results was a $5 million charge to
expense the unamortized portion of debt issuance costs related to our 2003
amended and restated senior credit facility due to our debt refinancing in the
first quarter of 2007.
We have three fixed-to-floating interest rate swaps that effectively
convert $150 million of our 10.25 percent fixed interest rate senior secured
notes into floating interest rate debt at an annual rate of LIBOR plus 5.68
percent. Based upon the current LIBOR rate of 5.39 percent (which is in effect
until January 15, 2008) these swaps are expected to increase our interest
expense by $1 million in 2007 excluding any impact from marking the swaps to
market. Since entering into these swaps, we have realized a net cumulative
benefit of $3 million through June 30, 2007, in reduced cash interest payments.
On June 30, 2007, we had $997 million in long-term debt obligations that have
fixed interest rates. Of that amount, $475 million is fixed through July 2013
and $500 million through November 2014, while the remainder is fixed from 2007
through 2025. Of the $475 million, $150 million has been swapped to floating
rate debt and we also have $431 million in long-term debt obligations
outstanding under our senior secured credit facility that are subject to
variable interest rates. See Note 4.
47
INCOME TAXES
We reported income tax expense of $20 million in the second quarter of 2007
compared to $13 million in the second quarter of 2006. The effective tax rate
for the second quarter of 2007 was 32 percent. The effective tax rate for the
second quarter of 2006 was 34 percent.
Income tax expense was $22 million for the first six months of 2007,
compared to $13 million for the first six months of 2006. The effective tax rate
for the first half of 2007 was 31 percent as compared to 30 percent for the
first six months of 2006.
RESTRUCTURING AND OTHER CHARGES
Over the past several years we have adopted plans to restructure portions
of our operations. These plans were approved by the Board of Directors and were
designed to reduce operational and administrative overhead costs throughout the
business. Prior to the change in accounting required for exit or disposal
activities, we recorded charges to income related to these plans for costs that
did not benefit future activities in the period in which the plans were
finalized and approved, while actions necessary to affect these restructuring
plans occurred over future periods in accordance with established plans.
Our recent restructuring activities began in the fourth quarter of 2001,
when our Board of Directors approved a restructuring plan, a project known as
Project Genesis, which was designed to lower our fixed costs, relocate capacity,
reduce our work force, improve efficiency and utilization, and better optimize
our global footprint. We have subsequently engaged in various other
restructuring projects related to Project Genesis. We incurred $27 million in
restructuring and restructuring-related costs during 2006, of which $23 million
was recorded in cost of sales and $4 million was recorded in selling, general
and administrative expense. In the second quarter of 2007, we incurred $2
million in restructuring and restructuring-related costs which was recorded in
cost of sales. For the first six months of 2007, we incurred $4 million in
restructuring and restructuring-related costs of which $3 million was recorded
in cost of sales and $1 million in selling, general and administrative expense.
Since Project Genesis was initiated, we have incurred costs of $134 million
through June 30, 2007. We estimate that our current annual savings rate for
completed projects is approximately $88 million. When all actions are complete,
we expect an additional $16 million of annual savings.
Under the terms of our amended and restated senior credit agreement that
took effect on March 16, 2007, we are allowed to exclude $80 million of cash
charges and expenses, before taxes, related to cost reduction initiatives
incurred after March 16, 2007 from the calculation of the financial covenant
ratios required under our senior credit facility. As of June 30, 2007, we have
excluded $4 million in allowable charges relating to restructuring initiatives
against the $80 million available under the terms of the March 2007 amended and
restated to the senior credit facility.
In addition to the announced actions, we will continue to evaluate
additional opportunities and expect that we will initiate actions that will
reduce our costs through implementing the most appropriate and efficient
logistics, distribution and manufacturing footprint for the future. We expect to
continue to undertake additional restructuring actions as deemed necessary,
however, there can be no assurances we will undertake such actions. Actions that
we take, if any, will require the approval of our Board of Directors, or its
authorized committee. We plan to conduct any workforce reductions that result in
compliance with all legal and contractual requirements including obligations to
consult with workers' councils, union representatives and others.
EARNINGS PER SHARE
We reported net income of $41 million or $0.85 per diluted common share for
the second quarter of 2007, as compared to net income of $24 million or $0.51
per diluted common share for the second quarter of 2006. Included in the results
for the second quarter of 2007 were negative impacts from expenses related to
our restructuring and restructuring related activities. The net impact of these
items decreased earnings per diluted share by $0.03. Included in the results for
the second quarter of 2006 were negative impacts from expenses related to our
restructuring activities decreasing earnings per diluted share by $0.12 and the
negative impact of new aftermarket
48
customer changeovers of $0.08 per diluted share. Please read the Notes to the
consolidated financial statements for more detailed information on earnings per
share.
We reported net income of $46 million or $0.96 per diluted common share for
the first half of 2007, as compared to net income of $27 million or $0.58 per
diluted common share for the first half of 2006. Included in the results for the
first half of 2007 were negative impacts from expenses related to our
restructuring activities and charges relating to refinancing in the first
quarter. The net impact of these items decreased earnings per diluted share by
$0.06 and $0.07, respectively. Included in the results for the first half of
2006 were negative impacts from expenses related to our restructuring activities
of $0.21 per diluted share and new aftermarket customer changeover costs of
$0.09 per diluted share, partially offset by a positive impact from a tax
adjustment of $0.06 per diluted share. Please read the Notes to the consolidated
financial statements for more detailed information on earnings per share.
OUTLOOK
Current industry predictions indicate for the second half of the year that
the North American light vehicle production levels will be stronger year-over-
year. We believe we are well-positioned to benefit with our new diesel pick-up
truck platforms and a good position on strong-selling cross-over vehicles.
However, we will continue to closely monitor market uncertainties, namely rising
inventory levels and labor negotiations, in North America.
We also expect that our strong performance will continue in Europe and in
emerging markets like China, where industry conditions are expected to remain
positive. In the aftermarket, we continue to support our strong brands and
aggressively pursue new customers, actions that we hope will counter any
continued softness in the European and North American markets.
We will continue to invest in engineering and new technologies, primarily
to develop next generation emission and ride control products. Our diesel after-
treatment capabilities and innovative hot-end emission control solutions are
generating new business opportunities and positioning us for future growth. In
addition, we will continue to focus globally on increasing productivity and cost
improvements through Six Sigma, Lean manufacturing and restructuring activities.
CASH FLOWS FOR THE THREE MONTHS ENDED JUNE 30, 2007 AND 2006
THREE MONTHS THREE MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
2007 2006
------------ ------------
(MILLIONS)
Cash provided (used) by:
Operating activities................................... $ 67 $ 73
Investing activities................................... (38) (42)
Financing activities................................... (8) (9)
Operating Activities
For the three months ended June 30, 2007, operating activities provided $67
million in cash compared to $73 million in cash provided during the same period
last year. For the three months ended June 30, 2007, cash used for working
capital was $15 million versus $10 million for the three months ended June 30,
2006 because of increased working capital needs for new business launches.
Receivables were a use of cash of $111 million compared to a use of cash of $16
million in the prior year. Inventory represented a cash inflow of $3 million
during the three months ended June 30, 2007, an improvement of $16 million over
the prior year. Accounts payable provided cash of $91 million, an increase from
last year's cash inflow of $16 million. The year-over-year increase in the net
use of cash for accounts receivable, inventory, and accounts payable was
primarily a result of working capital requirements for our new platform launches
in North America. Cash taxes were $20 million, driven by a final payment on a
foreign audit and the timing of certain tax payments, for the three months ended
June 30, 2007, compared to $7 million in the prior year which included a tax
refund.
