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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 September 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: 46,565,899 shares as of October 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 39
and Results of Operations..........................................
Item 3. Quantitative and Qualitative Disclosures About Market Risk.... 65
Item 4. Controls and Procedures....................................... 65
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings............................................. *
Item 1A. Risk Factors.............................................. 67
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds... 67
Item 3. Defaults Upon Senior Securities............................... *
Item 4. Submission of Matters to a Vote of Security Holders........... *
Item 5. Other Information............................................. *
Item 6. Exhibits...................................................... 67
--------
* 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 September 30, 2007, and
the related consolidated statements of income, cash flows, comprehensive income
(loss) for the three-month and nine-month periods ended September 30, 2007 and
2006, and of changes in shareholders' equity for the nine-month periods ended
September 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 review, 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 12, 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 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
November 6, 2007
4
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
STATEMENTS OF INCOME
(UNAUDITED)
AS RESTATED AS RESTATED
(NOTE 2) (NOTE 2)
------------- -------------
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2007 2006 2007 2006
------------- ------------- ------------- -------------
(MILLIONS EXCEPT SHARE AND PER SHARE AMOUNTS)
REVENUES
Net sales and operating revenues.... $ 1,556 $ 1,121 $ 4,619 $ 3,473
----------- ----------- ----------- -----------
COSTS AND EXPENSES
Cost of sales (exclusive of
depreciation and amortization
shown below)..................... 1,313 925 3,869 2,817
Engineering, research, and
development...................... 30 24 86 68
Selling, general and
administrative................... 101 81 300 288
Depreciation and amortization of
other intangibles................ 52 45 150 136
----------- ----------- ----------- -----------
1,496 1,075 4,405 3,309
----------- ----------- ----------- -----------
OTHER INCOME (EXPENSE)
Loss on sale of receivables......... (3) (3) (8) (7)
Other income........................ -- -- 3 --
----------- ----------- ----------- -----------
(3) (3) (5) (7)
----------- ----------- ----------- -----------
INCOME BEFORE INTEREST EXPENSE, INCOME
TAXES, AND MINORITY INTEREST........ 57 43 209 157
Interest expense (net of interest
capitalized)..................... 32 30 112 102
Income tax expense.................. -- 4 22 17
Minority interest................... 4 2 8 4
----------- ----------- ----------- -----------
NET INCOME............................ $ 21 $ 7 $ 67 $ 34
=========== =========== =========== ===========
EARNINGS PER SHARE
Weighted average shares of common
stock outstanding --
Basic............................... 45,973,687 44,986,076 45,725,202 44,466,543
Diluted............................. 47,899,357 47,207,110 47,521,738 46,790,147
Basic earnings per share of common
stock............................... $ 0.47 $ 0.16 $ 1.48 $ 0.78
Diluted earnings per share of common
stock............................... $ 0.45 $ 0.16 $ 1.42 $ 0.74
The accompanying notes to financial statements are an integral part of these
statements of income.
5
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
BALANCE SHEETS
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2007 2006
------------- ------------
(MILLIONS)
ASSETS
Current assets:
Cash and cash equivalents............................... $ 203 $ 202
Receivables --
Customer notes and accounts, net..................... 880 578
Other................................................ 34 17
Inventories --
Finished goods....................................... 216 193
Work in process...................................... 205 90
Raw materials........................................ 119 122
Materials and supplies............................... 40 36
Deferred income taxes................................... 29 51
Prepayments and other................................... 168 126
------- -------
1,894 1,415
------- -------
Other assets:
Long-term notes receivable, net......................... 22 26
Goodwill................................................ 207 203
Intangibles, net........................................ 26 8
Deferred income taxes................................... 393 397
Other................................................... 136 132
------- -------
784 766
------- -------
Plant, property, and equipment, at cost................... 2,902 2,643
Less -- Accumulated depreciation and amortization....... (1,758) (1,550)
------- -------
1,144 1,093
------- -------
$ 3,822 $ 3,274
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term debt (including current maturities of long-
term debt)........................................... $ 33 $ 28
Trade payables.......................................... 1,025 781
Accrued taxes........................................... 37 49
Accrued interest........................................ 29 33
Accrued liabilities..................................... 231 194
Other................................................... 31 34
------- -------
1,386 1,119
------- -------
Long-term debt............................................ 1,503 1,357
------- -------
Deferred income taxes..................................... 83 107
------- -------
Postretirement benefits................................... 329 350
------- -------
Deferred credits and other liabilities.................... 75 87
------- -------
Commitments and contingencies
Minority interest......................................... 33 28
------- -------
Shareholders' equity:
Common stock............................................ -- --
Premium on common stock and other capital surplus....... 2,798 2,790
Accumulated other comprehensive loss.................... (134) (252)
Retained earnings (accumulated deficit)................. (2,011) (2,072)
------- -------
653 466
Less -- Shares held as treasury stock, at cost.......... 240 240
------- -------
413 226
------- -------
$ 3,822 $ 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 AS RESTATED
(NOTE 2) (NOTE 2)
------------- -------------
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2007 2006 2007 2006
------------- ------------- ------------- -------------
(MILLIONS)
OPERATING ACTIVITIES
Net income............................. $ 21 $ 7 $ 67 $ 34
Adjustments to reconcile net income to
cash provided (used) by operating
activities --
Depreciation and amortization of
other intangibles................. 52 45 150 136
Deferred income taxes................ (10) 2 (23) 9
Stock-based compensation............. 3 1 7 5
Loss on sale of assets, net.......... 3 -- 8 2
Changes in components of working
capital --
(Increase) decrease in
receivables..................... 29 14 (283) (86)
(Increase) decrease in
inventories..................... (42) (8) (113) (48)
(Increase) decrease in prepayments
and other current assets........ (11) (7) (35) (44)
Increase (decrease) in payables... (46) (37) 195 54
Increase (decrease) in accrued
taxes........................... (6) (8) (10) (8)
Increase (decrease) in accrued
interest........................ (1) (1) (4) --
Increase (decrease) in other
current liabilities............. 7 3 26 8
Other................................ (8) (6) (20) 3
---- ---- ----- -----
Net cash provided (used) by operating
activities........................... (9) 5 (35) 65
---- ---- ----- -----
INVESTING ACTIVITIES
Net proceeds from the sale of assets... 1 4 2 6
Cash payments for plant, property, and
equipment............................ (41) (45) (116) (134)
Cash payment for net assets purchased.. (16) -- (16) --
Cash payments for software related
intangible assets.................... (3) (3) (14) (9)
Investments and other.................. (2) (2) -- (1)
---- ---- ----- -----
Net cash used by investing activities.. (61) (46) (144) (138)
---- ---- ----- -----
FINANCING ACTIVITIES
Issuance of common shares.............. 2 3 6 13
Issuance of long-term debt............. -- -- 150 --
Debt issuance cost of long-term debt... -- -- (6) --
Retirement of long-term debt........... (2) (1) (361) (3)
Net increase (decrease) in revolver
borrowings and short-term debt
excluding current maturities of long-
term debt............................ 87 32 360 29
Distributions to minority interest
partners............................. (2) -- (3) (1)
Other.................................. 2 -- 2 2
---- ---- ----- -----
Net cash provided by financing
activities........................... 87 34 148 40
---- ---- ----- -----
Effect of foreign exchange rate changes
on cash and cash equivalents......... 18 -- 32 8
Increase (decrease) in cash and cash
equivalents.......................... 35 (7) 1 (25)
Cash and cash equivalents, July 1 and
January 1, respectively.............. 168 123 202 141
---- ---- ----- -----
Cash and cash equivalents, September 30
(Note)............................... $203 $116 $ 203 $ 116
==== ==== ===== =====
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the period for
interest............................. $ 34 $ 36 $ 111 $ 103
Cash paid during the period for income
taxes (net of refunds)............... $ 17 $ 11 $ 45 $ 18
NON-CASH INVESTING AND FINANCING
ACTIVITIES
Period ended balance of payables for
plant, property, and equipment....... $ 24 $ 21 $ 24 $ 21
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)
--------------------
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2007 SEPTEMBER 30, 2006
-------------------- --------------------
SHARES AMOUNT SHARES AMOUNT
---------- ------- ---------- -------
(MILLIONS EXCEPT SHARE AMOUNTS)
COMMON STOCK
Balance January 1............................ 47,085,274 $ -- 45,544,668 $ --
Issued (Reacquired) pursuant to benefit
plans................................... 238,071 -- (114,546) --
Stock options exercised.................... 491,970 -- 1,389,261 --
---------- ------- ---------- -------
Balance September 30......................... 47,815,315 -- 46,819,383 --
========== ==========
PREMIUM ON COMMON STOCK AND OTHER CAPITAL
SURPLUS
Balance January 1............................ 2,790 2,776
Premium on common stock issued pursuant to
benefit plans........................... 8 10
------- -------
Balance September 30......................... 2,798 2,786
------- -------
ACCUMULATED OTHER COMPREHENSIVE LOSS
Balance January 1............................ (252) (281)
Other comprehensive income................. 118 45
------- -------
Balance September 30......................... (134) (236)
------- -------
RETAINED EARNINGS (ACCUMULATED DEFICIT)
Balance January 1............................ (2,072) (2,118)
Net income................................. 67 34
Measurement date implementation of SFAS No.
