10-Q/A 1 k10855ae10vqza.txt AMENDMENT NO. 1 TO QUARTERLY REPORT, DATED MARCH 31, 2006 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q/A (AMENDMENT NO. 1) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT of 1934 For the quarterly period ended March 31, 2006 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT of 1934 For the transition period from __________ to __________ COMMISSION FILE NUMBER: 0-452 TECUMSEH PRODUCTS COMPANY (Exact name of registrant as specified in its charter) MICHIGAN 38-1093240 (State of Incorporation) (IRS Employer Identification Number)
100 EAST PATTERSON STREET TECUMSEH, MICHIGAN 49286 (Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (517) 423-8411 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class of Stock Outstanding at March 31, 2006 -------------- ----------------------------- Class B Common Stock, $1.00 par value 5,077,746 Class A Common Stock, $1.00 par value 13,401,938
Page 1 Explanatory Note This Form 10-Q/A (this "Amendment No. 1") amends the Quarterly Report on Form 10-Q for the period ended March 31, 2006 that we filed on May 10, 2006 to correct our accounting for interim period income taxes, which is more fully discussed in Note 2 of the consolidated financial statements included in Part I - Financial Information. Accordingly, we have restated our Consolidated Financial Statements including our Consolidated Balance Sheet at March 31, 2006, the Consolidated Statements of Operations for the three months ended March 31, 2006 and 2005, and the related footnotes thereto. This Amendment No. 1 amends and restates Items 1, 2, and 4 of Part I of the original Form 10-Q. We have also expanded disclosures related to goodwill in response to comment letters received from the staff of the Securities and Exchange Commission on July 26, 2006 and October 19, 2006. No other items in the original Form 10-Q have been amended, and this Amendment No. 1 does not reflect events occurring after the filing of the original Form 10-Q, or modify or update the disclosures therein in any other way. Pursuant to the rules of the SEC, Item 6 of Part II of the original Form 10-Q has been amended to contain currently-dated certifications from the Company's President and Chief Executive Officer and Chief Financial Officer as required by Section 302 and 906 of the Sarbanes-Oxley Act of 2002. The certifications of the Company's President and Chief Executive Officer and Chief Financial Officer are attached to the Amendment No. 1 as Exhibits 31.1, 31.2, 32.1 and 32.2. Items not being amended and restated are presented for the convenience of the reader only. Page 2 TABLE OF CONTENTS
Page -------- Part I. Financial Information Item 1. Financial Statements Consolidated Condensed Balance Sheets............................. 4 Consolidated Condensed Statements of Operations................... 5 Consolidated Condensed Statements of Cash Flows................... 6 Notes to Consolidated Condensed Financial Statements.............. 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......................... 20 Item 3. Quantitative and Qualitative Disclosures About Market Risk.......................................................... 32 Item 4. Controls and Procedures....................................... 34 Part II. Other Information............................................... 37 Signatures............................................................... 39 Amendment No. 1 to First Lien Credit Agreement........................... Exh 4.1 Amendment No. 1 to Second Lien Credit Agreement.......................... Exh 4.2 Management Incentive Plan as amended and restated on March 29, 2006...... Exh 10.1 Executive Deferred Compensation Plan adopted on March 29, 2006........... Exh 10.2 Director Retention Phantom Share Plan as amended and restated on March 29................................................................. Exh 10.3 Certification of CEO Pursuant to Section 302............................. Exh 31.1 Certification of CFO Pursuant to Section 302............................. Exh 31.2 Certification of CEO Pursuant to Section 906............................. Exh 32.1 Certification of CFO Pursuant to Section 906............................. Exh 32.2
Page 3 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART I. FINANCIAL INFORMATION - ITEM 1 CONSOLIDATED CONDENSED BALANCE SHEETS (Unaudited)
MARCH 31, 2006 December 31, (Dollars in millions, except share data) (RESTATED) 2005 ---------- ------------ ASSETS Current Assets: Cash and cash equivalents $ 82.8 $ 116.6 Accounts receivable, less allowance for doubtful accounts of $10.9 in 2006 and $11.3 in 2005 232.6 211.1 Inventories 348.4 346.8 Deferred and recoverable income taxes 40.0 43.4 Other current assets 91.6 89.2 Assets held for sale 48.3 -- -------- -------- Total current assets 843.7 807.1 Property, plant, and equipment, net 590.1 578.6 Goodwill 126.1 130.9 Other intangibles 56.0 54.8 Deferred income taxes 0.5 -- Prepaid pension expense 188.7 185.3 Other assets 50.8 43.8 Assets held for sale 14.7 -- -------- -------- Total assets $1,870.6 $1,800.5 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable, trade $ 201.7 $ 187.3 Income taxes payable 5.3 -- Short-term borrowings 121.2 82.5 Accrued liabilities 133.7 135.3 Liabilities held for sale 15.0 -- -------- -------- Total current liabilities 476.9 405.1 Long-term debt 281.8 283.0 Deferred income taxes 16.8 25.0 Other postretirement benefit liabilities 210.6 210.9 Product warranty and self-insured risks 12.6 14.5 Pension liabilities 15.4 15.2 Other non-current liabilities 36.3 32.4 -------- -------- Total liabilities 1,050.4 986.1 -------- -------- Commitments and contingencies Stockholders' Equity Class A common stock, $1 par value; authorized 75,000,000 shares; issued and outstanding 13,401,938 shares in 2005 and 2004 13.4 13.4 Class B common stock, $1 par value; authorized 25,000,000 shares; issued and outstanding 5,077,746 shares in 2005 and 2004 5.1 5.1 Retained earnings 794.1 806.6 Accumulated other comprehensive income (loss) 7.6 (10.7) -------- -------- Total stockholders' equity 820.2 814.4 -------- -------- Total liabilities and stockholders' equity $1,870.6 $1,800.5 ======== ========
The accompanying notes are an integral part of these Consolidated Condensed Financial Statements. Page 4 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART I. FINANCIAL INFORMATION - ITEM 1 CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (Unaudited)
THREE MONTHS ENDED MARCH 31, ----------------------- 2006 2005 (Dollars in millions, except per share data) (RESTATED) (restated) ---------- ---------- Net sales $ 446.1 $ 440.2 Cost of sales and operating expenses 411.6 412.7 Selling and administrative expenses 45.2 43.4 Impairments, restructuring charges, and other items 0.6 0.1 ------- ------- Operating loss (11.3) (16.0) Interest expense (8.4) (6.3) Interest income and other, net 5.0 3.3 ------- ------- Loss from continuing operations before taxes (14.7) (19.0) Tax benefit (2.6) (2.9) ------- ------- Loss from continuing operations (12.1) (16.1) Income (Loss) from discontinued operations, net of tax (0.5) 0.1 ------- ------- Net loss ($12.6) ($16.0) ======= ======= Basic and diluted earnings (loss) per share Loss from continuing operations ($0.65) ($0.88) Income (Loss) from discontinued operations, net of tax ($0.03) $ 0.01 ------- ------- Net loss ($0.68) ($0.87) ======= ======= Weighted average shares (in thousands) 18,480 18,480 ------- ------- Cash dividends declared per share $ 0.00 $ 0.32 ------- -------