49
One of our European subsidiaries receives payment from one of its OE
customers whereby the accounts receivable are satisfied through the delivery of
negotiable financial instruments. We may collect these financial instruments
before their maturity date by either selling them at a discount or using them to
satisfy accounts receivable that have previously been sold to a European bank.
Any of these financial instruments which are not sold are classified as other
current assets as they do not meet our definition of cash equivalents. The
amount of these financial instruments that was collected before their maturity
date totaled $21 million for the six months ended June 30, 2007, compared with
$36 million for the same period in 2006.
In certain instances several of our Chinese subsidiaries receive payment
from OE customers and satisfy vendor payments through the receipt and delivery
of negotiable financial instruments. Financial instruments used to satisfy
vendor payables and not redeemed totaled $11 million and $5 million at June 30,
2007 and 2006, respectively, and were classified as notes payable. Financial
instruments received from OE customers and not redeemed totaled $6 million and
$11 million at June 30, 2007 and 2006, respectively, and were classified as
other current assets. One of our Chinese subsidiaries is required to maintain a
cash balance at a financial institution issuing the financial instruments which
are used to satisfy vendor payments. The balance was less than $1 million at
both June 30, 2007 and 2006, respectively, and was classified as cash and cash
equivalents.
Investing Activities
Cash used for investing activities was $4 million lower in the second
quarter of 2007 compared to the same period a year ago. Cash payments for plant,
property and equipment were $36 million in the second quarter of 2007 versus
payments of $42 million in the second quarter of 2006. The decrease of $6
million in cash payments for plant, property and equipment was primarily due to
the timing of investment in OE customer platform launches. Cash payments for
software-related intangible assets were $4 million in the second three months of
2007 compared to $3 million in the second three months of 2006.
Financing Activities
Cash flow from financing activities was an $8 million outflow in the second
quarter of 2007 compared to an outflow of $9 million in the same period of 2006.
CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 2007 AND 2006
AS RESTATED
-----------
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
2007 2006
---------- -----------
(MILLIONS)
Cash provided (used) by:
Operating activities...................................... $(26) $ 60
Investing activities...................................... (83) (92)
Financing activities...................................... 61 6
Operating Activities
For the six months ended June 30, 2007, operating activities used $26
million in cash compared to $60 million in cash provided during the same period
last year. For the six months ended June 30, 2007, cash used for working capital
was $154 million versus $80 million for the six months ended June 30, 2006
because of working capital needs for new business launches. Receivables were a
use of cash of $312 million compared to a cash use of $100 million in the prior
year. Inventory represented a cash outflow of $71 million during the six months
ended June 30, 2007, an increase of $31 million over the prior year. The year-
over-year increase in the use of cash for both accounts receivable and inventory
was primarily a result of working capital requirements for our new platform
launches in North America. In addition to the higher level of receivables
related to the revenue increase, we must carry higher inventory levels for these
new platforms, a portion of which relates to higher value substrates sourced
from South Africa. This inventory in transit from South Africa to the U.S.
increased our cash outflow from operating
50
activities during the first six months of 2007 by $29 million. Accounts payable
provided cash of $241 million, an increase from last year's cash inflow of $91
million. This increase also primarily resulted from the working capital needed
for our new platform launches in North America. Cash taxes were $28 million,
driven by a final payment on a foreign audit and the timing of certain tax
payments, for the six months ended June 30, 2007, compared to $7 million in the
prior year which included a tax refund.
Investing Activities
Cash used for investing activities was $9 million lower in the first half
of 2007 compared to the same period a year ago. Cash payments for plant,
property and equipment were $75 million in the first half of 2007 versus
payments of $89 million in the first six months of 2006. The decrease of $14
million in cash payments for plant, property and equipment was primarily due to
the timing of investment in OE customer platform launches. Cash payments for
software-related intangible assets were $11 million in the first six months of
2007 compared to $6 million in the first six months of 2006.
Financing Activities
Cash flow from financing activities was a $61 million inflow in the first
six months of 2007 compared to an inflow of $6 million in the same period of
2006. The primary reason for the change is attributable to an increase in
borrowings to fund 2007 working capital needs partially offset by debt issuance
costs due to our debt refinancing in the first quarter of 2007.
CRITICAL ACCOUNTING POLICIES
We prepare our financial statements in accordance with accounting
principles generally accepted in the United States of America. Preparing our
financial statements in accordance with generally accepted accounting principles
requires us to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. The following paragraphs include a
discussion of some critical areas where estimates are required.
Revenue Recognition
We recognize revenue for sales to our original equipment and aftermarket
customers when title and risk of loss passes to the customers under the terms of
our arrangements with those customers, which is usually at the time of shipment
from our plants or distribution centers. In connection with the sale of exhaust
systems to certain original equipment manufacturers, we purchase catalytic
converters or components thereof and diesel particulate filters including
precious metals ("substrates") on behalf of our customers which are used in the
assembled system. These substrates are included in our inventory and "passed
through" to the customer at our cost, plus a small margin, since we take title
to the inventory and are responsible for both the delivery and quality of the
finished product. Revenues recognized for substrate sales were $803 million, and
$409 million for the first six months of 2007 and 2006, respectively. For our
aftermarket customers, we provide for promotional incentives and returns at the
time of sale. Estimates are based upon the terms of the incentives and
historical experience with returns.
Warranty Reserves
Where we have offered product warranty, we also provide for warranty costs.
Those estimates are based upon historical experience and upon specific warranty
issues as they arise. While we have not experienced any material differences
between these estimates and our actual costs, it is reasonably possible that
future warranty issues could arise that could have a significant impact on our
financial statements.
Long-Term Receivables
We expense pre-production design and development costs incurred for our
original equipment customers unless we have a contractual guarantee for
reimbursement of those costs from the customer. At June 30, 2007, we had
approximately $20 million recorded as a long-term receivable from original
equipment customers for
51
guaranteed pre-production design and development arrangements. While we believe
that the vehicle programs behind these arrangements will enter production, these
arrangements allow us to recover our pre-production design and development costs
in the event that the programs are cancelled or do not reach expected production
levels. We have not experienced any material losses on arrangements where we
have a contractual guarantee of reimbursement from our customers.
Income Taxes
We have a U.S. Federal tax net operating loss carryforward ("NOL") at
December 31, 2006 of $597 million, which will expire in varying amounts from
2018 to 2026. The federal tax effect of that NOL is $209 million, and is
recorded as a deferred tax asset on our balance sheet at December 31, 2006. We
also have state NOL carryforwards of $585 million, which will expire in various
years through 2026. The tax effect of the state NOL, net of a valuation
allowance, is $29 million and is recorded as a deferred tax asset on our balance
sheet at December 31, 2006. In the six months ended June 30, 2007, we have a
loss for U.S. Federal tax of $26 million for which we recorded an additional $9
million in deferred tax assets. We estimate, based on available evidence both
positive and negative, that it is more likely than not that we will utilize
these NOLs within the prescribed carryforward period. That estimate is based
upon our expectations regarding future taxable income of our U.S. operations and
the implementation of available tax planning strategies that accelerate usage of
the NOL. Circumstances that could change that estimate include future U.S.
earnings at lower than expected levels or a majority ownership change as defined
in the rules of the U.S. tax law. If that estimate changed, we would be required
to cease recognizing an income tax benefit for any new NOL and could be required
to record a reserve for some or all of the asset currently recorded on our
balance sheet.
Stock-Based Compensation
Effective January 1, 2006, we account for our stock-based compensation
plans in accordance with Statement of Financial Accounting Standards ("SFAS")
No. 123(R), "Share-Based Payment" which requires a fair value method of
accounting for compensation costs related to our stock-based compensation plans.