158, net of tax......................... (5) --
Other...................................... (1) (2)
------- -------
Balance September 30......................... (2,011) (2,086)
------- -------
LESS -- COMMON STOCK HELD AS TREASURY STOCK,
AT COST
Balance January 1 and September 30........... 1,294,692 240 1,294,692 240
========== ------- ========== -------
Total................................... $ 413 $ 224
======= =======
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 SEPTEMBER THREE MONTHS ENDED
30, 2007 SEPTEMBER 30, 2006
---------------------------- -----------------------------
ACCUMULATED ACCUMULATED
OTHER OTHER
COMPREHENSIVE COMPREHENSIVE COMPREHENSIVE COMPREHENSIVE
INCOME INCOME INCOME INCOME
(LOSS) (LOSS) (LOSS) (LOSS)
------------- ------------- ------------- -------------
(MILLIONS)
NET INCOME............................ $21 $ 7
--- ---
ACCUMULATED OTHER COMPREHENSIVE INCOME
(LOSS)
CUMULATIVE TRANSLATION ADJUSTMENT
Balance July 1...................... $ (12) $ (96)
Translation of foreign currency
statements..................... 63 63 (8) (8)
----- -----
Balance September 30................ 51 (104)
----- -----
ADDITIONAL LIABILITY FOR PENSION
BENEFITS
Balance July 1 and September 30..... (185) (132)
----- -----
Balance September 30.................. $(134) $(236)
===== --- ===== ---
OTHER COMPREHENSIVE INCOME (LOSS)..... 63 (8)
--- ---
COMPREHENSIVE INCOME (LOSS)........... $84 $(1)
=== ===
AS RESTATED (NOTE 2)
-----------------------------
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2007 SEPTEMBER 30, 2006
----------------------------- -----------------------------
ACCUMULATED ACCUMULATED
OTHER OTHER
COMPREHENSIVE COMPREHENSIVE COMPREHENSIVE COMPREHENSIVE
INCOME INCOME INCOME INCOME
(LOSS) (LOSS) (LOSS) (LOSS)
------------- ------------- ------------- -------------
(MILLIONS)
NET INCOME.......................... $ 67 $34
---- ---
ACCUMULATED OTHER COMPREHENSIVE
INCOME (LOSS)
CUMULATIVE TRANSLATION ADJUSTMENT
Balance January 1................. $ (53) $(149)
Translation of foreign currency
statements................... 104 104 45 45
----- -----
Balance September 30.............. 51 (104)
----- -----
ADDITIONAL LIABILITY FOR PENSION
BENEFITS
Balance January 1................. (199) (132)
Measurement date implementation of
SFAS No. 158, net of tax....... 14 14 -- --
----- -----
Balance September 30.............. (185) (132)
----- -----
Balance September 30................ $(134) $(236)
===== ---- ===== ---
OTHER COMPREHENSIVE INCOME (LOSS)... 118 45
---- ---
COMPREHENSIVE INCOME (LOSS)......... $185 $79
==== ===
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 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 condensed consolidated financial
statements pursuant to the rules and regulations of the U.S. Securities and
Exchange Commission for interim financial information. 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 corrected
our past accounting for the swaps as hedges. Therefore, we recorded 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 corrected other errors as part of the 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
September 30, 2006 and by $1 million in the nine month period ended September
30, 2006. Selling, general and administrative expense was also reduced by less
than one million dollars in the three month period ended September 30, 2006 and
by $2 million in the nine month period ended September 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 nine months ended September 30, 2006 have been restated from the
amounts previously reported. The December 31, 2006 balance sheet was restated in
Form 10-K/A filed on August 14, 2007. In connection with this restatement, the
following
11
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(Unaudited)
Notes to the Consolidated Financial Statements have been restated: 4, 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 NINE MONTHS ENDED SEPTEMBER
SEPTEMBER 30, 2006 30, 2006
--------------------------- ---------------------------
REVENUE
Net sales and operating
revenues..................... $ 1,122 $ 1,121 $ 3,476 $ 3,473
----------- ----------- ----------- -----------
COSTS AND EXPENSES
Costs and expenses (exclusive of
depreciation and amortization
shown below)................. 926 925 2,819 2,817
Engineering, research, and
development.................. 24 24 68 68
Selling, general, and
administrative............... 82 81 290 288
Depreciation and amortization of
other intangibles............ 45 45 136 136
----------- ----------- ----------- -----------
1,077 1,075 3,313 3,309
----------- ----------- ----------- -----------
OTHER INCOME (EXPENSE)
Loss on sale of receivables..... (2) (3) (4) (7)
Other income ................... 2 -- 1 --
----------- ----------- ----------- -----------
-- (3) (3) (7)
----------- ----------- ----------- -----------
INCOME BEFORE INTEREST EXPENSE,
INCOME TAXES, AND MINORITY
INTEREST........................ 45 43 160 157
Interest expense (net of
interest capitalized)........ 34 30 101 102
Income tax expense.............. 3 4 18 17
Minority interest............... 2 2 4 4
----------- ----------- ----------- -----------
NET INCOME........................ $ 6 $ 7 $ 37 $ 34
=========== =========== =========== ===========
EARNINGS PER SHARE
Weighted average shares of common
stock outstanding --
Basic........................... 44,986,076 44,986,076 44,466,543 44,466,543
Diluted......................... 47,207,110 47,207,110 46,790,147 46,790,147
Basic earnings per share of common
stock........................... $ 0.13 $ 0.16 $ 0.84 $ 0.78
Diluted earnings per share of
common stock.................... $ 0.12 $ 0.16 $ 0.79 $ 0.74
12
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(Unaudited)
AS PREVIOUSLY AS PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED
------------- ----------- ------------- -----------
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER
SEPTEMBER 30, 2006 30, 2006
--------------------------- ---------------------------
(MILLIONS) (MILLIONS)
OPERATING ACTIVITIES
Net income................................ $ 6 $ 7 $ 37 $ 34
Adjustments to reconcile net income to
cash provided by operating
activities --
Depreciation and amortization of other
intangibles.......................... 45 45 136 136
Deferred income taxes................... 1 2 9 9
Stock-based compensation................ 1 1 3 5
Loss on sale of assets, net............. -- -- 2 2
Changes in components of working
capital --
(Increase) decrease in receivables... 17 14 (85) (86)
(Increase) decrease in inventories... (7) (8) (47) (48)
(Increase) decrease in prepayments
and other current assets........... (7) (7) (34) (44)
Increase (decrease) in payables...... (39) (37) 51 54
Increase (decrease) in accrued
taxes.............................. (8) (8) (8) (8)
Increase (decrease) in accrued
interest........................... (5) (1) (4) --
Increase (decrease) in other current
liabilities........................ 4 3 -- 8
Other................................... (5) (6) -- 3
---- ---- ----- -----
Net cash provided by operating
activities.............................. 3 5 60 65
---- ---- ----- -----
INVESTING ACTIVITIES
Net proceeds from the sale of assets...... 4 4 6 6
Cash payments for plant, property, and
equipment............................... (43) (45) (130) (134)
Cash payments for software related
intangible assets....................... (3) (3) (9) (9)
Investments and other..................... (2) (2) (1) (1)
---- ---- ----- -----
Net cash used by investing activities..... (44) (46) (134) (138)
---- ---- ----- -----
FINANCING ACTIVITIES
Issuance of common shares................. 3 3 13 13
Issuance of long-term debt................ -- -- -- --
Debt issuance costs on long-term debt..... -- -- -- --
Retirement of long-term debt.............. (1) (1) (3) (3)
Net increase (decrease) in revolver
borrowings and short-term debt excluding
current maturities of long-term debt.... 32 32 29 29
Distribution to minority interest
partners................................ -- -- -- (1)
Other..................................... -- -- 2 2
---- ---- ----- -----
Net cash provided by financing
activities.............................. 34 34 41 40
---- ---- ----- -----
Effect of foreign exchange rate changes on
cash and cash equivalents............... -- -- 8 8
---- ---- ----- -----
Increase (decrease) in cash and cash
equivalents............................. (7) (7) (25) (25)
Cash and cash equivalents, July 1 and
January 1, respectively................. 123 123 141 141
---- ---- ----- -----
Cash and cash equivalents, September 30... $116 $116 $ 116 $ 116
==== ==== ===== =====
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the year for interest.... $ 36 $ 36 $ 103 $ 103
Cash paid during the year for income taxes
(net of refunds)........................ $ 11 $ 11 $ 18 $ 18
NON-CASH INVESTING AND FINANCING
ACTIVITIES
Period ended balance of payables for
plant, property, and equipment.......... -- $ 21 -- $ 21
13
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(Unaudited)
(3) In September 2007, we completed the acquisition of Combustion
Components Associates' ELIM-NOx(TM) technology for $16 million. The acquisition
included a complete reactant dosing system design and associated intellectual
property including granted patents and patent applications yet to be granted for
selective catalytic reduction emission control systems that reduce emissions of
oxides of nitrogen from diesel powered vehicles. The technology can be used for
both urea and hydrocarbon injection. We have recorded the acquisition as part of
intangible assets on our balance sheet.
(4) 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 September 30, 2007, up to 1,292,416 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 nine
months ended September 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.
14
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(Unaudited)
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2007 2006
----------------- -----------------
(MILLIONS) (MILLIONS)
Selling, general and administrative................ $ 3 $ 3
------ ------
Loss before interest expense, income taxes and
minority interest................................ (3) (3)
Income tax benefit................................. 1 1
------ ------
Net loss........................................... $ (2) $ (2)
====== ======
Decrease in basic earnings per share............... $(0.05) $(0.04)
Decrease in diluted earnings per share............. $(0.05) $(0.04)
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 September 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 1.0 year.
Compensation expense for restricted stock, stock equivalent units, long-
term performance units and SARs, net of tax, was approximately $6 million for
the nine months ended September 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 nine months ended September 30,
2007, was approximately $4 million. Stock option exercises during the first nine
months of 2007 generated an excess tax benefit of approximately $6 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.
15
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(Unaudited)
NINE MONTHS
ENDED
SEPTEMBER 30,
-------------
2007 2006
----- -----
Stock Options
Weighted average grant date fair value, per share................ $9.93 $9.27
Weighted average assumptions used:
Expected volatility.............................................. 38.4% 42.6%
Expected lives................................................... 4.1 5.1
Risk-free interest rates......................................... 4.71% 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.
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:
NINE MONTHS ENDED SEPTEMBER 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
Granted................................. 5,884 32.08
Canceled................................ -- --
Forfeited............................... (6,419) 20.30
Exercised............................... (108,310) 8.72 $ 3
---------
Outstanding, September 30, 2007........... 2,958,541 $12.82 4.9 $61
=========
16
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(Unaudited)
Restricted Stock -- The following table reflects the status for all
nonvested restricted shares for the period indicated:
NINE MONTHS ENDED
SEPTEMBER 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
Granted.................................................. 3,054 32.46
Vested................................................... (612) 16.59
Forfeited................................................ -- --
--------
Nonvested balance at September 30, 2007.................... 483,450 $24.83
========
The fair value of restricted stock grants is equal to the average market
price of our stock at the date of grant. As of September 30, 2007, approximately
$8 million of total unrecognized compensation costs related to restricted stock
awards is expected to be recognized over a weighted-average period of
approximately 2.0 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 September 30, 2007, approximately $4 million of total unrecognized
compensation costs is expected to be recognized over the weighted-average period
of approximately 1.6 years.
(5) 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 September
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.
17
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(Unaudited)
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 1/4 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 September 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 September 30, 2007,
the fair value of the interest rate swaps was a liability of approximately $5
million which has been recorded in other long-term liabilities.
On November 1, 2007, we announced that we had priced a private placement
offering of $250 million of 8 1/8 percent senior notes due November 15, 2015.
The offering and related transactions are designed to (1) reduce our interest
expense and extend the maturity of a portion of our debt (by using the proceeds
of the offering to tender for a portion of our outstanding $475 million 10 1/4
percent senior secured notes due 2013), (2) facilitate the realignment of the
ownership structure of some of our foreign subsidiaries and (3) otherwise amend
certain of the covenants in the indenture for the senior secured notes to be
consistent with those contained in our subordinated notes, including conforming
the limitation on incurrence of indebtedness and the absence of a limitation on
issuances or transfers of restricted subsidiary stock, and make other minor
modifications. We expect to close this offering on November 20, 2007, assuming
we receive the requisite consents to amend the indenture for the senior secured
notes. We expect the indenture governing the new notes to be substantially
similar to the indenture for our existing senior subordinated notes.
(6) 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
18
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(Unaudited)
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 (accumulated deficit) 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.
(7) 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 third quarter of 2007, we incurred $3 million
in restructuring and restructuring-related costs which was recorded in cost of
sales, $2 million of which related to a charge for asset impairments. For the
first nine months of 2007, we incurred $7 million in restructuring and
restructuring-related costs of which $6 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 $137 million through September
30, 2007.
19
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(Unaudited)
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,
excluding any charges for asset impairment, incurred after March 16, 2007 from
the calculation of the financial covenant ratios required under our senior
credit facility. As of September 30, 2007, we have excluded $5 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.
(8) 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 September 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
20
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(Unaudited)
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.