The accompanying notes are an integral part of these Consolidated Condensed Financial Statements. Page 5 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART I. FINANCIAL INFORMATION - ITEM 1 CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (Unaudited)
THREE MONTHS ENDED MARCH 31, ----------------- (Dollars in millions) 2006 2005 ------- ------- Cash Flows from Operating Activities: Cash used by operating activities ($44.5) ($67.4) Cash Flows from Investing Activities: Proceeds from sale of assets 9.0 -- Capital expenditures (20.0) (28.7) Business acquisition (2.0) -- ------- ------- Cash used in investing activities (13.0) (28.7) ------- ------- Cash Flows from Financing Activities: Dividends paid -- (5.9) Repayment of Senior Guaranteed Notes (250.0) (50.0) Repayment of Industrial Development Revenue Bonds (10.5) -- Proceeds from First Lien Credit Agreement 168.3 -- Proceeds from Second Lien Credit Agreement 100.0 -- Other proceeds (repayments), net 16.2 8.5 ------- ------- Cash provided by (used in) financing activities 24.0 (47.4) ------- ------- Effect of exchange rate changes on cash (0.3) 1.1 ------- ------- Decrease in cash and cash equivalents (33.8) (142.4) Cash and Cash Equivalents: Beginning of period 116.6 227.9 ------- ------- End of period $ 82.8 $ 85.5 ======= =======
The accompanying notes are an integral part of these Consolidated Condensed Financial Statements. Page 6 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 1 NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited) 1. The consolidated condensed financial statements of Tecumseh Products Company and Subsidiaries (the "Company") are unaudited and reflect all adjustments (including normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of the financial position and operating results for the interim periods. The December 31, 2005 condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles in the United States ("U.S. GAAP"). The consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company's Annual Report for the fiscal year ended December 31, 2005. Due to the seasonal nature of the Company's business, the results of operations for the interim period are not necessarily indicative of the results for the entire fiscal year. 2. Restatement The Company has restated the quarterly financial data for errors in the interim period tax provisions. Generally accepted accounting principles require interim period income taxes to be recorded based on an estimated annual effective rate. The Company in error combined the income from foreign jurisdictions with losses from foreign jurisdictions for which tax benefits are not expected to be realizable, which resulted in an overstatement in the tax benefit of $3.0 million for the three month period ended March 31, 2006 and $3.6 million for the three month period ended March 31, 2005. The footnotes contained herein have been adjusted for matters discussed in this footnote. Adjustments made to the period ended March 31, 2006 are as follows:
THREE MONTHS ENDED MARCH 31, 2006 ------------------------------------ (Dollars in millions, except per share data) AS REPORTED ADJUSTMENTS ADJUSTED ----------- ----------- -------- Loss from continuing operations before taxes (14.7) (14.7) Tax benefit (5.6) 3.0 (2.6) ------ -------- Loss from continuing operations (9.1) (3.0) (12.1) Loss from discontinued operations, net of tax (0.5) (0.5) ------ -------- Net loss ($9.6) ($3.0) ($12.6) ====== ======== Basic and diluted earnings (loss) per share Loss from continuing operations ($0.49) ($0.16) ($0.65) Loss from discontinued operations, net of tax ($0.03) ($0.03) ------ -------- Net loss ($0.52) ($0.16) ($0.68) ====== ========
Page 7 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 1 NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited) Adjustments made to the period ended March 31, 2005 are as follows:
THREE MONTHS ENDED MARCH 31, 2005 ------------------------------------ (Dollars in millions, except per share data) AS REPORTED ADJUSTMENTS ADJUSTED ----------- ----------- -------- Loss from continuing operations before taxes (19.0) (19.0) Tax benefit (6.5) (3.6) (2.9) ------ ------ Loss from continuing operations (12.5) 3.6 (16.1) Income from discontinued operations, net of tax 0.1 0.1 ------ ------ Net loss ($12.4) $ 3.6 ($16.0) ====== ====== Basic and diluted earnings (loss) per share Loss from continuing operations ($0.68) ($0.20) ($0.88) Income from discontinued operations, net of tax $ 0.01 $ 0.01 ------- ------- Net loss ($0.67) ($0.20) ($0.87) ======= =======
Adjustments made to selected Consolidated Balance Sheet data are as follows:
March 31, 2006 March 31, 2006 (Dollars in millions) As reported Adjustments restated -------------- ----------- -------------- Selected Balance Sheet Data: Income Taxes Payable 2.3 3.0 5.3 Retained Earnings 797.1 (3.0) 794.1 ----- -----
3. Comprehensive Income
THREE MONTHS ENDED MARCH 31, ----------------------- 2006 2005 (Dollars in millions) (RESTATED) (restated) ---------- ---------- Net loss ($12.6) ($16.0) Other comprehensive income (loss): Foreign currency translation adjustments $ 23.2 (6.5) Gain (Loss) on derivatives (0.9) 3.9 Unrealized gain (loss) on investment holdings (3.9) 3.8 ------- ------ Total comprehensive income (loss) $ 5.8 ($14.8) ======= ======
Page 8 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 1 NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited) 4. Inventories
MARCH 31, DECEMBER 31, (Dollars in millions) 2006 2005 --------- ------------ Raw material $123.2 $128.5 Work in progress 84.5 73.3 Finished goods 132.4 136.7 Supplies 8.3 8.3 ------ ------ Total inventories $348.4 $346.8 ====== ======
Page 9 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 1 NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited) 5. Business Segments The Company has three reportable segments based on the criteria set forth in SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information": Compressor Products, Electrical Component Products, and Engine & Power Train Products. Previously, the Company also reported a Pump Products business segment; however, as a result of the decision, during the first quarter of 2006, to sell 100% of its ownership in Little Giant Pump Company, such operations are no longer reported in loss from continuing operations before tax. Little Giant operations represented approximately 90% of that previously reported segment. Since the Company's remaining pump business does not meet the definition of a reporting segment as defined by SFAS No. 131, "Segment Reporting," the Company will no longer report a Pump Products segment, and operating results of the remaining pump business are included in Other for segment reporting purposes. Revenues and operating income by segment for the periods indicated are as follows:
THREE MONTHS ENDED MARCH 31, BUSINESS SEGMENT DATA ------------------ (Dollars in millions) 2006 2005 ------- ------- Net sales: Compressor Products $ 251.5 $ 241.0 Electrical Component Products 109.1 100.2 Engine & Power Train Products 80.9 94.9 Other (a) 4.6 4.1 ------- ------- Total Net Sales $ 446.1 $ 440.2 ======= ======= Operating income (loss): Compressor Products $ 6.6 $ 8.6 Electrical Component Products 4.9 (1.1) Engine & Power Train Products (18.5) (20.9) Other (a) 0.3 (0.2) Corporate expenses (4.0) (2.3) Impairments, restructuring charges, and other items (0.6) (0.1) ------- ------- Total operating loss from continuing operations (11.3) (16.0) Interest expense (8.4) (6.3) Interest income and other, net 5.0 3.3 ------- ------- Loss from continuing operations before taxes ($14.7) ($19.0) ======= =======
(a) "Other" consists of non-reportable business segments. The Electrical Component Products segment had inter-segment sales of $11.9 million and $16.7 million in the first quarter of 2006 and 2005, respectively. Page 10 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 1 NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited) 6. Goodwill and Other Intangible Assets At March 31, 2006, goodwill by segment consisted of the following:
ELECTRICAL COMPRESSOR COMPONENTS PUMPS TOTAL ---------- ---------- ----- ------ Balance at 1/1/2006 $16.9 $108.9 $ 5.1 $130.9 Reclassified to held for sale (5.1) (5.1) Foreign Currency Translation 0.3 0.3 ----- ------ ----- ------ Balance at 3/31/2006 $17.2 $108.9 $ 0.0 $126.1 ===== ====== ===== ======
At March 31, 2005, goodwill by segment consisted of the following:
ELECTRICAL ENGINE & POWER COMPRESSOR COMPONENTS TRAIN OTHER TOTAL ---------- ---------- -------------- ----- ------ Balance at 1/1/2005 $18.6 $216.9 $ 2.9 $5.1 $243.5 Foreign Currency Translation (0.6) -- (0.1) -- (0.7) ----- ------ ----- ---- ------ Balance at 3/31/2005 $18.0 $216.9 $ 2.8 $5.1 $242.8 ===== ====== ===== ==== ======
As discussed in the Significant Accounting Policies and Critical Accounting Estimates sections of the Form 10-K for the year ended December 31, 2005, the Company traditionally conducts its annual assessment of impairment in the fourth quarter by comparing the carrying value of the Company's reporting units to their fair value. Fair value of the Company's goodwill and other intangible assets is estimated based upon a present value technique using discounted future cash flows, forecasted out over a six year period, with residual growth rates forecasted at 3.0% thereafter. The Company uses management business plans and projections as the basis for expected future cash flows. In evaluating such business plans for reasonableness in the context of their use for predicting discounted cash flows in its valuation model, the Company evaluates whether there is a reasonable basis for differences between actual results of the preceding year and projected results for the upcoming years. This methodology can potentially yield significant improvements in growth rates in the first few years of forecast data, due to multiple factors such as improved efficiencies or incremental sales volume opportunities that are deemed to be reasonably likely to be achieved. Assumptions in estimating future cash flows are subject to a high degree of judgment and complexity. The Company makes every effort to forecast these future cash flows as accurately as possible with the information available at the time the forecast is developed. However, changes in the assumptions and estimates may affect the carrying value of goodwill, and could result in additional impairment charges in future periods. Factors that have the potential to create variances between forecasted cash flows and actual results include but are not limited to (i) fluctuations in sales volumes, which can be driven by multiple external factors, including weather conditions affecting demand; (ii) product costs, particularly commodities such as copper; (iii) currency exchange fluctuations; (iv) acceptance of the Company's pricing actions undertaken in response to rapidly changing commodity prices and other product costs; and (v) interest rate Page 11 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 1 NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited) fluctuations. Refer to "Cautionary Statements Relating to Forward-Looking Statements" in Item 2 for other factors that have the potential to impact estimates of future cash flows. Discount rates utilized in the goodwill valuation analysis are derived from published resources such as Ibbotson. The rates utilized were 9.25% at December 31, 2005 for all business units for which goodwill is currently recorded. Operating profit (loss) as a percentage of sales revenue is also a key assumption in the fair value calculation. The range of assumptions used incorporates the anticipated results of the Company's ongoing productivity improvements over the life of the forecast model. Other intangible assets consisted of the following:
GROSS CARRYING ACCUMULATED AMOUNT AMORTIZATION NET AMORTIZABLE LIFE -------- ------------ ----- ---------------- Intangible assets subject to amortization: Customer relationships and contracts $39.3 $ 8.6 $30.7 6-15 years Technology 12.0 3.6 8.4 5-10 years ----- ----- ----- Total 51.3 12.2 39.1 Intangible assets not subject to amortization: Trade name 16.9 -- 16.9 ----- ----- ----- Total intangible assets $68.2 $12.2 $56.0 ===== ===== =====
The estimated amortization expense over the next five years is $4.2 million for 2006 through 2008 and approximately $3.9 million annually for 2009 through 2010. Amortization expense for the three months ended March 31 was $0.9 million and $1.3 million for 2006 and 2005, respectively. As a result of the acquisition of In Motion Technologies Pty. Ltd. (IMT), the Company recorded an additional technology intangible asset of $2.0 million during the quarter. Page 12 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 1 NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited) 7. Pension and Other Postretirement Benefit Plans Components of net periodic benefit (income) cost are as follows:
PENSION BENEFITS OTHER BENEFITS ------------------ ------------------ THREE MONTHS ENDED THREE MONTHS ENDED MARCH 31, MARCH 31, ------------------ ------------------ 2006 2005 2006 2005 ------ ------ ----- ----- Service Cost $ 2.4 $ 2.1 $ 0.8 $ 1.1 Interest Cost 5.3 5.1 2.4 2.6 Expected return on plan assets (11.1) (10.0) -- -- Amortization of prior service costs 0.1 0.1 (1.2) (0.3) Amortization of net gain -- (0.6) -- (0.7) ------ ------ ----- ----- Net periodic benefit (income) cost ($3.3) ($3.3) $ 2.0 $ 2.7 ====== ====== ===== =====