Under the fair value method recognition provision of the statement, a share-
based payment is measured at the grant date based upon the value of the award
and is recognized as expense over the vesting period. Determining the fair value
of share-based awards requires judgment in estimating employee and market
behavior. If actual results differ significantly from these estimates, stock-
based compensation expense and our results of operations could be materially
impacted. As of June 30, 2007, there is approximately $5 million, net of tax, of
total unrecognized compensation costs related to these stock-based awards that
is expected to be recognized over a weighted average period of 1.2 years as
compared to $4 million, net of tax and a weighted average period of 1.5 years as
of June 30, 2006.
Goodwill and Other Intangible Assets
We utilize an impairment-only approach to value our purchased goodwill in
accordance with SFAS No. 142, "Goodwill and Other Intangible Assets." Each year
in the fourth quarter, we perform an impairment analysis on the balance of
goodwill. Inherent in this calculation is the use of estimates as the fair value
of our designated reporting units is based upon the present value of our
expected future cash flows. In addition, our calculation includes our best
estimate of our weighted average cost of capital and growth rate. If the
calculation results in a fair value of goodwill which is less than the book
value of goodwill, an impairment charge would be recorded in the operating
results of the impaired reporting unit.
Pension and Other Postretirement Benefits
We have various defined benefit pension plans that cover substantially all
of our employees. We also have postretirement health care and life insurance
plans that cover a majority of our domestic employees. Our pension and
postretirement health care and life insurance expenses and valuations are
dependent on assumptions used by our actuaries in calculating those amounts.
These assumptions include discount rates, health care cost trend rates, long-
term return on plan assets, retirement rates, mortality rates and other factors.
Health care cost trend rate assumptions are developed based on historical cost
data and an assessment of likely long-term trends. Retirement rates are based
52
primarily on actual plan experience while mortality rates are based upon the
general population experience which is not expected to differ materially from
our experience.
Our approach to establishing the discount rate assumption for both our
domestic and foreign plans starts with high-quality investment-grade bonds
adjusted for an incremental yield based on actual historical performance. This
incremental yield adjustment is the result of selecting securities whose yields
are higher than the "normal" bonds that comprise the index. Based on this
approach, for 2007 we raised the weighted average discount rate for all of our
pension plans to 5.6 percent, from 5.5 percent. The discount rate for
postretirement benefits was raised from approximately 5.9 percent for 2006 to
approximately 6.0 percent for 2007.
Our approach to determining expected return on plan asset assumptions
evaluates both historical returns as well as estimates of future returns, and is
adjusted for any expected changes in the long-term outlook for the equity and
fixed income markets. As a result, our estimate of the weighted average long-
term rate of return on plan assets for all of our pension plans was left
unchanged at 8.2 percent for 2007.
Except in the U.K., generally, our pension plans do not require employee
contributions. Our policy is to fund our pension plans in accordance with
applicable U.S. and foreign government regulations and to make additional
payments as funds are available to achieve full funding of the accumulated
benefit obligation. At June 30, 2007, all legal funding requirements had been
met. Other postretirement benefit obligations, such as retiree medical, and
certain foreign pension plans are not funded.
Effective December 31, 2006, we froze future accruals under our defined
benefit plans for substantially all U.S. salaried and non-union hourly employees
and replaced these benefits with additional contributions under defined
contribution plans. We estimate that these changes will save about $11 million
in earnings before taxes annually, starting January 1, 2007.
CHANGES IN ACCOUNTING PRONOUNCEMENTS
In September 2006, the Financial Accounting Standards Board (FASB) issued
SFAS No. 157, "Fair Value Measurement." This statement defines fair value,
establishes a framework for measuring fair value in generally accepted
accounting principles and expands disclosures about fair value measurements.
This statement applies under other accounting pronouncements that require or
permit fair value measurements. The statement is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years. We do not expect the adoption of this
statement to have a material impact to our financial statements.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB
Statements No. 87, 88, 106, and 132(R)." Part of this Statement was effective as
of December 31, 2006, and requires companies that have defined benefit pension
plans and other postretirement benefit plans to recognize the funded status of
those plans on the balance sheet on a prospective basis from the effective date.
The funded status of these plans is determined as of the plans' measurement
dates and represents the difference between the amount of the obligations owed
to participants under each plan (including the effects of future salary
increases for defined benefit plans) and the fair value of each plan's assets
dedicated to paying those obligations. To record the funded status of those
plans, unrecognized prior service costs and net actuarial losses experienced by
the plans will be recorded in the Accumulated Other Comprehensive Loss section
of shareholders' equity on the balance sheet. The initial adoption as of
December 31, 2006 resulted in a reduction of Accumulated Other Comprehensive
Loss in shareholders' equity of $59 million.
In addition, SFAS No. 158 requires that companies using a measurement date
for their defined benefit pension plans and other postretirement benefit plans
other than their fiscal year end, change the measurement date effective for
fiscal years ending after December 15, 2008. Effective January 1, 2007, we
elected to early adopt the measurement date provision of SFAS No. 158. Adoption
of this part of the statement was not material to our financial position and
results of operations. See Note 11.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities." This statement permits companies to
choose to measure at fair value many financial instruments and certain other
items that are not currently required to be measured at fair value. SFAS No. 159
is effective for
53
financial statements issued for fiscal years beginning on or after November 15,
2007. We do not believe the statement will have a material effect on our
financial statements and related disclosures.
In April 2007, the FASB issued Interpretation No. 39-1, "Amendment of FASB
Interpretation No. 39". This amendment allows a reporting entity to offset fair
value amounts recognized for derivative instruments with fair value amounts
recognized for the right to reclaim or realize cash collateral. Additionally,
this amendment requires disclosure of the accounting policy on the reporting
entity's election to offset or not offset amounts for derivative instruments.
FIN 39-1 is effective for fiscal years beginning after November 15, 2007. We do
not expect the adoption of FIN 39-1 to have a material impact on our financial
statements.
In May 2007, the FASB issued Interpretation No. 48-1, "Definition of
Settlement in FASB Interpretation No. 48". FIN 48-1 is effective for fiscal
years beginning after December 15, 2006 and provides guidance on how a reporting
entity should determine when a tax position is effectively settled. We have
applied FIN 48-1 in the current quarter. The adoption of FIN 48-1 did not have a
material impact to our financial statements and related disclosures. See Note 5.
In June 2007, the Emerging Issues Task Force ("EITF") issued EITF 06-11,
"Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards".
EITF 06-11 provides the final consensus on the application of paragraphs 62 and
63 of SFAS 123(R) on the accounting for income tax benefits relating to the
payment of dividends on equity-classified employee share-based payment awards
that are charged to retained earnings. EITF 06-11 affirms that the realized
income tax benefit from dividends or dividend equivalents that are charged to
retained earnings for equity classified nonvested equity shares, nonvested
equity share units, and outstanding equity share options should be recognized as
an increase in additional paid-in-capital. Additionally, EITF 06-11 provides
guidance on the amount of tax benefits from dividends that are reclassified from
additional paid-in-capital to the income statement when an entity's estimate of
forfeitures changes. EITF 06-11 is effective prospectively to the income tax
benefits that result from dividends on equity-classified employee share-based
payment awards that are declared in fiscal years beginning after December 15,
2007. We do not expect the adoption of EITF 06-11 to have a material impact on
our financial statements.
In June 2007, the EITF issued EITF 07-3, "Accounting for Nonrefundable
Advance Payments for Goods or Services Received for Use in Future Research and
Development Activities". EITF 07-3 requires the deferral and capitalization of
nonrefundable advance payments for goods or services that an entity will use in
research and development activities pursuant to an executory contractual
agreement. Expenditures which are capitalized under EITF 07-3 should be expensed
as the goods are delivered or the related services are performed. EITF 07-3 is
effective prospectively for fiscal years beginning after December 15, 2007 and
interim periods within those fiscal years. EITF 07-3 is applicable to new
contracts entered into after the effective date of this Issue. We do not expect
the adoption of EITF 07-3 to have a material impact on our financial statements.