Below is a table that shows the activity in the warranty accrual accounts:
NINE MONTHS
ENDED
SEPTEMBER
30,
-----------
2007 2006
---- ----
(MILLIONS)
Beginning Balance January 1,....................................... $25 $ 22
Accruals related to product warranties............................. 11 16
Reductions for payments made....................................... (8) (12)
--- ----
Ending Balance September 30,....................................... $28 $ 26
=== ====
The current year increase in the warranty accrual is primarily driven by
higher unit pricing and product mix in the North American aftermarket.
21
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(Unaudited)
(9) 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 12.
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.
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 second quarter. The adoption of FIN 48-1 did not have a
material impact to our financial statements and related disclosures. See Note 6.
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,
22
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(Unaudited)
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.
(10) 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 without recourse, 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 $149 million and $144
million at September 30, 2007 and 2006, respectively. We recognized a loss of $8
million for the nine months ended September 30, 2007, and $7 million for the
nine months ended September 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)
(11) Earnings per share of common stock outstanding were computed as
follows:
AS RESTATED AS RESTATED
(NOTE 2) (NOTE 2)
------------- -------------
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2007 2006 2007 2006
------------- ------------- ------------- -------------
(MILLIONS EXCEPT SHARE AND PER SHARE AMOUNTS)
Basic earnings per share --
Net Income.......................... $ 21 $ 7 $ 67 $ 34
=========== =========== =========== ===========
Weighted average shares of common
stock outstanding................ 45,973,687 44,986,076 45,725,202 44,466,543
=========== =========== =========== ===========
Earnings per weighted average share
of common stock.................. $ 0.47 $ 0.16 $ 1.48 $ 0.78
=========== =========== =========== ===========
Diluted earnings per share --
Net Income.......................... $ 21 $ 7 $ 67 $ 34
=========== =========== =========== ===========
Weighted average shares of common
stock outstanding................ 45,973,687 44,986,076 45,725,202 44,466,543
Effect of dilutive securities:
Restricted stock................. 206,495 335,432 208,175 409,223
Stock options.................... 1,719,175 1,885,602 1,588,361 1,914,381
----------- ----------- ----------- -----------
Weighted average shares of common
stock outstanding including
dilutive securities.............. 47,899,357 47,207,110 47,521,738 46,790,147
=========== =========== =========== ===========
Earnings per weighted average share
of common stock.................. $ 0.45 $ 0.16 $ 1.42 $ 0.74
=========== =========== =========== ===========
Options to purchase 351,429 and 1,020,145 shares of common stock were
outstanding at September 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 September 30, 2007 and 2006, respectively.
(12) Net periodic pension costs (income) and postretirement benefit costs
(income) consist of the following components:
THREE MONTHS ENDED SEPTEMBER 30,
---------------------------------------------
POSTRETIRE-
PENSION MENT
----------------------------- -------------
2007 2006 2007 2006
------------- ------------- ---- ----
US FOREIGN US FOREIGN US US
--- ------- --- ------- ---- ----
(MILLIONS)
Service cost -- benefits earned during the
period..................................... $ 1 $ 3 $ 4 $ 2 $ 1 $--
Interest cost................................ 4 4 5 3 2 2
Expected return on plan assets............... (5) (5) (4) (4) -- --
Net amortization:
Actuarial loss............................. 2 1 2 1 1 2
Prior service cost......................... -- -- -- 1 (1) (1)
--- --- --- --- --- ---
Net pension and postretirement costs......... $ 2 $ 3 $ 7 $ 3 $ 3 $ 3
=== === === === === ===
24
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(Unaudited)
NINE MONTHS ENDED SEPTEMBER 30,
-----------------------------------------------
POSTRETIRE-
PENSION MENT
------------------------------- -------------
2007 2006 2007 2006
-------------- -------------- ---- ----
US FOREIGN US FOREIGN US US
---- ------- ---- ------- ---- ----
(MILLIONS)
Service cost -- benefits earned during the
period.................................... $ 2 $ 7 $ 12 $ 6 $ 2 $ 2
Interest cost............................... 14 13 14 11 7 6
Expected return on plan assets.............. (16) (15) (14) (12) -- --
Net amortization:
Actuarial loss............................ 3 4 4 4 4 5
Prior service cost........................ -- -- 2 1 (4) (4)
---- ---- ---- ---- --- ---
Net pension and postretirement costs........ $ 3 $ 9 $ 18 $ 10 $ 9 $ 9
==== ==== ==== ==== === ===
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 nine months ended September 30, 2007, we made pension contributions
of approximately $13 million for our domestic pension plans and $12 million for
our foreign pension plans. Based on current actuarial estimates, we believe we
will be required to make approximately $4 million in contributions for the
remainder of 2007.
We made postretirement contributions of approximately $7 million during the
first nine months of 2007. Based on current actuarial estimates, we believe we
will be required to make approximately $3 million in contributions for the
remainder of 2007.
As of December 31, 2006, $71 million of our total projected benefit
obligation related to plans that do not require contributions.
(13) 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 a million at September 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
25
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(Unaudited)
subsidiaries. No assets or capital stock of our direct or indirect foreign
subsidiaries secure these notes. You should also read Note 15 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 issued $18 million in letters of credit
to support some of our subsidiaries' insurance arrangements. In addition, we
have issued $13 million in guarantees through letters of credit to guarantee
other obligations of subsidiaries primarily related to environmental remediation
activities and a foreign employee benefit program.
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 September 30, 2007
and 2006 are classified as other current assets and are excluded from our
definition of cash equivalents. We had sold approximately $16 million of these
instruments at September 30, 2007 and $20 million at September 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 $12 million and $9 million at September
30, 2007 and 2006, respectively, and were classified as notes payable. Financial
instruments received from OE customers and not redeemed totaled $7 million as of
September 30, 2007 and 2006, 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 a million dollars at September 30, 2007 and
2006, respectively, and was classified as cash and cash equivalents.
(14) 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:
SEGMENT
-----------------------------------------------------
NORTH ASIA RECLASS &
AMERICA EUROPE PACIFIC ELIMS CONSOLIDATED
------- ------ ------- --------- ------------
(MILLIONS)
AT SEPTEMBER 30, 2007 AND FOR THE THREE
MONTHS THEN ENDED
Revenues from external customers.......... $ 734 $ 672 $150 $ -- $1,556
Intersegment revenues..................... 3 118 4 (125) --
Income before interest expense, income
taxes, and minority interest............ 24 22 11 -- 57
AT SEPTEMBER 30, 2007 AND FOR THE NINE
MONTHS THEN ENDED
Revenues from external customers.......... $2,187 $2,034 $398 $ -- $4,619
Intersegment revenues..................... 7 310 11 (328) --
Income before interest expense, income
taxes, and minority interest............ 104 80 25 -- 209
Total assets.............................. 1,627 1,740 369 86 3,822
TOTAL ASSETS AT DECEMBER 31, 2006......... $1,460 $1,422 $301 $ 91 $3,274
AS RESTATED (NOTE 2)
-----------------------------------------------------
SEGMENT
-----------------------------------------------------
NORTH ASIA RECLASS &
AMERICA EUROPE PACIFIC ELIMS CONSOLIDATED
------- ------ ------- --------- ------------
(MILLIONS)
AT SEPTEMBER 30, 2006 AND FOR THE THREE
MONTHS THEN ENDED
Revenues from external customers.......... $ 441 $ 569 $111 $ -- $1,121
Intersegment revenues..................... 2 15 4 (21) --
Income before interest expense, income
taxes, and minority interest............ 15 23 5 -- 43
AT SEPTEMBER 30, 2006 AND FOR THE NINE
MONTHS THEN ENDED
Revenues from external customers.......... $1,478 $1,692 $303 $ -- $3,473
Intersegment revenues..................... 5 47 11 (63) --
Income before interest expense, income
taxes, and minority interest............ 85 65 7 -- 157
Total assets.............................. 1,412 1,411 290 57 3,170
27
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(Unaudited)
(15) 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 using 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.
28
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(Unaudited)
STATEMENT OF INCOME (LOSS)
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2007
---------------------------------------------------------------------
TENNECO INC.
GUARANTOR NONGUARANTOR (PARENT RECLASS &
SUBSIDIARIES SUBSIDIARIES COMPANY) ELIMS CONSOLIDATED
------------ ------------ ------------ --------- ------------
(MILLIONS)
REVENUES
Net sales and operating
revenues -- External......... $725 $ 831 $ -- $ -- $1,556
Affiliated companies......... 19 249 -- (268) --
---- ------ ---- ----- ------
744 1,080 -- (268) 1,556
---- ------ ---- ----- ------
COSTS AND EXPENSES
Cost of sales (exclusive of
depreciation shown below).... 694 887 -- (268) 1,313
Engineering, research, and
development.................. 14 16 -- -- 30
Selling, general, and
administrative............... 43 57 1 -- 101
Depreciation and amortization of
other intangibles............ 21 31 -- -- 52
---- ------ ---- ----- ------
772 991 1 (268) 1,496
---- ------ ---- ----- ------
OTHER INCOME (EXPENSE)
Loss on sale of receivables..... -- (3) -- -- (3)
Other income (loss)............. 7 (3) (4) -- --
---- ------ ---- ----- ------
7 (6) (4) -- (3)
---- ------ ---- ----- ------
INCOME BEFORE INTEREST EXPENSE,
INCOME TAXES, MINORITY INTEREST,
AND EQUITY IN NET INCOME FROM
AFFILIATED COMPANIES............ (21) 83 (5) -- 57
---- ------ ---- ----- ------
Interest expense --
External (net of interest
capitalized)............... (1) -- 33 -- 32
Affiliated companies (net of
interest income)........... 48 (4) (44) -- --
Income tax expense (benefit).... (24) 26 6 (8) --
Minority interest............... -- 4 -- -- 4
---- ------ ---- ----- ------
(44) 57 -- 8 21
Equity in net income from
affiliated companies......... 51 -- 21 (72) --
---- ------ ---- ----- ------
NET INCOME........................ $ 7 $ 57 $ 21 $ (64) $ 21
==== ====== ==== ===== ======
29
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 SEPTEMBER 30, 2006
---------------------------------------------------------------------
TENNECO INC.
GUARANTOR NONGUARANTOR (PARENT RECLASS &
SUBSIDIARIES SUBSIDIARIES COMPANY) ELIMS CONSOLIDATED
------------ ------------ ------------ --------- ------------
(MILLIONS)
REVENUES
Net sales and operating
revenues -- External......... $429 $692 $ -- $ -- $1,121
Affiliated companies......... 22 112 -- (134) --
---- ---- ---- ----- ------
451 804 -- (134) 1,121
---- ---- ---- ----- ------
COSTS AND EXPENSES
Cost of sales (exclusive of
depreciation shown below).... 373 685 -- (133) 925
Engineering, research, and
development.................. 8 16 -- -- 24
Selling, general, and
administrative............... 34 46 1 -- 81
Depreciation and amortization of
other intangibles............ 17 28 -- -- 45
---- ---- ---- ----- ------
432 775 1 (133) 1,075
---- ---- ---- ----- ------
OTHER INCOME (EXPENSE)
Loss on sale of receivables..... -- (3) -- -- (3)
Other income (loss)............. 2 -- (3) 1 --
---- ---- ---- ----- ------
2 (3) (3) 1 (3)
---- ---- ---- ----- ------
INCOME (LOSS) BEFORE INTEREST
EXPENSE, INCOME TAXES, MINORITY
INTEREST, AND EQUITY IN NET
INCOME FROM AFFILIATED
COMPANIES....................... 21 26 (4) -- 43
Interest expense --
External (net of interest
capitalized)............... (2) 1 31 -- 30
Affiliated companies (net of
interest income)........... 43 (3) (40) -- --
Income tax expense (benefit).... (5) 8 13 (12) 4
Minority interest............... -- 2 -- -- 2
---- ---- ---- ----- ------
(15) 18 (8) 12 7
Equity in net income (loss) from
affiliated companies......... 12 1 15 (28) --
---- ---- ---- ----- ------
NET INCOME (LOSS)................. $ (3) $ 19 $ 7 $ (16) $ 7
==== ==== ==== ===== ======
30
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(Unaudited)
STATEMENT OF INCOME (LOSS)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007
---------------------------------------------------------------------
TENNECO INC.