During the second quarter of 2005, the Company announced some changes to certain of its retiree medical benefits. Included among these changes were plans to phase in retiree contributions and raise plan deductibles (both as of January 1, 2006). The Company also implemented plans to eliminate Post-65 prescription drug benefits starting January 1, 2008 and discontinue all retiree medical benefits for anyone hired after January 1, 2006. The Company does not expect to contribute to its pension plans in 2006. 8. Guarantees and Warranties A portion of accounts receivable at the Company's Brazilian subsidiary are sold with recourse. Brazilian receivables sold at March 31, 2006 and December 31, 2005 were $35.2 million and $32.1 million, respectively. The Company estimates the fair value of the contingent liability related to these receivables to be $0.5 million, which is included in operating income and allowance for doubtful accounts. Page 13 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 1 NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited) A provision for estimated future warranty costs and estimated returns for credit relating to warranty are recorded when products are sold and revenue recognized. A reconciliation of the changes in the Company's product warranty liability follows:
Three Months Ended Three Months Ended (Dollars in millions) March 31, 2006 March 31, 2005 ------------------ ------------------ Balance at January 1, 2006 $29.4 $38.1 Accruals for warranties 4.3 2.6 Settlements made (in cash or in kind) (4.4) (5.5) Effect of foreign currency translation 0.2 (0.3) Reclassification to held for sale (2.7) -- ----- ----- Balance at March 31, 2006 $26.8 $34.9 ===== =====
As of March 31, 2006, $21.3 million was included in accrued liabilities and $5.5 million was included in product warranty and self-insured risks. 9. Debt During the first quarter of 2005, the Senior Guaranteed Notes and Revolving Credit Facility outstanding at December 31, 2005 were replaced by a new financing package that included a $275 million First Lien Credit Agreement and a $100 million Second Lien Credit Agreement. The agreements provide for security interests in substantially all of the Company's assets and specific financial covenants related to EBITDA, capital expenditures, and fixed charge coverage. Additionally, under the terms of the agreements, no dividends can be paid prior to December 31, 2006 and minimum amounts of credit availability are required before dividends can be paid thereafter. The new arrangements bore a weighted average annual interest rate of 9.0% based upon outstanding balances at closing versus the rate of 6.6% applicable to the $250 million Senior Guaranteed Notes. At March 31, 2006, the Company had outstanding letters of credit of $4.8 million. At March 31, 2006, the Company had total availability of $32.8 million under its $275 million First Lien Credit Agreement. As more fully described in Note 15, subsequent to March 31, 2006, the Company sold Little Giant Pump Company and proceeds from the sale were used to repay portions of the new debt arrangements. Approximately, 63% of the proceeds were applied against the First Lien borrowing and 37% against the Second Lien borrowing. After giving effect to the repayments, the weighted average annual interest rate of these borrowings was 8.8%. 10. Environmental Matters The Company has been named by the U.S. Environmental Protection Agency ("EPA") as a potentially responsible party ("PRP") in connection with the Sheboygan River and Harbor Superfund Site in Wisconsin. The EPA has indicated its intent to address the site in two phases, with the Company's Sheboygan Falls plant site and the upper river constituting the first phase ("Phase I") and the middle and lower river and harbor being the second phase ("Phase II"). In May Page 14 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 1 NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited) 2003, the Company concluded a Consent Decree with the EPA concerning the performance of remedial design and remedial action for Phase I, deferring for an unspecified period any action regarding Phase II. In March 2003, with the cooperation of the EPA, the Company and Pollution Risk Services, LLC ("PRS") entered into a Liability Transfer and Assumption Agreement (the "Liability Transfer Agreement"). Under the terms of the Liability Transfer Agreement, PRS assumed all of the Company's responsibilities, obligations and liabilities for remediation of the entire Site and the associated costs, except for certain specifically enumerated liabilities. Also, as required by the Liability Transfer Agreement, the Company has purchased Remediation Cost Cap insurance, with a 30-year term, in the amount of $100.0 million and Environmental Site Liability insurance in the amount of $20.0 million. The Company believes such insurance coverage will provide sufficient assurance for completion of the responsibilities, obligations and liabilities assumed by PRS under the Liability Transfer Agreement. On October 10, 2003, in conjunction with the Liability Transfer Agreement, the Company completed the transfer of title to the Sheboygan Falls, Wisconsin property to PRS. The total cost of the Liability Transfer Agreement to the Company, including the cost of the insurance policies, was $39.2 million. The Company recognized a charge of $13.6 million ($8.7 million net of tax) in the first quarter of 2003. The charge consisted of the difference between the cost of the Liability Transfer Agreement and amounts previously accrued for the cleanup. The Company continues to maintain an additional reserve of $0.5 million to reflect its potential environmental liability arising from operations at the Site, including potential residual liabilities not assumed by PRS pursuant to the Liability Transfer Agreement. As the Liability Transfer Agreement was executed prior to the signing of the original Consent Decree for the Phase I work, the original Consent Decree was amended in the fourth quarter of 2005 to include PRS as a signing party. This assigns PRS full responsibility for complying with the terms of the Consent Decree and allows the EPA to enforce the Consent Decree directly with PRS. Prior to the execution of this amendment, U.S. GAAP required that the Company continue to record the full amount of the estimated remediation liability of $39.7 million and a corresponding asset of $39.2 million included in Other Assets in the balance sheet. With the subsequent amendment, the Company has removed the asset and $39.2 million of the liability from the balance sheet. While the Company believes the arrangements with PRS are sufficient to satisfy substantially all of the Company's environmental responsibilities with respect to the Site, these arrangements do not constitute a legal discharge or release of the Company's liabilities with respect to the Site. The actual cost of this obligation will be governed by numerous factors, including, without limitation, the requirements of the WDNR, and may be greater or lower than the amount accrued. With respect to other environmental matters, the Company has been voluntarily participating in a cooperative effort to investigate and cleanup PCB contamination in the watershed of the south branch of the Manitowoc River, at and downstream from the Company's New Holstein, Wisconsin facility. On December 29, 2004, the Company and TRC Companies and TRC Environmental Corporation (collectively, "TRC") entered into a Consent Order with the Wisconsin Department of Natural Resources (the "WDNR") relating to this effort known as the Hayton Area Remediation Project ("HARP"). The Consent Order provides a framework for the completion of the remediation and regulatory closure at HARP. Page 15 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 1 NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited) Concurrently, on December 29, 2004, the Company and two of its subsidiaries and TRC entered into an Exit Strategy Agreement (the "Agreement"), whereby the Company transferred to TRC substantially all of its obligations to complete the HARP remediation pursuant to the Consent Order and in accordance with applicable environmental laws and regulations. TRC's obligations under the Agreement include any ongoing monitoring or maintenance requirements and certain off-site mitigation or remediation, if required. TRC will also manage any third-party remediation claims that might arise or otherwise be filed against the Company. As required by the Agreement, the Company also purchased a Pollution Legal Liability Select Cleanup Cost Cap Policy (the "Policy") from American International Specialty Lines Company. The term of the Policy is 20 years with an aggregate combined policy limit of $41 million. The policy lists the Company and TRC as named insureds and includes a number of first and third party coverages for remediation costs and bodily injury and property damage claims associated with the HARP remediation and contamination. The Company believes that the Policy provides additional assurance that the responsibilities, obligations, and liabilities transferred and assigned by the Company and assumed by TRC under the Agreement will be completed. Although the arrangements with TRC and the WDNR do not constitute a legal discharge or release of the Company's liabilities, the Company believes that the specific work substitution provisions of the Consent Order and the broad coverage terms of the Policy, collectively, are sufficient to satisfy substantially all of the Company's environmental obligations with respect to the HARP remediation. The total cost of the exit strategy insured remediation arrangement to Tecumseh was $16.4 million. This amount included $350,000 that was paid to the WDNR pursuant to the Consent Order to settle any alleged liabilities associated with natural resource damages. The charge represented the cost of the agreements less what was previously provided for cleanup costs to which the Company had voluntarily agreed. The Company, in cooperation with the WDNR, also conducted an investigation of soil and groundwater contamination at the Company's Grafton, Wisconsin plant. It was determined that contamination from petroleum and degreasing products used at the plant were contributing to an off-site groundwater plume. The Company began remediation of soils in 2001 on the east side of the facility. Additional remediation of soils began in the fall of 2002 in two other areas on the plant site. At March 31, 2006, the Company had accrued $2.3 million for the total estimated cost associated with the investigation and remediation of the on-site contamination. Investigation efforts related to the potential off-site groundwater contamination have to date been limited in their nature and scope. The extent, timing and cost of off-site remediation requirements, if any, are not presently determinable. In addition to the above-mentioned sites, the Company is also currently participating with the EPA and various state agencies at certain other sites to determine the nature and extent of any remedial action that may be necessary with regard to such other sites. At March 31, 2006 and December 31, 2005, the Company had accrued $3.4 million and $3.5 million, respectively, for environmental remediation. As these matters continue toward final resolution, amounts in excess of those already provided may be necessary to discharge the Company from its obligations for these sites. Such amounts, depending on their amount and timing, could be material to reported net income in the particular quarter or period that they are recorded. In addition, the ultimate resolution of these matters, either individually or in the aggregate, could be material to the consolidated financial statements. Page 16 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 1 NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited) 11. Income Taxes The first quarter 2006 consolidated statement of operations reflects a $2.6 million income tax benefit, which was recorded pursuant to SFAS No. 109, "Accounting for Income Taxes." SFAS 109 specifies the allocation method of income taxes between categories of income defined by that statement as those that are included in net income (continuing operations and discontinued operations) and those included in comprehensive income but excluded from net income. SFAS 109 is applied by tax jurisdiction, and in periods in which there is a pre-tax loss from continuing operations and pre-tax income in another category (such as other comprehensive income), tax expense is first allocated to other comprehensive income with a related benefit recorded in continuing operations. The first quarter of 2006 reflects tax benefit in the statement of operations and tax expense in other comprehensive income. At March 31, 2006 and December 31, 2005, full valuation allowances are recorded for net operating loss carryovers for those tax jurisdictions in which the Company is in a cumulative year loss position. 12. Commitments and Contingencies A lawsuit filed against the Company and other defendants alleges that the horsepower labels on the products the plaintiffs purchased were inaccurate. The plaintiffs seek certification of a class of all persons in the United States who, beginning January 1, 1995 through the present, purchased a lawnmower containing a two stroke or four stroke gas combustible engine up to 20 horsepower that was manufactured by defendants. The complaint seeks an injunction, compensatory and punitive damages, and attorneys' fees. No orders have been entered in the case, and there has been limited discovery. While the Company believes it has meritorious defenses and intends to assert them vigorously, there can be no assurance that the Company will prevail. The Company also may pursue settlement discussions. It is not possible to reasonably estimate the amount of the Company's ultimate liability, if any, or the amount of any future settlement, but the amount could be material to the Company's financial position, consolidated results of operations and cash flows. The Company is also the subject of, or a party to, a number of other pending or threatened legal actions involving a variety of matters, including class actions, incidental to its business. Although their ultimate outcome cannot be predicted with certainty, and some may be disposed of unfavorably to the Company, management does not believe that the disposition of these other matters will have a material adverse effect on the consolidated financial position or results of operations of the Company. 