LIQUIDITY AND CAPITAL RESOURCES
CAPITALIZATION
AS RESTATED
------------
JUNE 30, DECEMBER 31,
2007 2006 % CHANGE
-------- ------------ --------
(MILLIONS)
Short-term debt and current maturities............... $ 31 $ 28 11%
Long-term debt....................................... 1,419 1,357 5
------ ------
Total debt........................................... 1,450 1,385 5
------ ------
Total minority interest.............................. 32 28 14
Shareholders' equity................................. 326 226 44
------ ------ --
Total capitalization................................. $1,808 $1,639 10
====== ======
General. Short-term debt, which includes the current portion of long-term
obligations and borrowings by foreign subsidiaries, was $31 million and $28
million as of June 30, 2007 and December 31, 2006, respectively.
54
Borrowings under our revolving credit facilities, which are now classified as
long-term debt, were approximately $272 million and $0 as of June 30, 2007 and
December 31, 2006, respectively. The overall increase in debt resulted primarily
from increased working capital levels.
The year-to-date increase in shareholders' equity primarily resulted from
$41 million related to the translation of foreign balances into U.S. dollars. In
addition, net income, the implementation of the measurement date provision of
SFAS No. 158 and other transactions contributed $59 million to shareholders'
equity. While our book equity balance was small at June 30, 2007, it had no
effect on our business operations. We have no debt covenants that are based upon
our book equity, and there are no other agreements that are adversely impacted
by our relatively low book equity.
Overview and Recent Transactions. Our financing arrangements are primarily
provided by a committed senior secured financing arrangement with a syndicate of
banks and other financial institutions. The arrangement is secured by
substantially all our domestic assets and pledges of 66 percent of the stock of
certain first-tier foreign subsidiaries, as well as guarantees by our material
domestic subsidiaries.
In March 2007 we refinanced our $831 million senior credit facility. This
transaction reduced the interest rates we pay on all portions of the facility.
While the total amount of the new senior credit facility is $830 million,
approximately the same as the previous facility, we changed the components of
the facility to enhance our financial flexibility. We increased the amount of
commitments under our revolving loan facility from $320 million to $550 million,
reduced the amount of commitments under our tranche B-1 letter of
credit/revolving loan facility from $155 million to $130 million and replaced
the $356 million term loan B with a $150 million term loan A. As of June 30,
2007, the senior credit facility consisted of a five-year, $150 million term
loan A maturing in March 2012, a five-year, $550 million revolving credit
facility maturing in March 2012, and a seven-year $130 million tranche B-1
letter of credit/revolving loan facility maturing in March 2014.
The refinancing of the prior facility allowed us to: (i) amend the
consolidated net debt to EBITDA ratio, (ii) eliminate the fixed charge coverage
ratio, (iii) eliminate the restriction on capital expenditures, (iv) increase
the amount of acquisitions permitted to $250 million, (v) improve the
flexibility to repurchase and retire higher cost junior debt, (vi) increase our
ability to enter into capital leases, (vii) increase the ability of our foreign
subsidiaries to incur debt, (viii) increase our ability to pay dividends and
repurchase common stock, (ix) increase our ability to invest in joint ventures,
(x) allow for the increase in the existing tranche B-1 facility and/or the term
loan A or the addition of a new term loan of up to $275 million in order to
reduce our 10.25 percentage second lien notes, and (xi) make other
modifications.
Following the refinancing, the term loan A facility is payable in twelve
consecutive quarterly installments, commencing June 30, 2009 as follows: $6
million due each of June 30, September 30, December 31, 2009 and March 31, 2010,
$15 million due each of June 30, September 30, December 31, 2010 and March 31,
2011, and $17 million due each of June 30, September 30, December 31, 2011 and
March 16, 2012. The revolving credit facility requires that any amounts drawn,
be repaid by March 2012. Prior to that date, funds may be borrowed, repaid and
reborrowed under the revolving credit facility without premium or penalty.
Letters of credit may be issued under the revolving credit facility.
The tranche B-1 letter of credit/revolving loan facility requires that it
be repaid by March 2014. We can borrow revolving loans and issue letters of
credit under the $130 million tranche B-1 letter of credit/revolving loan
facility. The tranche B-1 letter of credit/revolving loan facility lenders have
deposited $130 million with the administrative agent, who has invested that
amount in time deposits. We do not have an interest in any of the funds on
deposit. When we draw revolving loans under this facility, the loans are funded
from the $130 million on deposit with the administrative agent. When we make
repayments, the repayments are redeposited with the administrative agent.
The tranche B-1 letter of credit/revolving loan facility is reflected as
debt on our balance sheet only if we borrow money under this facility or if we
use the facility to make payments for letters of credit. We will not be liable
for any losses to or misappropriation of any (i) return due to the
administrative agent's failure to achieve the return described above or to pay
all or any portion of such return to any lender under such facility or (ii)
funds on deposit in such account by such lender (other than the obligation to
repay funds released from such accounts and provided to us as revolving loans
under such facility).
55
Senior Credit Facility -- Forms of Credit Provided. Following the March
2007 refinancing, the term loan A facility is payable in twelve consecutive
quarterly installments, commencing June 30, 2009 as follows: $6 million due each
of June 30, September 30, December 31, 2009 and March 31, 2010, $15 million due
each of June 30, September 30, December 31, 2010 and March 31, 2011, and $17
million due each of June 30, September 30, December 31, 2011 and March 16, 2012.
The revolving credit facility requires that if any amounts are drawn, they be
repaid by March 2012. Prior to that date, funds may be borrowed, repaid and
reborrowed under the revolving credit facility without premium or penalty.
Letters of credit may be issued under the revolving credit facility.
The tranche B-1 letter of credit/revolving loan facility requires that it
be repaid by March 2014. We can borrow revolving loans from the $130 million
tranche B-1 letter of credit/revolving loan facility and use that facility to
support letters of credit. The tranche B-1 letter of credit/revolving loan
facility lenders have deposited $130 million with the administrative agent, who
has invested that amount in time deposits. We do not have an interest in any of
the funds on deposit. When we draw revolving loans under this facility, the
loans are funded from the $130 million on deposit with the administrative agent.
When we make repayments, the repayments are redeposited with the administrative
agent.
The tranche B-1 letter of credit/revolving loan facility is reflected as
debt on our balance sheet only if we borrow money under this facility or if we
use the facility to make payments for letters of credit. We will not be liable
for any losses to or misappropriation of any (i) return due to the
administrative agent's failure to achieve the return described above or to pay
all or any portion of such return to any lender under such facility or (ii)
funds on deposit in such account by such lender (other than the obligation to
repay funds released from such accounts and provided to us as revolving loans
under such facility).