GUARANTOR NONGUARANTOR (PARENT RECLASS &
SUBSIDIARIES SUBSIDIARIES COMPANY) ELIMS CONSOLIDATED
------------ ------------ ------------ --------- ------------
(MILLIONS)
REVENUES
Net sales and operating
revenues -- External......... $2,123 $2,496 $ -- $ -- $4,619
Affiliated companies......... 77 678 -- (755) --
------ ------ ----- ----- ------
2,200 3,174 -- (755) 4,619
------ ------ ----- ----- ------
COSTS AND EXPENSES
Cost of sales (exclusive of
depreciation shown below).... 1,973 2,651 -- (755) 3,869
Engineering, research, and
development.................. 40 46 -- -- 86
Selling, general, and
administrative............... 119 178 3 -- 300
Depreciation and amortization of
other intangibles............ 58 92 -- -- 150
------ ------ ----- ----- ------
2,190 2,967 3 (755) 4,405
------ ------ ----- ----- ------
OTHER INCOME (EXPENSE)
Loss on sale of receivables..... -- (8) -- -- (8)
Other income (loss)............. 10 (2) (1) (4) 3
------ ------ ----- ----- ------
10 (10) (1) (4) (5)
------ ------ ----- ----- ------
INCOME BEFORE INTEREST EXPENSE,
INCOME TAXES, MINORITY INTEREST,
AND EQUITY IN NET INCOME FROM
AFFILIATED COMPANIES............ 20 197 (4) (4) 209
------ ------ ----- ----- ------
Interest expense --
External (net of interest
capitalized)............... (2) 3 111 -- 112
Affiliated companies (net of
interest income)........... 140 (12) (128) -- --
Income tax expense (benefit).... (48) 60 7 3 22
Minority interest............... -- 8 -- -- 8
------ ------ ----- ----- ------
(70) 138 6 (7) 67
Equity in net income (loss) from
affiliated companies......... 132 -- 61 (193) --
------ ------ ----- ----- ------
NET INCOME (LOSS)................. $ 62 $ 138 $ 67 $(200) $ 67
====== ====== ===== ===== ======
31
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(Unaudited)
STATEMENT OF INCOME (LOSS)
AS RESTATED (NOTE 2)
---------------------------------------------------------------------
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006
---------------------------------------------------------------------
TENNECO INC.
GUARANTOR NONGUARANTOR (PARENT RECLASS &
SUBSIDIARIES SUBSIDIARIES COMPANY) ELIMS CONSOLIDATED
------------ ------------ ------------ --------- ------------
(MILLIONS)
REVENUES
Net sales and operating
revenues -- External......... $1,435 $2,038 $ -- $ -- $3,473
Affiliated companies......... 66 360 -- (426) --
------ ------ ----- ----- ------
1,501 2,398 -- (426) 3,473
------ ------ ----- ----- ------
COSTS AND EXPENSES
Cost of sales (exclusive of
depreciation shown below).... 1,210 2,032 -- (425) 2,817
Engineering, research, and
development.................. 25 43 -- -- 68
Selling, general, and
administrative............... 125 160 3 -- 288
Depreciation and amortization of
other intangibles............ 52 84 -- -- 136
------ ------ ----- ----- ------
1,412 2,319 3 (425) 3,309
------ ------ ----- ----- ------
OTHER INCOME (EXPENSE)
Loss on sale of receivables..... -- (7) -- -- (7)
Other income (loss)............. 7 (5) (1) (1) --
------ ------ ----- ----- ------
7 (12) (1) (1) (7)
INCOME BEFORE INTEREST EXPENSE,
INCOME TAXES, MINORITY INTEREST,
AND EQUITY IN NET INCOME FROM
AFFILIATED COMPANIES............ 96 67 (4) (2) 157
Interest expense --
External (net of interest
capitalized)............... (4) 2 104 -- 102
Affiliated companies (net of
interest income)........... 121 (9) (112) -- --
Income tax expense (benefit).... (1) 19 39 (40) 17
Minority interest............... -- 4 -- -- 4
------ ------ ----- ----- ------
(20) 51 (35) 38 34
Equity in net income (loss) from
affiliated companies......... 38 1 69 (108) --
------ ------ ----- ----- ------
NET INCOME (LOSS)................. $ 18 $ 52 $ 34 $ (70) $ 34
====== ====== ===== ===== ======
32
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(Unaudited)
BALANCE SHEET
SEPTEMBER 30, 2007
-----------------------------------------------------------------
TENNECO INC.
GUARANTOR NONGUARANTOR (PARENT RECLASS &
SUBSIDIARIES SUBSIDIARIES COMPANY) ELIMS CONSOLIDATED
------------ ------------ ------------ --------- ------------
(MILLIONS)
ASSETS
Current assets:
Cash and cash equivalents........ $ 5 $ 198 $ -- $ -- $ 203
Receivables, net................. 464 1,186 24 (760) 914
Inventories...................... 230 350 -- -- 580
Deferred income taxes............ 13 16 39 (39) 29
Prepayments and other............ 17 151 -- -- 168
------ ------- ------ -------- -------
729 1,901 63 (799) 1,894
------ ------- ------ -------- -------
Other assets:
Investment in affiliated
companies..................... 702 2 1,242 (1,946) --
Notes and advances receivable
from affiliates............... 3,422 232 5,172 (8,826) --
Long-term notes receivable, net.. -- 22 -- -- 22
Goodwill......................... 135 72 -- -- 207
Intangibles, net................. 17 9 -- -- 26
Deferred income taxes............ 326 67 180 (180) 393
Other............................ 38 70 28 -- 136
------ ------- ------ -------- -------
4,640 474 6,622 (10,952) 784
------ ------- ------ -------- -------
Plant, property, and equipment, at
cost............................. 982 1,920 -- -- 2,902
Less -- Accumulated depreciation
and amortization.............. (658) (1,100) -- -- (1,758)
------ ------- ------ -------- -------
324 820 -- -- 1,144
------ ------- ------ -------- -------
5,693 3,195 6,685 (11,751) 3,822
====== ======= ====== ======== =======
LIABILITIES AND SHAREHOLDERS'
EQUITY
Current liabilities:
Short-term debt (including
current maturities of long-
term debt)
Short-term debt -- non-
affiliated.................. $ -- 31 2 $ -- 33
Short-term
debt -- affiliated.......... 216 391 10 (617) --
Trade payables................... 392 775 -- (142) 1,025
Accrued taxes.................... 59 30 -- (52) 37
Other............................ 126 138 28 (1) 291
------ ------- ------ -------- -------
793 1,365 40 (812) 1,386
------ ------- ------ -------- -------
Long-term debt -- non-affiliated... -- 9 1,494 -- 1,503
Long-term debt -- affiliated....... 4,049 43 4,734 (8,826) --
Deferred income taxes.............. 141 115 -- (173) 83
Postretirement benefits and other
liabilities...................... 286 108 4 6 404
Commitments and contingencies
Minority interest.................. -- 33 -- -- 33
Shareholders' equity............... 424 1,522 413 (1,946) 413
------ ------- ------ -------- -------
5,693 3,195 6,685 (11,751) 3,822
====== ======= ====== ======== =======
33
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(Unaudited)
BALANCE SHEET
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
====== ====== ====== ======== =======
34
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(Unaudited)
STATEMENT OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2007
-----------------------------------------------------------------
TENNECO INC.
GUARANTOR NONGUARANTOR (PARENT RECLASS &
SUBSIDIARIES SUBSIDIARIES COMPANY) ELIMS CONSOLIDATED
------------ ------------ ------------ --------- ------------
(MILLIONS)
OPERATING ACTIVITIES
Net cash provided (used) by operating
activities........................... $ 181 $ 24 $(240) $-- $ (35)
----- ---- ----- --- -----
INVESTING ACTIVITIES
Net proceeds from the sale of assets... 2 -- -- -- 2
Cash payment for plant, property, and
equipment............................ (41) (75) -- -- (116)
Cash payment for net assets purchased.. (16) -- -- -- (16)
Cash payment for software related
intangible assets.................... (9) (5) -- -- (14)
Acquisition of businesses.............. -- -- -- -- --
Investments and other.................. -- -- -- -- --
----- ---- ----- --- -----
Net cash used by investing activities.. (64) (80) -- -- (144)
----- ---- ----- --- -----
FINANCING ACTIVITIES
Issuance of common stock............... -- -- 6 -- 6
Issuance of long-term debt............. -- -- 150 -- 150
Debt issuance cost of long-term debt... -- -- (6) -- (6)
Retirement of long-term debt........... -- (2) (359) -- (361)
Net increase (decrease) in revolver
borrowings and short-term debt
excluding current maturities of long-
term debt............................ -- 3 357 -- 360
Intercompany dividends and net increase
(decrease) in intercompany
obligations.......................... (168) 76 92 -- --
Distribution to minority interest
partners............................. -- (3) -- -- (3)
Other.................................. -- 2 -- -- 2
----- ---- ----- --- -----
Net cash provided (used) by financing
activities........................... (168) 76 240 -- 148
----- ---- ----- --- -----
Effect of foreign exchange rate changes
on cash and cash equivalents......... -- 32 -- -- 32
----- ---- ----- --- -----
Increase (decrease) in cash and cash
equivalents.......................... (51) 52 -- -- 1
Cash and cash equivalents, January 1... 56 146 -- -- 202
----- ---- ----- --- -----
Cash and cash equivalents, September 30
(Note)............................... $ 5 $198 $ -- $-- $ 203
===== ==== ===== === =====
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
AS RESTATED (NOTE 2)
---------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, 2006
---------------------------------------------------------------------
TENNECO INC.