13. New Accounting Standards On November 24, 2004, the FASB issued Statement No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4 (FAS 151). The standard adopts the IASB view related to inventories that abnormal amounts of idle capacity and spoilage costs should be excluded from the cost of inventory and expensed when incurred. Additionally, the Board made the decision to clarify the meaning of the term `normal capacity'. The provisions of FAS 151 are applicable to inventory costs incurred during fiscal years beginning after June 15, 2005. The Company's adoption of this pronouncement during the first quarter of 2006 did not have a material effect. Page 17 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 1 NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited) 14. Discontinued Operations During the first quarter of 2006, the Company approved a plan to proceed with a transaction to sell 100% of its ownership interest in its Little Giant Pump Company subsidiary. The net assets of the subsidiary are classified as held for sale at March 31, 2006 and December 31, 2005, and its results for the quarters ended March 31, 2006 and 2005 are included in income (loss) from discontinued operations. Interest expense of $2.3 million and $1.4 million was allocated to discontinued operations for all the periods presented because the Company's new financing package required that the proceeds from the sale be utilized to repay portions of the Company's debt. The Company's remaining pump business does not meet the definition of an operating segment as defined by SFAS No. 131, "Segment Reporting." Accordingly, its operating results are included in Other within the Results by Segment table. Following is a summary of assets and liabilities of Little Giant Pump Company at March 31, 2006 and December 31, 2005, which are reflected in the consolidated balance sheets as held for sale:
March 31, December 31, (Dollars in millions) 2006 2005 --------- ----------------- Accounts receivable, net $17.2 $13.5 Inventories 30.8 25.7 Other current assets 0.3 0.3 Property, plant and equipment, net 9.6 10.1 Goodwill 5.1 5.1 ----- ----- Assets held for sale $63.0 $54.7 ===== ===== Accounts payable, trade $ 9.6 $ 7.2 Accrued liabilities 5.4 5.5 ----- ----- Liabilities held for sale $15.0 $12.7 ===== =====
Following is a summary of income (loss) from discontinued operations for the quarters ended March 31, 2006 and 2005:
March 31, March 31, (Dollars in millions) 2006 2005 --------- --------- Net sales $26.8 $24.2 Costs of sales and operating expenses 19.2 17.9 Selling and administrative expenses 5.6 4.7 ----- ----- Operating income 2.0 1.6 Interest expense allocated 2.3 1.4 ----- ----- Income (Loss) from discontinued operations before income taxes (0.3) 0.2 Tax provision 0.2 0.1 ----- ----- Income (Loss) from discontinued operations, net of tax ($0.5) $ 0.1 ===== =====
Page 18 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 1 NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited) 15. Subsequent Event During the first quarter of 2006, the Company entered into an agreement to sell its Little Giant Pump Company subsidiary to Franklin Electric Company, Inc. for approximately $121 million, subject to post-closing adjustments. The subsidiary is classified as held for sale at March 31, 2006, and its results for the periods ended March 31, 2006 and 2005 are included in income (loss) from discontinued operations. On April 21, 2006, the Company completed the sale. As required by the Company's new financing package, the proceeds from the sale were used to repay portions of the Company's debt. Page 19 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS Restatement of Previously Issued Financial Statements The Company has restated the quarterly financial statements for matters, principally regarding the interim period tax provisions, discussed in Footnote 2 to the consolidated financial statements included in Item 1 of Part 1 of this Form 10-Q/A. Generally accepted accounting principles require interim period income taxes to be recorded based on an estimated annual effective rate. The Company in error combined the income from foreign jurisdictions with losses from foreign jurisdictions for which tax benefits are not expected to be realizable. Accordingly, the Company has restated its Consolidated Financial Statements as of and for the three months ended March 31, 2006 and 2005. Executive Summary We are one of the largest independent producers of hermetically sealed compressors in the world, one of the world's leading manufacturers of small gasoline engines and power train products used in lawn and garden applications, and one of the leading manufacturers of fractional horsepower motors for the United States market. Our net sales have grown by approximately $400 million from the year ended December 31, 2001 to the year ended December 31, 2005. The primary source of sales growth was our 2002 acquisition of FASCO Motors, now the key component of our presence in the U.S. fractional horsepower motor market. Our products are sold in countries all over the world. In evaluating our financial condition and operating performance, we focus primarily on profitable sales growth and cash flows, as well as return on invested capital on a consolidated basis. In addition to maintaining and expanding our business with our existing customers in our more established markets, we rely on developing new products and improving our ability to penetrate new markets through enhancements to the functionality, performance and quality of our existing products. For instance, our Compressor Group will introduce a scroll-style compressor to serve commercial refrigeration and air conditioning markets throughout the globe, and it will begin producing a new expanded range rotary compressor in India for global applications, while our Electrical Components Group has expanded its range of Brushless DC ("BLDC") variable speed motor products. To continue to grow sales and improve cash flows, we must successfully bring these products to market in a timely manner and win customer acceptance. International sales are important to our business as a whole with sales to customers outside the United States representing approximately 50% of total consolidated net sales in 2005. The Company's dependence on sales in foreign countries entails certain commercial and political risks, including currency fluctuations, unstable economic or political conditions in some areas and the possibility of various government interventions into trade policy. We have experienced some of these factors and continue to carefully pursue these markets. Our operating results are indicative of the environment that manufacturers face in today's global economy. The addition of new productive capacities in low-cost locations, like China, has resulted in new capacities and deflationary pricing in many of the market segments in which we operate. Like many of our customers and competitors, we have restructured older operations to remain cost competitive, including the movement of productive capacities to low-cost locations or nearer to customer facilities. These restructurings involve significant costs, in both financial and human terms. Page 20 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS In addition, many of our markets are subject to macroeconomics trends, which expand and contract, and many overall trends, which affect demand, such as weather. The foreign manufacturing operations we have developed are subject to many risks, including governmental expropriation, governmental regulations that may be disadvantageous to businesses owned by foreign nationals, and instabilities in the workforce due to changing political and social conditions. These considerations are especially significant in the context of our Brazilian operations. The Brazilian compressor operations provided a significant portion of total Compressor Products segment production during 2005, and our Curitiba, Brazil facility is the key future manufacturing site to supply worldwide demand for lawn and garden engines. As a global manufacturer with production in 11 countries and sales in over 110 countries throughout the world, results are sensitive to changes in foreign currency exchange rates. In total, those movements have not been favorable to us during 2005 and the first three months of 2006. We have developed strategies to mitigate or partially offset the impact, primarily hedging where the risk of loss is greatest. In particular, we have entered into foreign currency forward purchases to hedge the Brazilian export sales denominated in both U.S. Dollars and Euros. Additionally, we have structured local financing relationships as natural hedges. Lastly, commodity prices increased very rapidly during 2004, 2005 and into 2006. Due to competitive markets, we were not able to fully recover these cost increases through price increases and other cost savings. Increases in certain raw material, energy and commodity costs have had a material adverse impact on our operating results during these periods. We have developed strategies to mitigate or partially offset the impact, which include aggressive cost reduction actions, cost optimization engineering strategies, selective in-sourcing of components where we have available capacity, continued consolidation of our supply base, and acceleration of low-cost country sourcing. In addition, the sharing of increased raw material costs has been, and will continue to be, the subject of negotiations with our customers. While we believe that our mitigation strategies eventually will offset a substantial portion of the financial impact of these increased costs, no assurances can be given that the magnitude and duration of these increased costs will not have a continued material adverse impact on our operating results. We are very focused on efforts to help us maintain our ability to compete on cost. Our success in generating cash flow will depend, in part, on our ability to efficiently manage working capital. In this regard, changes in inventory management practices and customer and vendor payment terms had a positive impact on our reported cash flows when comparing the first quarter of 2006 to 2005. In addition, our cash flow is also dependent on our ability to efficiently manage our capital spending. We use cash return on invested capital as a measure of the efficiency with which assets are deployed to increase earnings. Improvements in our return on invested capital will depend on our ability to maintain an appropriate asset base for our business and to increase productivity and operating efficiency. For further information related to other factors that have had, or may in the future have, a significant impact on our business, financial condition or results of operations, see "Cautionary Statements Relating To Forward-Looking Statements" below. Page 21 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations A summary of our operating results as a percentage of net sales is shown below (dollar amounts in millions):
THREE MONTHS ENDED MARCH 31, (dollars in millions) 2006 % 2005 % ------- ----- ------- ----- Net sales $ 446.1 100.0% $ 440.2 100.0% Cost of sales and operating expenses 411.6 92.3% 412.7 93.8% Selling and administrative expenses 45.2 10.1% 43.4 9.9% Impairments, restructuring charges, and other items 0.6 0.1% 0.1 0.0% ------- ------- Operating loss (11.3) (2.5%) (16.0) (3.6%) Interest expense (8.4) 1.9% (6.3) 1.4% Interest income and other, net 5.0 1.1% 3.3 0.7% ------- ------- Loss from continuing operations before taxes (14.7) (3.3%) (19.0) (4.3%) Tax benefit (2.6) (0.6%) (2.9) (0.6%) ------- ------- Loss from continuing operations ($12.1) (2.7%) ($16.1) (3.7%) ======= =======
Three Months Ended March 31, 2006 vs. Three Months Ended March 31, 2005 Consolidated net sales from continuing operations in the first quarter of 2006 increased to $446.1 million from $440.2 million in 2005. Excluding the increase in sales due to the effects of currency fluctuation of $9.1 million, 2006 first quarter sales declined by $3.2 million. While sales improved in the Compressor and Electrical Components segments, declines in sales in the Engine & Power Train segment more than offset the increases. Cost of sales and operating expenses was $411.6 million in the three months ended March 31, 2006, as compared to $412.7 million in the three months ended March 31, 2005. As a percentage of net sales, cost of sales and operating expenses were 92.3% and 93.8% in the first quarters of 2006 and 2005, respectively. The improvement was primarily due to improved operational efficiencies and lower fixed costs associated with plant closures. Also included in cost of sales and operating expenses was the $3.5 million gain from the sale of the Douglas, Georgia engine facility. Selling, general and administrative expenses were $45.2 million in the three months ended March 31, 2006, as compared to $43.4 million in the three months ended March 31, 2005. As a percentage of net sales, selling, general and administrative expenses were 10.1% and 9.9% in the first quarters of 2006 and 2005, respectively. The increase was primarily related to AlixPartners' fees of $9.0 million offset by improved variable selling costs and global headcount reductions. Interest expense amounted to $8.4 million in the first quarter of 2006 compared to $6.3 million in the first quarter of 2005. The increase was primarily related to the higher average interest rates associated with the Company's current borrowing arrangements. Page 22 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS Interest income and other, net was $5.0 million in the first quarter of 2006 compared to $3.3 million in the first quarter of 2005. The impact of lower interest income due to lower cash balances was more than offset by a gain of $3.6 million on the sale of the Company's interest in Kulthorn Kirby Public Company Limited, a manufacturer of compressors based in Thailand. The sale of the stock was completed in conjunction with the end of a licensing agreement between the Company's Compressor operations and Kulthorn Kirby. The first quarter 2006 consolidated statement of operations reflects a $2.6 million income tax benefit, which was recorded pursuant to SFAS No. 109, "Accounting for Income Taxes." SFAS 109 specifies the allocation method of income taxes between categories of income defined