Senior Credit Facility -- Interest Rates and Fees. Prior to the March 2007
refinancing borrowings under the term loan B facility and the tranche B-1 letter
of credit/revolving loan facility bore interest at an annual rate equal to, at
our option, either (i) the London Interbank Offering Rate plus a margin of 200
basis points; or (ii) a rate consisting of the greater of the JP Morgan Chase
prime rate or the Federal Funds rate plus 50 basis points, plus a margin of 100
basis points. As of June 30, 2007 borrowings under the term loan A facility and
the tranche B-1 letter of credit/revolving loan facility bore interest at an
annual rate equal to, at our option, either (i) the London Interbank Offering
Rate plus a margin of 150 basis points; or (ii) a rate consisting of the greater
of the JP Morgan Chase prime rate or the Federal Funds rate plus 50 basis
points, plus a margin of 50 basis points. The interest margin for borrowings
under the term loan A are subject to adjustment based on the consolidated net
leverage ratio (consolidated indebtedness net of cash divided by consolidated
EBITDA as defined in the senior credit facility agreement). The margin we pay on
the term loan A and the tranche B-1 facility is reduced by 25 basis points
following each fiscal quarter for which the consolidated net leverage ratio is
less than 2.5 beginning in March 2007, and would increase by 25 basis points
following each fiscal quarter for which the consolidated net leverage ratio
exceeds 3.5. There is no cost to us for issuing letters of credit under the
tranche B-1 letter of credit/revolving loan facility, however outstanding
letters of credit reduce our availability to borrow revolving loans under this
portion of the facility. If a letter of credit issued under this facility is
subsequently paid and we do not reimburse the amount paid in full, then a
ratable portion of each lender's deposit would be used to fund the letter of
credit. We pay the tranche B-1 lenders a fee which is equal to LIBOR plus 150
basis points. This fee is offset by the return on the funds deposited with the
administrative agent which earn interest at a per annum rate approximately equal
to LIBOR. Outstanding revolving loans reduce the funds on deposit with the
administrative agent which in turn reduce the earnings of those deposits and
effectively increases our interest expense at a per annum rate equal to LIBOR.
Prior to the March 2007 refinancing, borrowings under the revolving credit
facility bore interest at an annual rate equal to, at our option, either (i) the
London Interbank Offering Rate plus a margin of 275 basis points; or (ii) a rate
consisting of the greater of the JP Morgan Chase prime rate or the Federal Funds
rate plus 37.5 basis points, plus a margin of 175 basis points. As of June 30,
2007 borrowings under the revolving credit facility bore interest at an annual
rate equal to, at our option, either (i) the London Interbank Offering Rate plus
a margin of 150 basis points; or (ii) a rate consisting of the greater of the JP
Morgan Chase prime rate or the Federal Funds rate plus 50 basis points, plus a
margin of 50 basis points. Letters of credit issued under the revolving credit
facility accrue a letter of credit fee at a per annum rate of 150 basis points
for the pro rata account of the lenders under such facility and a fronting fee
for the ratable account of the issuers thereof at a per annum rate in an amount
to be agreed upon payable quarterly in arrears. We also pay a commitment fee of
35 basis points on the unused portion of the revolving credit
56
facility. The interest margins for borrowings and letters of credit issued under
the revolving credit facility are subject to adjustment based on the
consolidated net leverage ratio (consolidated indebtedness net of cash divided
by consolidated EBITDA as defined in the senior credit facility agreement)
measured at the end of each quarter. The margin we pay on the revolving credit
facility is reduced by 25 basis points and the commitment fee we pay on the
revolving credit facility is reduced by 5 basis points following each fiscal
quarter for which the consolidated net leverage ratio is less than 2.5 beginning
in March 2007. The margin and the commitment fee would increase by 25 basis
points and 2.5 basis points, respectively, following each fiscal quarter for
which the consolidated net leverage ratio exceeds 3.5.
Senior Credit Facility -- Other Terms and Conditions. As described above,
we are highly leveraged. Our refinanced senior credit facility requires that we
maintain financial ratios equal to or better than the following consolidated net
leverage ratio (consolidated indebtedness net of cash divided by consolidated
EBITDA, as defined in the senior credit facility agreement), and consolidated
interest coverage ratio (consolidated EBITDA divided by consolidated interest
expense, as defined under the senior credit facility agreement) at the end of
each period indicated. Failure to maintain these ratios will result in a default
under our senior credit facility. See "Contractual Obligations" below. The
financial ratios required under the amended and restated senior credit facility
and, the actual ratios we achieved for the first and second quarter of 2007, are
shown in the following tables:
AS RESTATED
--------------------------------------------------------
QUARTER ENDED
--------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
2007 2007 2007 2007
----------- ----------- ------------- ------------
REQ. ACT. REQ. ACT. REQ. REQ.
---- ---- ---- ---- ------------- ------------
Leverage Ratio (maximum).................. 4.25 3.27 4.25 2.99 4.25 4.25
Interest Coverage Ratio (minimum)......... 2.10 3.09 2.10 3.21 2.10 2.10
2008 2009 2010 2011 2012
REQ. REQ. REQ. REQ. REQ.
---- ---- ---- ---- ----
Leverage Ratio (maximum)............................... 4.00 3.75 3.50 3.50 3.50
Interest Coverage Ratio (minimum)...................... 2.10 2.25 2.40 2.55 2.75
The senior credit facility agreement provides the ability to refinance our
senior subordinated notes and/or our senior secured notes in an amount equal to
the sum of (i) the net cash proceeds of equity issued after the closing date
plus (ii) the portion of annual excess cash flow (as defined in the senior
credit facility agreement) that is not required to be applied to the payment of
the credit facilities and which is not used for other purposes, provided that
the amount of the subordinated notes and the aggregate amount of the senior
secured notes and the subordinated notes that may be refinanced is capped based
the pro forma consolidated leverage ratio after giving effect to such
refinancing as shown in the following table:
AGGREGATE SENIOR AND
PROFORMA CONSOLIDATED SUBORDINATED NOTES SUBORDINATE NOTE
LEVERAGE RATIO MAXIMUM AMOUNT MAXIMUM AMOUNT
--------------------- ------------------ --------------------
Greater than or equal to
3.0x $50 million $150 million
Greater than or equal to
2.5x $100 million $300 million
Less than 2.5x $125 million $375 million
In addition, the senior secured notes may be refinanced with (i) the net
cash proceeds of incremental facilities and permitted refinancing indebtedness
(as defined in the senior credit facility agreement), (ii) the net cash proceeds
of any new senior or subordinated unsecured indebtedness, (iii) proceeds of
revolving credit loans (as defined in the senior credit facility agreement),
(iv) up to $200 million of unsecured indebtedness of the company's foreign
subsidiaries and (v) cash generated by the company's operations.
The refinanced senior credit facility agreement also contains restrictions
on our operations that are customary for similar facilities, including
limitations on: (i) incurring additional liens; (ii) sale and leaseback
transactions (except for the permitted transactions as described in the amended
and restated agreement); (iii) liquidations and dissolutions; (iv) incurring
additional indebtedness or guarantees; (v) investments and acquisitions (vi)
dividends and share repurchases; (vii) mergers and consolidations; and (viii)
refinancing of subordinated and 10.25 percent
57
senior secured notes. Compliance with these requirements and restrictions is a
condition for any incremental borrowings under the senior credit facility
agreement and failure to meet these requirements enables the lenders to require
repayment of any outstanding loans. After giving effect to the waiver we
received as described above, as of June 30, 2007, we were in compliance with all
the financial covenants and operational restrictions of the facility.
Our senior credit facility does not contain any terms that could accelerate
the payment of the facility as a result of a credit rating agency downgrade.
Senior Secured and Subordinated Notes. Our outstanding debt also includes
$475 million of 10.25 percent senior secured notes due July 15, 2013, in
addition to the $500 million of 8 5/8 percent senior subordinated notes due
November 15, 2014. We can redeem some or all of the notes at any time after July
15, 2008, in the case of the senior secured notes, and November 15, 2009, in the
case of the senior subordinated notes. If we sell certain of our assets or
experience specified kinds of changes in control, we must offer to repurchase
the notes. We are permitted to redeem up to 35 percent of the senior
subordinated notes with the proceeds of certain equity offerings completed
before November 15, 2007.