GUARANTOR NONGUARANTOR (PARENT RECLASS &
SUBSIDIARIES SUBSIDIARIES COMPANY) ELIMS CONSOLIDATED
------------ ------------ ------------ --------- ------------
(MILLIONS)
OPERATING ACTIVITIES
Net cash provided (used) by operating
activities......................... $ 85 $ 193 $(213) $-- $ 65
---- ----- ----- --- -----
INVESTING ACTIVITIES
Net proceeds from the sale of
assets............................. -- 6 -- -- 6
Cash payment for plant, property, and
equipment.......................... (63) (71) -- -- (134)
Cash payment for software related
intangible assets.................. (6) (3) -- -- (9)
Investments and other................ 1 (2) -- -- (1)
---- ----- ----- --- -----
Net cash used by investing
activities......................... (68) (70) -- -- (138)
---- ----- ----- --- -----
FINANCING ACTIVITIES
Issuance of common shares............ -- -- 13 -- 13
Retirement of long-term debt......... -- (2) (1) -- (3)
Net increase (decrease) in revolver
borrowings and short-term debt
excluding current maturities of
long-term debt..................... -- -- 29 -- 29
Intercompany dividends and net
increase (decrease) in intercompany
obligations........................ (47) (125) 172 -- --
Distribution to minority interest
partners........................... -- (1) -- -- (1)
Other................................ -- 2 -- -- 2
---- ----- ----- --- -----
Net cash provided (used) by financing
activities......................... (47) (126) 213 -- 40
---- ----- ----- --- -----
Effect of foreign exchange rate
changes on cash and cash
equivalents........................ -- 8 -- -- 8
---- ----- ----- --- -----
Increase (decrease) in cash and cash
equivalents........................ (30) 5 -- -- (25)
Cash and cash equivalents, January
1.................................. 31 110 -- -- 141
---- ----- ----- --- -----
Cash and cash equivalents, September
30 (Note).......................... $ 1 $ 115 $ -- $-- $ 116
==== ===== ===== === =====
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 SEPTEMBER 30, 2007
-----------------------------------------------------------------
TENNECO INC.
GUARANTOR NONGUARANTOR (PARENT RECLASS &
SUBSIDIARIES SUBSIDIARIES COMPANY) ELIMS CONSOLIDATED
------------ ------------ ------------ --------- ------------
(MILLIONS)
OPERATING ACTIVITIES
Net cash provided (used) by operating
activities........................... $ 63 $ 9 $(81) $-- $ (9)
---- ---- ---- --- ----
INVESTING ACTIVITIES
Net proceeds from the sale of assets... 1 -- -- -- 1
Cash payments for plant, property, and
equipment............................ (14) (27) -- -- (41)
Cash payment for net assets purchased.. (16) -- -- -- (16)
Cash payments for software related
intangible assets.................... (3) -- -- -- (3)
Investments and other.................. -- (2) -- -- (2)
---- ---- ---- --- ----
Net cash provided (used) by investing
activities........................... (32) (29) -- -- (61)
---- ---- ---- --- ----
FINANCING ACTIVITIES
Issuance of common shares.............. -- -- 2 -- 2
Retirement of long-term debt........... -- -- (2) -- (2)
Net increase (decrease) in revolver
borrowings and short-term debt
excluding current maturities of long-
term debt............................ -- 1 86 -- 87
Intercompany dividends and net increase
(decrease) in intercompany
obligations.......................... (35) 40 (5) -- --
Distributions to minority interest
partners............................. -- (2) -- -- (2)
Other.................................. -- 2 -- -- 2
---- ---- ---- --- ----
Net cash provided (used) by financing
activities........................... (35) 41 81 -- 87
---- ---- ---- --- ----
Effect of foreign exchange rate changes
on cash and cash equivalents......... -- 18 -- -- 18
---- ---- ---- --- ----
Increase (decrease) in cash and cash
equivalents.......................... (4) 39 -- -- 35
Cash and cash equivalents, July 1...... 9 159 -- -- 168
---- ---- ---- --- ----
Cash and cash equivalents, September 30
(Note)............................... $ 5 $198 $ -- $-- $203
==== ==== ==== === ====
NOTE: Cash and cash equivalents include highly liquid investments with a
maturity of three months or less at the date of purchase.
37
TENNECO INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(Unaudited)
STATEMENT OF CASH FLOWS
AS RESTATED (NOTE 2)
---------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, 2006
---------------------------------------------------------------------
TENNECO INC.
GUARANTOR NONGUARANTOR (PARENT RECLASS &
SUBSIDIARIES SUBSIDIARIES COMPANY) ELIMS CONSOLIDATED
------------ ------------ ------------ --------- ------------
(MILLIONS)
OPERATING ACTIVITIES
Net cash provided (used) by operating
activities......................... $(103) $ 183 $(75) $-- $ 5
----- ----- ---- --- ----
INVESTING ACTIVITIES
Net proceeds from the sale of
assets............................. -- 4 -- -- 4
Cash payment for plant, property, and
equipment.......................... (18) (27) -- -- (45)
Cash payment for software related
intangible assets.................. (2) (1) -- -- (3)
Acquisition of businesses............ -- -- -- -- --
Investments and other................ 1 (3) -- -- (2)
----- ----- ---- --- ----
Net cash used by investing
activities......................... (19) (27) -- -- (46)
----- ----- ---- --- ----
FINANCING ACTIVITIES
Issuance of common shares............ -- -- 3 -- 3
Retirement of long-term debt......... -- (1) -- -- (1)
Net increase (decrease) in revolver
borrowings and short-term debt
excluding current maturities of
long-term debt..................... -- 3 29 -- 32
Intercompany dividends and net
increase (decrease) in intercompany
obligations........................ 111 (154) 43 -- --
Other................................ -- -- -- -- --
----- ----- ---- --- ----
Net cash provided (used) by financing
activities......................... 111 (152) 75 -- 34
----- ----- ---- --- ----
Effect of foreign exchange rate
changes on cash and cash
equivalents........................ -- -- -- -- --
----- ----- ---- --- ----
Increase (decrease) in cash and cash
equivalents........................ (11) 4 -- -- (7)
Cash and cash equivalents, July 1.... 12 111 -- -- 123
----- ----- ---- --- ----
Cash and cash equivalents, September
30 (Note).......................... $ 1 $ 115 $ -- $-- $116
===== ===== ==== === ====
NOTE: Cash and cash equivalents include highly liquid investments with a
maturity of three months or less at the date of purchase.
38
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
EXECUTIVE SUMMARY
As you read Management's Discussion and Analysis, you should also read our
Annual Report on Form 10-K/A for the year ended December 31, 2006. 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 September 30, 2006 and for the three and nine
months then ended have been restated. See Note 2.
Total revenues for the third quarter of 2007 were $1,556 million, compared
to $1,121 million in the third quarter of 2006. Excluding the impact of currency
and substrate sales, revenue was up $169 million, or 19 percent, from $900
million to $1,069 million, driven primarily by volume ramp-ups on platform
launches in North America and higher OE revenues in Europe and Asia, more than
offsetting lower aftermarket sales in North America and Europe. In addition, we
benefited from our geographic balance, broad platform diversity and wide
customer base.
In the third quarter of 2007, net sales and operating revenues less cost of
sales, excluding depreciation and amortization, as a percent of net sales and
operating revenues ("gross margin") was 15.6 percent, down 1.9 percentage points
from 17.5 percent in 2006. Substantially higher substrate sales, which typically
carry lower margins, primarily from newly launched diesel platforms in North
America and Europe, and a shift toward a lower percentage of total revenue
generated by higher margin aftermarket business negatively impacted overall
gross margin. Partially offsetting these items were favorable currency exchange
rates and lower restructuring. 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 third quarter of 2007 at 8.4 percent of revenues, as compared to 9.4 percent
of revenues for the third quarter of 2006. The improvement in this ratio was due
to leveraging our higher revenues by tightly controlling selling, general and
administrative spending while still making increased investments in engineering
for next generation ride and emission control technologies as well as higher
aftermarket changeover costs.
39
Earnings before interest expense, taxes and minority interest ("EBIT") was
$57 million for the third quarter of 2007, up $14 million, or 31 percent, from
the $43 million reported in the third quarter of 2006. Global sales growth on OE
platforms featuring advanced technology content, operational efficiencies, lower
costs for restructuring and favorable currency drove the year-over-year
improvement. Partially offsetting these improvements were higher aftermarket
changeover costs and softer global aftermarket conditions. EBIT as a percent of
revenue for the third quarter was 4%, unchanged from last year, as profit from
new platform launches and the improved selling, general, administrative and
engineering ratio offset the impact of gross margin dilution from the substrate
sales increase.
In the third quarter we also spent $16 million to acquire Combustion
Components Associates' ELIM-NOx(TM) technology. The acquisition enhances our
complete system integration capabilities for selective catalyst reduction (SCR)
emissions control technologies designed to meet future more stringent diesel
emissions regulations for passenger cars and trucks.
Total revenues for the first nine months of 2007 were $4,619 million,
compared to $3,473 million for the first nine months of 2006. Excluding the
impact of currency and substrate sales, revenue was up $410 million, or 15
percent, from $2,843 million to $3,253 million, driven primarily by the 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 for the first nine months of 2007 was 16.2 percent, down 2.7
percentage points from 18.9 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 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 nine months of 2007 at 8.4 percent of revenues, as compared to 10.3
percent of revenues for the first nine months of 2006. The improvement in this
ratio was due to leveraging our higher revenues while tightly controlling our
selling, general and administrative costs and continuing to increase our
investment in engineering and technology development to prepare to meet customer
needs for more stringent environmental regulations.
EBIT was $209 million for the first nine months of 2007, up $52 million, or
32 percent, from the $157 million for 2006. Global sales growth on OE platforms
benefits from the company's ongoing manufacturing efficiency programs, favorable
currency and lower restructuring and aftermarket customer changeover costs more
than offset higher material costs, reduced North American industry production
volumes and softer global aftermarket conditions. EBIT as a percent of revenue
was 5% for the first three quarters of 2007, unchanged from last year, as
profitability from the new launches and the improvement in our selling, general,
administrative and engineering ratio offset the impact of gross margin dilution
from the higher mix of substrate sales.
RESULTS FROM OPERATIONS
NET SALES AND OPERATING REVENUES FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2007
AND 2006
The following tables reflect our revenues for the third 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
40
capture more diesel after treatment 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 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 SEPTEMBER 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........................ $ 126 $ -- $ 126 $ -- $ 126
Emission Control.................... 476 2 474 245 229
------ ---- ------ ---- ------
Total North America Original
Equipment...................... 602 2 600 245 355
North America Aftermarket
Ride Control........................ 92 -- 92 -- 92
Emission Control.................... 40 -- 40 -- 40
------ ---- ------ ---- ------
Total North America Aftermarket.. 132 -- 132 -- 132
Total North America............ 734 2 732 245 487
Europe Original Equipment
Ride Control........................ 97 9 88 -- 88
Emission Control.................... 381 30 351 124 227
------ ---- ------ ---- ------
Total Europe Original Equipment.. 478 39 439 124 315
Europe Aftermarket
Ride Control........................ 52 4 48 -- 48
Emission Control.................... 56 4 52 -- 52
------ ---- ------ ---- ------
Total Europe Aftermarket......... 108 8 100 -- 100
South America & India................. 86 6 80 10 70
Total Europe, South America &
India....................... 672 53 619 134 485
Asia.................................. 99 6 93 33 60
Australia............................. 51 7 44 7 37
------ ---- ------ ---- ------
Total Asia Pacific............. 150 13 137 40 97
------ ---- ------ ---- ------
Total Tenneco......................... $1,556 $68 $1,488 $419 $1,069
====== ==== ====== ==== ======
41
AS RESTATED
----------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 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........................ $ 109 $ -- $ 109 $ -- $109
Emission Control.................... 198 -- 198 54 144
------ ---- ------ ---- ----
Total North America Original
Equipment...................... 307 -- 307 54 253
North America Aftermarket
Ride Control........................ 90 -- 90 -- 90
Emission Control.................... 44 -- 44 -- 44
------ ---- ------ ---- ----
Total North America Aftermarket.. 134 -- 134 -- 134
Total North America............ 441 -- 441 54 387
Europe Original Equipment
Ride Control........................ 87 -- 87 -- 87
Emission Control.................... 306 -- 306 130 176
------ ---- ------ ---- ----
Total Europe Original Equipment.. 393 -- 393 130 263
Europe Aftermarket
Ride Control........................ 48 -- 48 -- 48
Emission Control.................... 58 -- 58 -- 58
------ ---- ------ ---- ----
Total Europe Aftermarket......... 106 -- 106 -- 106
South America & India................. 70 -- 70 9 61
Total Europe, South America &
India....................... 569 -- 569 139 430
Asia.................................. 65 -- 65 23 42
Australia............................. 46 -- 46 5 41
------ ---- ------ ---- ----
Total Asia Pacific............. 111 -- 111 28 83
------ ---- ------ ---- ----
Total Tenneco......................... $1,121 $ -- $1,121 $221 $900
====== ==== ====== ==== ====
Revenues from our North American operations increased $293 million in the
third 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 $278 million in
the third quarter of 2007. Excluding substrate sales and currency impact,
revenues were up $85 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 third
quarter of 2007 were up $17 million from the prior year. Increased ride control
content on the GMT900 platform, the launch of the Chevy Trailblazer and GMC
Envoy platform and strong sales of the Chrysler Stratus and Sebring offset lower
heavy duty and commercial vehicle volumes. Our total North American OE revenues,
excluding substrate sales and currency, increased 41 percent in the third
quarter of 2007 compared to third quarter of 2006, outpacing the North American
light vehicle production rate increase of three percent. Aftermarket revenues
for North America were $132 million in the third quarter of 2007, a decrease of
$2 million compared to the prior year, driven by lower volumes in the emission
control product line due to soft market conditions. These volume decreases were
partially offset by price increases to recover steel
42
costs. Aftermarket ride control revenues increased three percent in the third
quarter of 2007 while aftermarket emission control revenues decreased nine
percent in the third quarter of 2007.
Our European, South American and Indian segment's revenues increased $103
million, or 18 percent, in the third quarter of 2007 compared to last year. The
third quarter total European light vehicle industry production increased seven
percent from the third quarter of 2006. Europe OE emission control revenues of
$381 million in the third quarter of 2007 were up 25 percent as compared to the
third quarter of last year. Excluding $30 million due to the impact of currency
and a $6 million decrease of substrate sales, Europe OE emission control
revenues increased 29 percent over 2006, due to a growing position on the hot-
end of exhaust platforms. In addition, higher volumes on the BMW 1 and 3-Series,
the Daimler Sprinter, the VW Golf and the Ford Mondeo drove the improvement.
Europe OE ride control revenues of $97 million in the third quarter of 2007 were
up 12 percent year-over-year. Excluding currency, revenues improved two percent
in the 2007 third quarter due to favorable volumes on the VW Transporter and
Renault's Dacia Logan, partially offset by lower volumes on the Nissan Almera
and Audi A4 as well as a shift in some production of the Audi A6 from Europe to
our Chinese operations. European aftermarket revenues increased $2 million in
the third quarter of 2007 compared to last year. When adjusted for currency,
aftermarket revenues were down $6 million year-over-year. Excluding the $4
million impact of currency, ride control aftermarket revenues were flat year-
over-year. Emission control aftermarket revenues were down 10 percent, excluding
$4 million in currency benefit, due to lower volumes which more than offset
improved pricing. South American and Indian revenues were $86 million during the
third quarter of 2007, compared to $70 million in the prior year. Stronger OE
and aftermarket sales and currency appreciation drove this increase.
Revenues from our Asia Pacific segment increased $39 million to $150
million in the third quarter of 2007 compared to the same period last year.
Excluding the impact of substrate sales and currency, revenues increased to $97
million from $83 million in the prior year. Asian revenues for the third quarter
of 2007 were $99 million, up 51 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. Third quarter revenues for
Australia increased 11 percent to $51 million. Excluding higher substrate sales
and favorable currency of $7 million, Australian revenue was down $4 million due
to lower volumes.
43
NET SALES FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
NINE MONTHS ENDED SEPTEMBER 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........................ $ 391 $ -- $ 391 $ -- $ 391
Emission Control.................... 1,381 2 1,379 677 702
------ ---- ------ ------ ------
Total North America Original
Equipment...................... 1,772 2 1,770 677 1,093
North America Aftermarket
Ride Control........................ 300 -- 300 -- 300
Emission Control.................... 115 -- 115 -- 115
------ ---- ------ ------ ------
Total North America Aftermarket.. 415 -- 415 -- 415
Total North America............ 2,187 2 2,185 677 1,508
Europe Original Equipment
Ride Control........................ 311 25 286 -- 286
Emission Control.................... 1,174 82 1,092 387 705
------ ---- ------ ------ ------
Total Europe Original Equipment.. 1,485 107 1,378 387 991
Europe Aftermarket
Ride Control........................ 152 10 142 -- 142
Emission Control.................... 160 12 148 -- 148
------ ---- ------ ------ ------
Total Europe Aftermarket......... 312 22 290 -- 290
South America & India................. 237 13 224 28 196
Total Europe, South America &
India....................... 2,034 142 1,892 415 1,477
Asia.................................. 254 6 248 89 159
Australia............................. 144 16 128 19 109
------ ---- ------ ------ ------
Total Asia Pacific............. 398 22 376 108 268
------ ---- ------ ------ ------
Total Tenneco......................... $4,619 $166 $4,453 $1,200 $3,253
====== ==== ====== ====== ======
44
AS RESTATED
----------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 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........................ $ 371 $ -- $ 371 $ -- $ 371
Emission Control.................... 677 -- 677 181 496
------ ---- ------ ---- ------
Total North America Original
Equipment...................... 1,048 -- 1,048 181 867
North America Aftermarket
Ride Control........................ 302 -- 302 -- 302
Emission Control.................... 128 -- 128 -- 128
------ ---- ------ ---- ------
Total North America Aftermarket.. 430 -- 430 -- 430
Total North America............ 1,478 -- 1,478 181 1,297
Europe Original Equipment
Ride Control........................ 280 -- 280 -- 280
Emission Control.................... 912 -- 912 352 560
------ ---- ------ ---- ------
Total Europe Original Equipment.. 1,192 -- 1,192 352 840
Europe Aftermarket
Ride Control........................ 138 -- 138 -- 138
Emission Control.................... 161 -- 161 -- 161
------ ---- ------ ---- ------
Total Europe Aftermarket....... 299 -- 299 -- 299
South America & India................. 201 -- 201 24 177
Total Europe, South America &
India.......................... 1,692 -- 1,692 376 1,316
Asia.................................. 173 -- 173 59 114
Australia............................. 130 -- 130 14 116
------ ---- ------ ---- ------
Total Asia Pacific............. 303 -- 303 73 230
------ ---- ------ ---- ------
Total Tenneco......................... $3,473 $ -- $3,473 $630 $2,843
====== ==== ====== ==== ======
Revenues from our North American operations increased $709 million in the
first nine 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 $704 million in
the first nine months of 2007. Excluding substrate sales and currency impact,
revenues were up $206 million compared to last year. This increase was primarily
due to significant new OE platform launches as discussed in the three month
section above. North American OE ride control revenues for the first nine months
of 2007 were up $20 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 26 percent in the first nine months of 2007 compared to the
first nine months of 2006 despite the North American light vehicle production
rate decrease of two percent. Aftermarket revenues for North America were $415
million in the first nine months of 2007, a decrease of $15 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 one percent in
the first nine months of 2007 while aftermarket emission control revenues
decreased 10 percent in the first nine months of 2007.
Our European, South American and Indian segment's revenues increased $342
million, or 20 percent, in the first nine months of 2007 compared to last year.
The first nine months total European light vehicle industry production increased
six percent from the first nine months of 2006. Europe OE emission control
revenues of
45
$1,174 million in the first nine months of 2007 were up 29 percent as compared
to the first nine months of last year. Excluding $82 million due to the impact
of currency and a $35 million increase in substrate sales, Europe OE emission
control revenues increased 26 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 $311 million in the first nine months of 2007 were up 11 percent
year-over-year. Excluding currency, revenues increased by two percent in the
first nine 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 $13 million in
the first nine months of 2007 compared to last year. When adjusted for currency,
aftermarket revenues were down three percent. Excluding the $10 million impact
of currency, ride control aftermarket revenues were up three percent due to
strong volumes and improved pricing. Emission control aftermarket revenues were
down eight percent, excluding $12 million in currency benefit, due to lower
volumes which more than offset improved pricing. South American and Indian
revenues were $237 million during the first nine months of 2007, compared to
$201 million in the prior year. Stronger OE and aftermarket sales and currency
appreciation drove this increase.
Revenues from our Asia Pacific segment increased $95 million to $398
million in the first nine months of 2007 compared to the same period last year.
Excluding the impact of substrate sales and currency, revenues increased to $268
million from $230 million in the prior year. Asian revenues for the first nine
months of 2007 were $254 million, up 47 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 nine
months of 2007 for Australia increased 11 percent to $144 million. Excluding
higher substrate sales and favorable currency of $16 million, Australian revenue
was down $7 million due to lower volumes.
EARNINGS BEFORE INTEREST EXPENSE, INCOME TAXES AND MINORITY INTEREST ("EBIT")
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
AS RESTATED
-------------
THREE MONTHS THREE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
2007 2006 CHANGE
------------- ------------- ------
(MILLIONS)
North America...................................... $24 $15 $ 9
Europe, South America & India...................... 22 23 (1)
Asia Pacific....................................... 11 5 6
--- --- ---
$57 $43 $14
=== === ===
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 THREE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
2007 2006
------------- -------------
(MILLIONS)
North America
Restructuring and restructuring-related expenses....... $ -- $ 3
Changeover costs for a major new aftermarket
customer(1)......................................... 5 --
Europe, South America & India
Restructuring and restructuring-related expenses....... 3 2
Asia Pacific
Restructuring and restructuring-related expenses....... -- 2
46
--------
(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 $24 million in the third
quarter of 2007, from $15 million one year ago. Driving the increase to EBIT
were strong OE emission control volumes, mainly on key truck platforms, of $12
million, improved pricing of $4 million, manufacturing efficiencies driven by
Lean and Six Sigma of $6 million and reduced restructuring charges of $3
million. These improvements were partially offset by higher steel costs of $11
million, increased spending on engineering of $3 million and a softer
aftermarket. Included in North America's third quarter 2007 EBIT was $5 million
of changeover costs for new aftermarket customers. Included in North America's
third quarter 2006 EBIT was $3 million in restructuring and restructuring-
related costs.