Our senior secured and subordinated notes require that, as a condition
precedent to incurring certain types of indebtedness not otherwise permitted,
our consolidated fixed charge coverage ratio, as calculated on a proforma basis,
to be greater than 2.25 and 2.00, respectively. We have not incurred any of the
types of indebtedness not otherwise permitted by the indentures. The indentures
also contain restrictions on our operations, including limitations on: (i)
incurring additional indebtedness or liens; (ii) dividends; (iii) distributions
and stock repurchases; (iv) investments; (v) asset sales and (vi) mergers and
consolidations. Subject to limited exceptions, all of our existing and future
material domestic wholly owned subsidiaries fully and unconditionally guarantee
these notes on a joint and several basis. In addition, the senior secured notes
and related guarantees are secured by second priority liens, subject to
specified exceptions, on all of our and our subsidiary guarantors' assets that
secure obligations under our senior credit facility, except that only a portion
of the capital stock of our subsidiary guarantor's domestic subsidiaries is
provided as collateral and no assets or capital stock of our direct or indirect
foreign subsidiaries secure the notes or guarantees. There are no significant
restrictions on the ability of the subsidiaries that have guaranteed these notes
to make distributions to us. The senior subordinated notes rank junior in right
of payment to our senior credit facility and any future senior debt incurred. As
of June 30, 2007, we were in compliance with the covenants and restrictions of
these indentures.
Accounts Receivable Securitization. In addition to our senior credit
facility, senior secured notes and senior subordinated notes, we also sell some
of our accounts receivable on a nonrecourse basis in North America and Europe.
In North America, we have an accounts receivable securitization program with two
commercial banks. We sell original equipment and aftermarket receivables on a
daily basis under this program. We sold accounts receivable under this program
of $89 million and $91 million for the first six months at June 30, 2007 and
2006, respectively. This program is subject to cancellation prior to its
maturity date if we were to (i) fail to pay interest or principal payments on an
amount of indebtedness exceeding $50 million, (ii) default on the financial
covenant ratios under the senior credit facility, or (iii) fail to maintain
certain financial ratios in connection with the accounts receivable
securitization program. In January 2007, this program was renewed for 364 days
to January 28, 2008 at a facility size of $100 million. We also sell some
receivables in our European operations to regional banks in Europe. For the
first six months of June 30, 2007, we sold $59 million of accounts receivable in
Europe up from $57 million at June 30, 2006. The arrangements to sell
receivables in Europe are not committed and can be cancelled at any time. If we
were not able to sell receivables under either the North American or European
securitization programs, our borrowings under our revolving credit agreements
may increase. These accounts receivable securitization programs provide us with
access to cash at costs that are generally favorable to alternative sources of
financing, and allow us to reduce borrowings under our revolving credit
agreements.
Capital Requirements. We believe that cash flows from operations, combined
with available borrowing capacity described above, assuming that we maintain
compliance with the financial covenants and other requirements of our loan
agreement, will be sufficient to meet our future capital requirements for the
following year. Our ability to meet the financial covenants depends upon a
number of operational and economic factors, many of which are beyond our
control. Factors that could impact our ability to comply with the financial
covenants include the rate at which consumers continue to buy new vehicles and
the rate at which they continue to repair vehicles already in
58
service, as well as our ability to successfully implement our restructuring
plans and offset higher raw material prices. Lower North American vehicle
production levels, weakening in the global aftermarket, or a reduction in
vehicle production levels in Europe, beyond our expectations, could impact our
ability to meet our financial covenant ratios. In the event that we are unable
to meet these financial covenants, we would consider several options to meet our
cash flow needs. These options could include further renegotiations with our
senior credit lenders, additional cost reduction or restructuring initiatives,
sales of assets or common stock, or other alternatives to enhance our financial
and operating position. Should we be required to implement any of these actions
to meet our cash flow needs, we believe we can do so in a reasonable time frame.
CONTRACTUAL OBLIGATIONS
Our remaining required debt principal amortization and payment obligations
under lease and certain other financial commitments as of June 30, 2007, are
shown in the following table:
PAYMENTS DUE IN:
--------------------------------------------------
BEYOND
2007 2008 2009 2010 2011 2011 TOTAL
---- ---- ---- ---- ---- ------ ------
(MILLIONS)
Obligations:
Revolver borrowings.................. $-- $ -- $ -- $ -- $ -- $ 272 $ 272
Senior long-term debt................ -- -- 17 50 66 17 150
Long-term notes...................... -- 2 -- -- -- 477 479
Capital leases....................... 1 3 3 3 -- -- 10
Subordinated long-term debt.......... -- -- -- -- -- 500 500
Other subsidiary debt................ 1 -- -- -- -- 2 3
Short-term debt...................... 25 -- -- -- -- -- 25
--- ---- ---- ---- ---- ------ ------
Debt and capital lease obligations..... 27 5 20 53 66 1,268 1,439
Operating leases....................... 9 15 11 8 7 5 55
Interest payments...................... 29 112 112 112 103 204 672
Capital commitments.................... 26 -- -- -- -- -- 26
--- ---- ---- ---- ---- ------ ------
Total Payments......................... $91 $132 $143 $173 $176 $1,477 $2,192
=== ==== ==== ==== ==== ====== ======
If we do not maintain compliance with the terms of our senior credit
facility, senior secured notes indenture and senior subordinated debt indenture
described above, all amounts under those arrangements could, automatically or at
the option of the lenders or other debt holders, become due. Additionally, each
of those facilities contains provisions that certain events of default under one
facility will constitute a default under the other facility, allowing the
acceleration of all amounts due. We currently expect to maintain compliance with
terms of all of our various credit agreements for the foreseeable future.
Included in our contractual obligations is the amount of interest to be
paid on our long-term debt. As our debt structure contains both fixed and
variable rate interest debt, we have made assumptions in calculating the amount
of the future interest payments. Interest on our senior secured notes and senior
subordinated notes is calculated using the fixed rates of 10 1/4 percent and
8 5/8 percent, respectively. Interest on our variable rate debt is calculated as
150 basis points plus LIBOR of 5.39 percent which was the rate at June 30, 2007.
We have assumed that LIBOR will remain unchanged for the outlying years. See
"-- Capitalization." In addition we have included the impact of our interest
rate swaps entered into in April 2004, excluding any impact marking the swaps to
market may have. See "Interest Rate Risk" below.
We have also included an estimate of expenditures required after June 30,
2007 to complete the facilities and projects authorized at December 31, 2006, in
which we have made substantial commitments in connections with facilities.
We have not included purchase obligations as part of our contractual
obligations as we generally do not enter into long-term agreements with our
suppliers. In addition, the agreements we currently have do not specify the
59
volumes we are required to purchase. If any commitment is provided, in many
cases the agreements state only the minimum percentage of our purchase
requirements we must buy from the supplier. As a result, these purchase
obligations fluctuate from year to year and we are not able to quantify the
amount of our future obligation.
We have not included material cash requirements for taxes as we are a
taxpayer in certain foreign jurisdictions but not in domestic locations.
Additionally, it is difficult to estimate taxes to be paid as changes in where
we generate income can have a significant impact on future tax payments. We have
also not included cash requirements for funding pension and postretirement
benefit costs. Based upon current estimates we believe we will be required to
make contributions of approximately $39 million to those plans in 2007, of which
approximately $17 million has been contributed as of June 30, 2007. Pension and
postretirement contributions beyond 2007 will be required but those amounts will
vary based upon many factors, including the performance of our pension fund
investments during 2007. In addition, we have not included cash requirements for
environmental remediation. Based upon current estimates we believe we will be
required to spend approximately $9 million over the next 20 to 30 years.
However, due to possible modifications in remediation processes and other
factors, it is difficult to determine the actual timing of the payments. See
"-- Environmental and Other Matters".
We occasionally provide guarantees that could require us to make future
payments in the event that the third party primary obligor does not make its
required payments. We have not recorded a liability for any of these guarantees.
The only third party guarantee we have made is the performance of lease
obligations by a former affiliate. Our maximum liability under this guarantee
was less than $1 million at both June 30, 2007 and 2006. We have no recourse in
the event of default by the former affiliate. However, we have not been required
to make any payments under this guarantee.
Additionally, we have from time to time issued guarantees for the
performance of obligations by some of our subsidiaries, and some of our
subsidiaries have guaranteed our debt. All of our then existing and future
material domestic wholly-owned subsidiaries fully and unconditionally guarantee
our senior credit facility, our senior secured notes and our senior subordinated
notes on a joint and several basis. The arrangement for the senior credit
facility is also secured by first-priority liens on substantially all our
domestic assets and pledges of 66 percent of the stock of certain first-tier
foreign subsidiaries. The arrangement for the $475 million senior secured notes
is also secured by second-priority liens on substantially all our domestic
assets, excluding some of the stock of our domestic subsidiaries. No assets or
capital stock of our direct or indirect foreign subsidiaries secure these notes.
You should also read Note 14 where we present the Supplemental Guarantor
Condensed Consolidating Financial Statements.
We have issued guarantees through letters of credit in connection with some
obligations of our affiliates. We have guaranteed $18 million in letters of
credit to support some of our subsidiaries' insurance arrangements. In addition,
we have issued $6 million in guarantees through letters of credit to guarantee
other obligations of subsidiaries primarily related to environmental remediation
activities.
INTEREST RATE RISK
Our financial instruments that are sensitive to market risk for changes in
interest rates are primarily our debt securities and our interest rate swaps. We
primarily use our revolving credit facilities to finance our short-term capital
requirements. We pay a current market rate of interest on these borrowings. We
have financed our long-term capital requirements with long-term debt with
original maturity dates ranging from five to ten years. On June 30, 2007, we had
$997 million in long-term debt obligations that have fixed interest rates. Of
that amount, $475 million is fixed through July 2013 and $500 million through
November 2014, while the remainder is fixed from 2007 through 2025. Of the $475
million, $150 million has been swapped to floating and we also have $431 million
in long-term debt obligations outstanding under our senior secured credit
facility that are subject to variable interest rates. See Note 4.
We estimate that the fair value of our long-term debt at June 30, 2007 was
about 104 percent of its book value. A one percentage point increase or decrease
in interest rates would increase or decrease the annual interest expense we
recognize in the income statement and the cash we pay for interest expense by
about $3 million after tax, excluding the effect of the interest rate swaps we
completed in April 2004. A one percentage point increase or decrease in interest
rates on the swaps we completed in April 2004 would increase or decrease the
annual interest
60
expense we recognize in the income statement and the cash we pay for interest
expense by approximately $1 million after tax, excluding the effect on interest
expense of marking the swaps to market.
ENVIRONMENTAL AND OTHER MATTERS
We are subject to a variety of environmental and pollution control laws and
regulations in all jurisdictions in which we operate. We expense or capitalize,
as appropriate, expenditures for ongoing compliance with environmental
regulations that relate to current operations. We expense costs related to an
existing environmental condition caused by past operations that do not
contribute to current or future revenue generation. We record liabilities when
environmental assessments indicate that remedial efforts are probable and the
costs can be reasonably estimated. Estimates of the liability are based upon
currently available facts, existing technology, and presently enacted laws and
regulations taking into consideration the likely effects of inflation and other
societal and economic factors. We consider all available evidence including
prior experience in remediation of contaminated sites, other companies' cleanup
experiences and data released by the United States Environmental Protection
Agency or other organizations. These estimated liabilities are subject to
revision in future periods based on actual costs or new information. Where
future cash flows are fixed or reliably determinable, we have discounted the
liabilities. All other environmental liabilities are recorded at their
undiscounted amounts. We evaluate recoveries separately from the liability and,
when they are assured, recoveries are recorded and reported separately from the
associated liability in our financial statements.
As of June 30, 2007, we are designated as a potentially responsible party
in one Superfund site. Including the Superfund site, we may have the obligation
to remediate current or former facilities, and we estimate our share of
environmental remediation costs at these facilities to be approximately $9
million. For the Superfund site and the current and former facilities, we have
established reserves that we believe are adequate for these costs. Although we
believe our estimates of remediation costs are reasonable and are based on the
latest available information, the cleanup costs are estimates and are subject to
revision as more information becomes available about the extent of remediation
required. At some sites, we expect that other parties will contribute to the
remediation costs. In addition, at the Superfund site, the Comprehensive
Environmental Response, Compensation and Liability Act provides that our
liability could be joint and several, meaning that we could be required to pay
in excess of our share of remediation costs. Our understanding of the financial
strength of other potentially responsible parties at the Superfund site, and of
other liable parties at our current and former facilities, has been considered,
where appropriate, in our determination of our estimated liability. We believe
that any potential costs associated with our current status as a potentially
responsible party in the Superfund site, or as a liable party at our current or
former facilities, will not be material to our results of operations or
consolidated financial position.
We also from time to time are involved in legal proceedings, claims or
investigations that are incidental to the conduct of our business. Some of these
proceedings allege damages against us relating to environmental liabilities
(including toxic tort, property damage and remediation), intellectual property
matters (including patent, trademark and copyright infringement, and licensing
disputes), personal injury claims (including injuries due to product failure,
design or warnings issues, and other product liability related matters), taxes,
employment matters, and commercial or contractual disputes, sometimes related to
acquisitions or divestitures. We vigorously defend ourselves against all of
these claims. In future periods, we could be subjected to cash costs or non-cash
charges to earnings if any of these matters is resolved on unfavorable terms.
However, although the ultimate outcome of any legal matter cannot be predicted
with certainty, based on current information, including our assessment of the
merits of the particular claim, we do not expect that these legal proceedings or
claims will have any material adverse impact on our future consolidated
financial position or results of operations.
In addition, we are subject to a number of lawsuits initiated by a
significant number of claimants alleging health problems as a result of exposure
to asbestos. A small percentage of claims have been asserted by railroad workers
alleging exposure to asbestos products in railroad cars manufactured by the
Pullman Company, one of our subsidiaries. Nearly all of the claims are related
to alleged exposure to asbestos in our automotive emission control products.
Only a small percentage of these claimants allege that they were automobile
mechanics and a significant number appear to involve workers in other industries
or otherwise do not include sufficient information to determine whether there is
any basis for a claim against us. We believe, based on scientific and other
evidence, it is unlikely that mechanics were exposed to asbestos by our former
muffler products and that, in any event, they would not be at
61
increased risk of asbestos-related disease based on their work with these
products. Further, many of these cases involve numerous defendants, with the
number of each in some cases exceeding 200 defendants from a variety of
industries. Additionally, the plaintiffs either do not specify any, or specify
the jurisdictional minimum, dollar amount for damages. As major asbestos
manufacturers continue to go out of business or file for bankruptcy, we may
experience an increased number of these claims. We vigorously defend ourselves
against these claims as part of our ordinary course of business. In future
periods, we could be subject to cash costs or non-cash charges to earnings if
any of these matters is resolved unfavorably to us. To date, with respect to
claims that have proceeded sufficiently through the judicial process, we have
regularly achieved favorable resolution. Accordingly, we presently believe that
these asbestos-related claims will not have a material adverse impact on our
future financial condition or results of operations.