Our European, South American and Indian segment's EBIT was $22 million for
the third quarter of 2007 compared to $23 million during the same period last
year. The decrease was primarily due to higher steel costs of $8 million, net
alloy surcharges of $3 million, increased spending on selling, general and
administrative expenses of $2 million, increased spending on engineering of $2
million and higher manufacturing costs, driven by an industry-wide strike in
South Africa and a Tenneco specific labor strike in France which had a combined
$1 million impact and a stamping machine breakdown which had a $2 million impact
at a major emission-control facility in Germany which caused a temporary
outsourcing of production. These decreases where partially offset by
manufacturing cost savings of $9 million gained primarily through material
substitutions, Lean manufacturing and Six Sigma programs, higher European OE
volumes on existing business and new platform launches combined for an EBIT
increase of $8 million, as well as favorable currency of $1 million.
Restructuring and restructuring-related expenses of $3 million were included in
the third quarter of 2007 compared to $2 million in the third quarter of 2006.
EBIT for our Asia Pacific segment in the third quarter of 2007 was $11
million compared to $5 million in the third quarter of 2006. Increased volume of
$2 million driven primarily by OE production and new launches in China, reduced
head count in Australia due to our 2006 restructuring activities and favorable
currency of $2 million was partially offset by $1 million of increased steel.
Included in the third quarter of 2006's EBIT was $2 million in restructuring and
restructuring related expenses.
Currency had a $4 million favorable impact on overall company EBIT for the
three months ended September 30, 2007, as compared to the prior year.
EBIT AS A PERCENTAGE OF REVENUE
AS RESTATED
-------------
THREE MONTHS THREE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
2007 2006
------------- -------------
North America........................................... 3% 3%
Europe, South America & India........................... 3% 4%
Asia Pacific............................................ 7% 5%
Total Tenneco......................................... 4% 4%
In North America, EBIT as a percentage of revenue for the third quarter of
2007 was even with last year. The benefits from our new platform launches, lower
selling, general and administrative expenses and manufacturing efficiencies were
offset by the margin impact from an increase in lower margin substrate sales,
higher material costs, increased investments in engineering and soft aftermarket
conditions. During the third quarter of 2007, North American results also
included lower restructuring and restructuring-related charges but higher
aftermarket customer changeover costs. In Europe, South America and India, EBIT
margin for the third quarter of 2007 was one percentage point less than prior
year. Higher European OE volumes on existing business, new platform launches and
favorable currency were offset by higher material costs and manufacturing
inefficiencies. Restructuring and restructuring-related expenses were $1 million
greater than the prior year. EBIT as a percentage of revenue for our
47
Asia Pacific segment increased two percentage points in the third 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.
EBIT FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
AS RESTATED
-------------
NINE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
2007 2006 CHANGE
------------- ------------- ------
(MILLIONS)
North America...................................... $104 $ 85 $19
Europe, South America & India...................... 80 65 15
Asia Pacific....................................... 25 7 18
---- ---- ---
$209 $157 $52
==== ==== ===
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:
NINE MONTHS
ENDED
SEPTEMBER 30,
-------------
2007 2006
---- ----
(MILLIONS)
North America
Restructuring and restructuring-related expenses................ $ 1 $10
Changeover costs for a major new aftermarket customer(1)........ 5 6
Europe, South America & India
Restructuring and restructuring-related expenses................ 6 6
Asia Pacific
Restructuring and restructuring-related expenses................ -- 5
--------
(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 $104 million in the first
nine months of 2007, from $85 million one year ago. Improved OE volumes impacted
EBIT by $18 million due to revenues on new platform launches, lower selling,
general and administrative expenses, manufacturing efficiencies driven by Lean
and Six Sigma of $18 million and lower restructuring costs of $9 million drove
the improvement. These increases were partially offset by higher steel costs of
$30 million, incremental launch costs, increased spending on engineering and a
softer aftermarket. Included in North America's first nine months 2007 EBIT was
$1 million in restructuring and restructuring-related expenses compared to $10
million in the first nine months of 2006. Also included in 2007 EBIT was $5
million of new aftermarket customer changeover costs compared to $6 million in
the first nine months of 2006.
Our European, South American and Indian segment's EBIT was $80 million for
the first nine months of 2007 compared to $65 million during the same period
last year. Higher European OE volumes on existing business, new platform
launches, favorable currency of $6 million and manufacturing efficiencies of $26
million gained through Lean manufacturing and Six Sigma programs drove the
improvement. These increases were partially offset by higher material costs
which included $19 million of higher steel costs. Restructuring and
restructuring-related expenses of $6 million were included in first nine months
EBIT of 2007 and 2006.
48
EBIT for our Asia Pacific segment in the first nine months of 2007 was $25
million compared to $7 million in the first nine months of 2006. Increased
volume of $7 million driven primarily by OE production and new launches in
China, reduced restructuring charges of $5 million and favorable currency of $4
million was partially offset by $3 million of increased steel costs and reduced
light vehicle production in Australia. Included in the first nine months of
2006's EBIT was $5 million in restructuring and restructuring-related expenses.
Currency had a $12 million favorable impact on overall company EBIT for the
nine months ended September 30, 2007, as compared to the prior year.
EBIT AS A PERCENTAGE OF REVENUE
AS RESTATED
-------------
NINE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
2007 2006
------------- -------------
North America............................................ 5% 6%
Europe, South America & India............................ 4% 4%
Asia Pacific............................................. 6% 2%
Total Tenneco.......................................... 5% 5%
In North America, EBIT as a percentage of revenue for the first nine 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 nine months of 2007, North
American results included lower restructuring and restructuring-related charges
but higher aftermarket changeover costs. In Europe, South America and India,
EBIT margin for the first nine 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 even with prior year. EBIT
as a percentage of revenue for our Asia Pacific segment increased four
percentage points in the first nine 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 third quarter of 2007 of $32 million,
up from $30 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 reduced interest expense by $4 million in
the third quarter of each year.
We reported interest expense for the first nine months of 2007 of $112
million, up from $102 million in the first nine months a year ago. Higher
borrowing levels for the first nine 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 reduced interest expense by $2 million for the
first nine months of 2007, versus increased expense of $2 million in the first
nine months of 2006. Included in the first nine 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 September 30, 2007, in reduced cash interest
payments. On September 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
49
$500 million through November 2014, while the remainder is fixed from 2008
through 2025. Of the $475 million, $150 million has been swapped to floating
rate debt and we also have $357 million in long-term debt obligations
outstanding under our senior secured credit facility that are subject to
variable interest rates. See Note 5.
INCOME TAXES
We reported no income tax expense in the third quarter of 2007. We reported
income tax expense of $4 million in the third quarter of 2006. The effective tax
rate for the third quarter of 2007 was zero percent including tax benefits of $8
million related to a reduction in income tax rates in Germany and other
jurisdictions and adjustments for prior year income tax returns. Absent these
adjustments our effective tax rate in the third quarter was 33 percent. The
effective tax rate for the third quarter of 2006 was 28 percent.
Income tax expense was $22 million for the first nine months of 2007,
compared to $17 million for the first nine months of 2006. The effective tax
rate for the first nine months of 2007 was 22 percent as compared to 29 percent
for the first nine months of 2006. The rate for 2007 included tax benefits of $8
million related to a reduction in income tax rates in Germany and other
jurisdictions and adjustments for prior year income tax returns. Absent these
adjustments our effective tax rate for the first nine months of 2007 was 33
percent. The rate for 2006 included a tax benefit of $3 million primarily
related to the resolution of tax issues with former affiliates. Without the
adjustment our effective tax rate was 35 percent.
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 third quarter of 2007, we incurred $3 million
in restructuring and restructuring-related costs which was recorded in cost of
sales, $2 million of which related to a charge for asset impairments. For the
first nine months of 2007, we incurred $7 million in restructuring and
restructuring-related costs of which $6 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 $137 million through September
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
excluding any charge for asset impairments incurred after March 16, 2007 from
the calculation of the financial covenant ratios required under our senior
credit facility. As of September 30, 2007, we have excluded $5 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.
50
EARNINGS PER SHARE
We reported net income of $21 million or $0.45 per diluted common share for
the third quarter of 2007, as compared to net income of $7 million or $0.16 per
diluted common share for the third quarter of 2006. Included in the results for
the third quarter of 2007 were negative impacts from expenses related to our
restructuring and restructuring-related activities and new aftermarket customer
changeover costs, more than offset by benefits from tax adjustments. The net
impact of these items increased earnings per diluted share by $0.06. Included in
the results for the third quarter of 2006 were negative impacts from expenses
related to our restructuring activities decreasing earnings per diluted share by
$0.10. Please read the Notes to the consolidated financial statements for more
detailed information on earnings per share.
We reported net income of $67 million or $1.42 per diluted common share for
the first nine months of 2007, as compared to net income of $34 million or $0.74
per diluted common share for the first nine months of 2006. Included in the
results for the first nine months of 2007 were negative impacts from expenses
related to our restructuring activities, new aftermarket customer changeover
costs and charges relating to refinancing in the first quarter partially offset
by benefits from tax adjustments. The net impact of these items decreased
earnings per diluted share by $0.06. Included in the results for the first nine
months of 2006 were negative impacts from expenses related to our restructuring
activities and new aftermarket customer changeover costs, partially offset by a
positive impact from a tax adjustment. The net impact of these items decreased
earnings per diluted share by $0.34. Please read the Notes to the consolidated
financial statements for more detailed information on earnings per share.
OUTLOOK
Current industry predictions indicate for the last three months of the year
that the North American light vehicle production levels will be down three
percent year-over-year. We believe that our new diesel pick-up truck platforms
and our favorable platform mix will help us manage these production declines. We
also believe the global aftermarket will remain relatively soft. However, we
will continue to closely monitor market uncertainties in North America,
including rising OE vehicle inventory levels and labor negotiations.
We also expect that our strong performance in Europe and in emerging
markets like China will continue, where industry production is projected to
increase in the fourth quarter. 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 SEPTEMBER 30, 2007 AND 2006
THREE MONTHS THREE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
2007 2006
------------- -------------
(MILLIONS)
Cash provided (used) by:
Operating activities................................... $ (9) $ 5
Investing activities................................... (61) (46)
Financing activities................................... 87 34
Operating Activities
For the three months ended September 30, 2007, cash used for operating
activities was $9 million compared to $5 million in cash provided during the
same period last year. For the three months ended September 30, 2007, cash used
for working capital was $70 million versus $44 million for the three months
ended September 30, 2006
51
because of increased working capital needs for new business launches.
Receivables provided cash of $29 million compared to $14 million in the prior
year. Inventory represented a cash outflow of $42 million during the three
months ended September 30, 2007. 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 from South Africa increased our cash outflow
from operating activities during the third quarter of 2007 by $24 million
compared to no impact in the third quarter of 2006. Accounts payable used cash
of $46 million, an increase from last year's cash outflow of $37 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. To manage this
growth efficiently, we focus on key working capital metrics that measure
receivables, inventory and payables in relation to revenues or cost of sales.
Cash taxes were $17 million, driven by a final payment on a foreign audit and
the timing of certain tax payments, for the three months ended September 30,
2007, compared to $11 million in the prior year which included a tax refund.
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 September 30, 2007 and 2006 are classified as other
current assets and are excluded from our definition of cash equivalents. We had
sold approximately $16 million of these instruments at September 30, 2007 and
$20 million at September 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 $12 million and $9 million at September
30, 2007 and 2006, respectively, and were classified as notes payable. Financial
instruments received from OE customers and not redeemed totaled $7 million as of
September 30, 2007 and 2006, 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 a million dollars at September 30, 2007 and
2006, respectively, and was classified as cash and cash equivalents.