EMPLOYEE STOCK OWNERSHIP PLANS
We have established Employee Stock Ownership Plans for the benefit of our
employees. Under the plans, subject to limitations in the Internal Revenue Code,
participants may elect to defer up to 75 percent of their salary through
contributions to the plan, which are invested in selected mutual funds or used
to buy our common stock. We currently match in cash 50 percent of each
employee's contribution up to eight percent of the employee's salary. In
connection with freezing the defined benefit pension plans for nearly all U.S.
based salaried and hourly employees effective December 31, 2006, and the related
replacement of those defined benefit plans with defined contribution plans, we
are making additional contributions to the Employee Stock Option Plans. We
recorded expense for these matching contributions of approximately $8 million
for the six months ended June 30, 2007 as compared to $3 million for the six
months ended June 30, 2006. All contributions vest immediately.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For information regarding our exposure to interest rate risk, see the
caption entitled "Interest Rate Risk" in "Item 2. Management's Discussion and
Analysis of Financial Condition and Results of Operations," which is
incorporated herein by reference.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
An evaluation was carried out under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of our disclosure controls and
procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Securities
Exchange Act of 1934) as of the end of the period covered by this report. As of
December 31, 2006 we reported a material weakness in our internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))
based upon our evaluation pursuant to Section 404 of the Sarbanes-Oxley Act of
2002. Due to the nature of the material weakness, remediation will not be
completed until the annual tax processes are performed during the 2007 year end
close. Based upon the June 30, 2007 evaluation, we have concluded that our
disclosure controls and procedures were not effective for the reasons more fully
described below related to the unremediated material weakness. To address this
control weakness, we performed additional analysis and performed other
procedures in order to prepare the unaudited quarterly consolidated financial
statements in accordance with generally accepted accounting principles in the
United States of America. Accordingly, we believe that the consolidated
financial statements included in this Quarterly Report on Form 10-Q fairly
present, in all material respects, our financial condition, results of
operations and cash flows for the periods presented.
INTERNAL CONTROLS SURROUNDING THE ACCOUNTING FOR INCOME TAXES
A material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected. Management identified a material weakness in our internal control
over financial reporting as of December 31, 2006, related to our accounting for
income taxes including income taxes payable, deferred income tax assets and
liabilities and the related income tax provision. Specifically, we did not
maintain effective controls
62
over the accuracy and completeness of the components of the income tax provision
calculation and related deferred income taxes and income taxes payable, and over
the monitoring of the differences between the income tax basis and the financial
reporting basis of assets and liabilities to effectively reconcile the
differences to the reported deferred income tax balances. This control
deficiency resulted in adjustments to the tax accounts for our financial
statements as of December 31, 2006. While the errors identified largely offset
each other, our internal controls did not operate effectively to detect errors
that could have been, individually or in the aggregate, material.
REMEDIATION PLAN FOR MATERIAL WEAKNESS IN INTERNAL CONTROL OVER FINANCIAL
REPORTING
We took actions to improve internal controls over our accounting for income
taxes during 2006. However, the actions taken have not yet been fully evidenced
and therefore we concluded that this weakness existed as of December 31, 2006.
To address the material weakness in the accounting for income taxes, we have
taken or will take the following actions:
- With the assistance of an outside professional service provider, during
the fourth quarter of 2006 we implemented procedures to more effectively
and accurately accumulate detailed support for approximately 70 foreign
tax basis balance sheets and related processes to quantify deferred tax
balances.
- We are re-engineering the tax provision reporting processes (including
U.S. federal and state tax provision processes) to improve visibility,
timeliness and accuracy, as well as technical support and documentation
standards.
- We will reorganize functional responsibilities in the tax department to
better control and manage the income tax data that is collected and
enhance our current process for completing the provision and performing
analysis.
- We are in the process of developing additional remediation plans which
will be implemented to address the material weakness in internal controls
in accounting for income taxes. Many of these newly designed controls and
procedures are only executed annually during the year-end closing
process. Our assessment of the remediation will remain open until that
time.
Due to the nature of the material weakness, remediation will not be
completed until the annual tax processes are performed during the 2007 year end
close.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
Except as described above, there have been no changes in our internal
control over financial reporting during the quarter ended June 30, 2007 that
have materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.
In connection with the restatement and the filing of this Form 10-Q/A, we,
with the participation of management, including our Chief Executive Officer and
our Chief Financial Officer, re-evaluated our disclosure controls and procedures
and internal control over financial reporting. In performing the re-evaluation,
we considered the effects of the restatement that resulted from the error in the
accounting for interest rate swap agreements. Based on the foregoing re-
evaluation of our disclosure controls and procedures and internal control over
financial reporting as of March 31, 2007 and our analysis of the circumstances
which led to the error in the accounting for interest rate swap agreements, our
Chief Executive Officer and Chief Financial Officer concluded that the error in
accounting for interest rate swaps does not indicate an additional material
weakness in internal controls over financial reporting.
63
PART II
ITEM 1A. RISK FACTORS
We are exposed to certain risks and uncertainties that could have a
material adverse impact on our business, financial condition and operating
results. There have been no material changes to the Risk Factors described in
Part I, Item 1A of our Annual Report on Form 10-K/A for the year ended December
31, 2006.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held our annual stockholders' meeting on May 8, 2007, to consider and
vote on two separate proposals: (1) a proposal to elect Charles W. Cramb, Gregg
Sherrill, Frank E. Macher, Roger B. Porter, David B. Price, Jr., Paul T. Stecko,
Mitsunobu Takeuchi and Jane L. Warner as directors of our company for a term
expiring at our next annual stockholders' meeting and (2) a proposal to ratify
the appointment of Deloitte & Touche LLP as independent public accountants for
2007. The following sets forth the vote results with respect to these proposals
at the meeting:
ELECTION OF DIRECTORS
VOTES FOR VOTES WITHHELD
---------- --------------
Charles W. Cramb......................................... 38,643,842 3,530,185
Gregg Sherrill........................................... 40,993,184 1,180,843
Frank E. Macher.......................................... 41,451,612 722,415
Roger B. Porter.......................................... 41,480,743 693,284
David B. Price, Jr. ..................................... 41,857,713 316,314
Paul T. Stecko........................................... 41,555,120 618,907
Mitsunobu Takeuchi....................................... 41,658,751 515,276
Jane L. Warner........................................... 41,895,991 278,036
RATIFICATION OF APPOINTMENT OF DELOITTE & TOUCHE LLP
VOTES FOR VOTES AGAINST ABSTENTIONS
--------- ------------- -----------
41,463,266 670,086 40,675
ITEM 6. EXHIBITS
(a) Exhibits. The exhibits filed with this report are listed on the
Exhibit Index following the signature page of this report, which is incorporated
herein by reference.
64
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
Tenneco Inc. has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
TENNECO INC.
By: /s/ KENNETH R. TRAMMELL
------------------------------------
Kenneth R. Trammell
Executive Vice President and Chief
Financial Officer
Dated: August 14, 2007
65
INDEX TO EXHIBITS
TO
QUARTERLY REPORT ON FORM 10-Q
FOR QUARTER ENDED JUNE 30, 2007
EXHIBIT
NUMBER DESCRIPTION
------- -----------
*4.5 (c) -- Waiver, dated as of July 23, 2007, under the Second Amended and
Restated Credit Agreement.
*10.64 -- Form of Long Term Performance Unit Award Under the 2006 Long-Term
Incentive Plan (stub period award).
*10.65 -- Form of Long Term Performance Unit Award Under the 2006 Long-Term
Incentive Plan (three year award).
*12 -- Computation of Ratio of Earnings to Fixed Charges.
*15 -- Letter of Deloitte and Touche LLP regarding interim financial
information.
*31.1 -- Certification of Gregg Sherrill under Section 302 of the Sarbanes-
Oxley Act of 2002.
*31.2 -- Certification of Kenneth R. Trammell under Section 302 of the
Sarbanes-Oxley Act of 2002.
*32.1 -- Certification of Gregg Sherrill and Kenneth R. Trammell under
Section 906 of the Sarbanes-Oxley Act of 2002
--------
* Filed herewith.
66