Investing Activities
Cash used for investing activities was $15 million higher in the third
quarter of 2007 compared to the same period a year ago. Cash payments for plant,
property and equipment were $41 million in the third quarter of 2007 versus
payments of $45 million in the third quarter of 2006. The decrease of $4 million
in cash payments for plant, property and equipment was primarily due to the
timing of investment in OE customer platform launches. In the third quarter of
2007, we spent $16 million to acquire Combustion Components Associates' ELIM-
NOx(TM) technology. Cash payments for software-related intangible assets were $3
million in the third three months of 2007 which was the same as the third three
months of 2006.
Our capital spending is focused on new platform launches and the continued
expansion of our engineering capabilities to take advantage of growth
opportunities driven by tightening emission regulations. In particular, we have
increased capital spending to meet launch dates beginning in mid 2008 for
platforms recently awarded by one of our large customers.
Financing Activities
Cash flow from financing activities was an $87 million inflow in the third
quarter of 2007 compared to an inflow of $34 million in the same period of 2006.
52
CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
AS RESTATED
-------------
NINE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
2007 2006
------------- -------------
(MILLIONS)
Cash provided (used) by:
Operating activities................................... $ (35) $ 65
Investing activities................................... (144) (138)
Financing activities................................... 148 40
Operating Activities
For the nine months ended September 30, 2007, operating activities used $35
million in cash compared to $65 million in cash provided during the same period
last year. For the nine months ended September 30, 2007, cash used for working
capital was $224 million versus $124 million for the nine months ended September
30, 2006 because of working capital needs for new business launches. Receivables
were a use of cash of $283 million compared to a cash use of $86 million in the
prior year. Inventory represented a cash outflow of $113 million during the nine
months ended September 30, 2007, an increased use of $65 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 from South Africa increased
our cash outflow from operating activities during the first nine months of 2007
by $53 million. Accounts payable provided cash of $195 million, an increase from
last year's cash inflow of $54 million. This increase also primarily resulted
from the working capital needed for our new platform launches in North America.
Cash taxes were $45 million, driven by a final payment on a foreign audit and
the timing of certain tax payments, for the nine months ended September 30,
2007, compared to $18 million in the prior year which included a tax refund.
Investing Activities
Cash used for investing activities was $6 million higher in the first nine
months of 2007 compared to the same period a year ago. Cash payments for plant,
property and equipment were $116 million in the first nine months of 2007 versus
payments of $134 million in the first nine months of 2006. The decrease of $18
million in cash payments for plant, property and equipment was primarily due to
the timing of investment in OE customer platform launches. In the first nine
months of 2007, we spent $16 million to acquire Combustion Components
Associates' ELIM-NOx(TM) technology. Cash payments for software-related
intangible assets were $14 million in the first nine months of 2007 compared to
$9 million in the first nine months of 2006.
Financing Activities
Cash flow from financing activities was a $148 million inflow in the first
nine months of 2007 compared to an inflow of $40 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.
53
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 $430 million, and
$221 million for the first nine 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 September 30, 2007, we had
approximately $20 million recorded as a long-term receivable from original
equipment customers for 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 nine months ended September 30, 2007, we have
a loss for U.S. Federal tax of $30 million for which we recorded an additional
$10 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
54
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 September 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 1.0 year as compared to $4 million,
net of tax, and a weighted average period of 1.2 years as of September 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
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 September 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
55
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 12.
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.
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 second quarter. The adoption of FIN 48-1 did not have a
material impact to our financial statements and related disclosures. See Note 6.
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
56
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
------------
SEPTEMBER 30, DECEMBER 31,
2007 2006 % CHANGE
------------- ------------ --------
(MILLIONS)
Short-term debt and current maturities............ $ 33 $ 28 18%
Long-term debt.................................... 1,503 1,357 11
------ ------
Total debt........................................ 1,536 1,385 11
------ ------
Total minority interest........................... 33 28 18
Shareholders' equity.............................. 413 226 83
------ ------ --
Total capitalization.............................. $1,982 $1,639 21%
====== ======
General. Short-term debt, which includes the current portion of long-term
obligations and borrowings by foreign subsidiaries, was $33 million and $28
million as of September 30, 2007 and December 31, 2006, respectively. Borrowings
under our revolving credit facilities, which are now classified as long-term
debt, were approximately $357 million and $0 as of September 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
$104 million of translation of foreign balances into U.S. dollars and net income
of $67 million. In addition, the implementation of the measurement date
provision of SFAS No. 158 and other transactions contributed $16 million to
shareholders' equity. While our book equity balance was small at September 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 September
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
57
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).
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 September 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
58
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 September
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
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 , second, and third quarter of
2007, are shown in the following tables:
QUARTER ENDED
------------------------------------------------------
(AS
RESTATED) SEPTEMBER
MARCH 31, JUNE 30, 30, DECEMBER 31,
2007 2007 2007 2007
----------- ----------- ----------- ------------
REQ. ACT. REQ. ACT. REQ. ACT. REQ.
---- ---- ---- ---- ---- ---- ------------
Leverage Ratio (maximum).............. 4.25 3.27 4.25 2.99 4.25 2.97 4.25
Interest Coverage Ratio (minimum)..... 2.10 3.09 2.10 3.21 2.10 3.35 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
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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 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.
As of September 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
60
our senior credit facility and any future senior debt incurred. As of September
30, 2007, we were in compliance with the covenants and restrictions of these
indentures.
Subsequent Transaction. On November 1, 2007, we announced that we had
priced a private placement offering of $250 million of 8 1/8 percent senior
notes due November 15, 2015. The offering and related transactions are designed
to (1) reduce our interest expense and extend the maturity of a portion of our
debt (by using the proceeds of the offering to tender for a portion of our
outstanding $475 million 10 1/4 percent senior secured notes due 2013), (2)
facilitate the realignment of the ownership structure of some of our foreign
subsidiaries and (3) otherwise amend certain of the covenants in the indenture
for the senior secured notes to be consistent with those contained in our
subordinated notes, including conforming the limitation on incurrence of
indebtedness and the absence of a limitation on issuances or transfers of
restricted subsidiary stock, and make other minor modifications. We expect to
close this offering on November 20, 2007, assuming we receive the requisite
consents to amend the indenture for the senior secured notes. We expect the
indenture governing the new notes to be substantially similar to the indenture
for our existing senior subordinated notes.
The ownership structure realignment we intend to undertake is designed to
more effectively align our domestic and foreign assets and revenues with
expenses in the appropriate local currencies. Some of the desired results of the
realignment will be to allow us to more rapidly use our U.S. net operating
losses and reduce our cash tax payments.
At present, the ownership structure realignment involves forming a new
European holding company which will own some of our foreign entities. We need
the consent of our lenders under our senior credit facility to complete these
realignment transactions, which we expect we will be able to obtain. The
realignment as currently structured is conditioned on our completing the
refinancing of our senior secured notes described above. We may alter the
components of the realignment from time to time. If market conditions permit in
2008, we may offer debt issued by the new European holding company. The proceeds
of that debt would be used to repay intercompany debt and, in turn, to fund the
redemption of our remaining senior secured notes outstanding. This realignment
involves utilizing part of our U.S. net operating tax losses. Consequently, we
expect to record a non-cash charge of about $66 million in the fourth quarter of
2007.
We expect that the net impact of the offering of new notes and related
initial repurchase of our senior secured notes, will be to (a) reduce our annual
interest expense by approximately $3 million for 2008 and (b) increase our total
debt outstanding to third-parties by approximately $20 million. In connection
with this offering and the related initial repurchase of our senior secured
notes, we also expect to record non-recurring pre-tax charges related to the
tender premium and fees, the write-off of deferred debt issuance costs, and the
write-off of previously recognized issuance premium totaling approximately $20
million in the fourth quarter of 2007.
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 $94 million and $92 million as of September 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. As of September 30, 2007, we sold $55 million of
accounts receivable in Europe up from $52 million at September 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
61
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 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 September 30, 2007,
are shown in the following table:
PAYMENTS DUE IN:
--------------------------------------------------
BEYOND
2007 2008 2009 2010 2011 2011 TOTAL
---- ---- ---- ---- ---- ------ ------
(MILLIONS)
Obligations:
Revolver borrowings.................. $-- $ -- $ -- $ -- $ -- $ 357 $ 357
Senior long-term debt................ -- -- 17 50 66 17 150
Long-term notes...................... -- 2 -- -- -- 476 478
Capital leases....................... 1 3 3 3 -- -- 10
Subordinated long-term debt.......... -- -- -- -- -- 500 500
Other subsidiary debt................ 1 -- -- -- -- 2 3
Short-term debt...................... 27 -- -- -- -- -- 27
--- ---- ---- ---- ---- ------ ------
Debt and capital lease obligations..... 29 5 20 53 66 1,352 1,525
Operating leases....................... 5 16 12 8 7 5 53
Interest payments...................... 10 113 112 112 104 204 655
Capital commitments.................... 16 -- -- -- -- -- 16
--- ---- ---- ---- ---- ------ ------
Total Payments......................... $60 $134 $144 $173 $177 $1,561 $2,249
=== ==== ==== ==== ==== ====== ======
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 5.12 percent which was the rate at September 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.
62
We have also included an estimate of expenditures required after September
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
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 $32 million has been contributed as of September 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 a million at both September 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 15 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 $13 million in guarantees through letters of credit to guarantee
other obligations of subsidiaries primarily related to environmental remediation
activities and a foreign employee benefit program.
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 September 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 2008 through 2025. Of
the $475 million, $150 million has been swapped to floating and we also have
$357 million in long-term debt obligations outstanding under our senior secured
credit facility that are subject to variable interest rates. See Note 5.
63
We estimate that the fair value of our long-term debt at September 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 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 September 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
64
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.
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 $12 million
for the nine months ended September 30, 2007 as compared to $5 million for the
nine months ended September 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. We have taken actions to address the identified weaknesses, but 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. Consequently,
our September 30, 2007 evaluation concluded that our disclosure controls and
procedures were not effective for the reasons more fully described below related
to the 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.
65
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 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 September 30, 2007
that have materially affected, or are reasonably likely to materially affect,
our internal control over financial reporting.
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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 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) None.
(b) Not applicable.
(c) Purchase of equity securities by the issuer and affiliated
purchasers. The following table provides information relating to our purchase
of shares of our common stock in the third quarter of 2007. All of these
purchases reflect shares withheld upon vesting of restricted stock, to satisfy
statutory minimum tax withholding obligations.
TOTAL NUMBER OF AVERAGE
PERIOD SHARES PURCHASED PRICE PAID
------ ---------------- ----------
July 2007........................................... 333 $35.34
August 2007......................................... -- --
September 2007...................................... -- --
--- ------
Total............................................. 333 $35.34
We presently have no publicly announced repurchase plan or program, but
intend to continue to satisfy statutory minimum tax withholding obligations in
connection with the vesting of outstanding restricted stock through the
withholding of shares.
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.
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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: November 9, 2007
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INDEX TO EXHIBITS
TO
QUARTERLY REPORT ON FORM 10-Q
FOR QUARTER ENDED SEPTEMBER 30, 2007
EXHIBIT
NUMBER DESCRIPTION
------- -----------
*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.
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