by that statement as those that are included in net income (continuing operations and discontinued operations) and those included in comprehensive income but excluded from net income. SFAS 109 is applied by tax jurisdiction, and in periods in which there is a pre-tax loss from continuing operations and pre-tax income in another category (such as other comprehensive income), tax expense is first allocated to other comprehensive income with a related benefit recorded in continuing operations. The first quarter of 2006 reflects tax benefit in the statement of operations and tax expense in other comprehensive income. At March 31, 2006 and December 31, 2005, full valuation allowances are recorded for net operating loss carryovers for those tax jurisdictions in which the Company is in a cumulative year loss position. Net loss from continuing operations in the first quarter of 2006 was $12.1 million, or $0.65 per share, as compared to net loss of $16.1 million, or $0.88 per share, in the first quarter of 2005. The improvement was primarily the result of the factors described above. Reportable Operating Segments The financial information presented below is for our three reportable operating segments for the periods presented: Compressor, Electrical Components, and Engine & Power Train. Financial measures regarding each segment's income (loss) before interest, other expense, income taxes, and impairments, restructuring charges, and other items ("operating income") and income (loss) before interest, other expense and income taxes and impairments, restructuring charges, and other items divided by net sales ("operating margin") are not measures of performance under accounting principles generally accepted in the United States (GAAP). Such measures are presented because we evaluate the performance of our reportable operating segments, in part, based on income (loss) before interest, other expense, income taxes, and impairments, restructuring charges, and other items. These measures should not be considered in isolation or as a substitute for net income, net cash provided by operating activities or other income statement or cash flow statement data prepared in accordance with GAAP or as measures of profitability or liquidity. In addition, these measures, as we determine them, may not be comparable to related or similarly titled measures reported by other companies. For a reconciliation of consolidated income (loss) before interest, other expense and income taxes, impairments, restructuring charges, and other items to income before provision for income taxes, see Note 5, Business Segments. Page 23 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS Compressor Products First quarter 2006 sales in the Compressor business increased 4.4% to $251.5 million from $241.0 million in the prior year. The increase for the period was mostly attributable to effects of foreign currency translation that increased current quarter sales by $9.2 million. Overall, unit sales volumes were relatively consistent with the prior year with some change in product mix. Compressor business operating income and related margin for the first quarter of 2006 were $6.6 million and 2.6%, respectively, compared to $8.6 million and 3.6% in the first quarter of 2005. The operating income decrease was attributable to an unfavorable product mix and higher material and other input costs offset by productivity improvements. The Brazilian Real that was on average 16% stronger against the U.S. Dollar in the first quarter of 2006 versus 2005, but hedging activities mitigated the financial impact. Electrical Component Products Electrical Components business sales were $109.1 million for the first quarter of 2006, an increase of 8.9% over sales of $100.2 million in the same quarter last year. Volume increases in residential and commercial motor markets of approximately 16%, where HVAC markets were particularly robust, more than compensated for a decrease of approximately 11% in the automotive motor market, as a result of lower build schedules and share losses by the Company's customers at their respective OEM customers. Electrical Components operating income and related margin for the first quarter of 2006 were $4.9 million and 4.5%, respectively, compared to a loss of $1.1 million and (1.1%) in the first quarter of 2005. The improvement was primarily due to higher sales volumes, improved operational efficiencies, and pricing actions taken during 2005. Engine & Power Train Products Engine & Power Train business sales were $80.9 million in the first quarter of 2006 compared to $94.9 million for the same period a year ago, a decrease of 14.8%. The decline in sales for the first quarter was due to the loss of sales into the European market from the Company's former Italian subsidiary. As previously disclosed on December 28, 2005, the Company closed its engine manufacturing operations of its wholly owned subsidiary, Tecumseh Europa S.p.A., located in Turin, Italy. The shutdown was accomplished through an Italian form of court-supervised liquidation. The effects of the liquidation were reflected in the Company's 2005 results. The Italian subsidiary was the primary, but not sole, source of engines for sales in the European market. This decline in unit volumes sold into Europe was partially offset by an increase in volumes sold into the United States that were primarily attributable to the placement of the Company's engines on additional product sku's at existing customers. North American engine unit deliveries were approximately 11% greater than the prior year's first quarter. Engine & Power Train business operating loss and related margin for the first quarter of 2006 were $18.5 million and (22.9%), respectively, compared to a loss of $20.9 million and (22.0%) during the same period a year ago. Included in the 2006 loss were AlixPartners' fees of $9.0 million and a $3.5 million gain from the sale of the Douglas, Georgia engine facility. Exclusive of these two items, Page 24 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS operating results improved by approximately 38%. The improvement reflected lower fixed costs associated with plant closures, higher productivity levels in Brazil, the non-recurrence of costs associated with a transmission recall, and higher U.S. volumes, partially offset by higher commodity and transportation costs and a less favorable value of the Brazilian Real. OTHER MATTERS Environmental Matters We are subject to various federal, state and local laws relating to the protection of the environment and are actively involved in various stages of investigation or remediation for sites where contamination has been alleged. (See Note 10 to the financial statements.) Liabilities relating to probable remediation activities are recorded when the costs of such activities can be reasonably estimated based on the facts and circumstances currently known. Difficulties exist estimating the future timing and ultimate costs to be incurred due to uncertainties regarding the status of laws, regulations, levels of required remediation, changes in remediation technology and information available. At March 31, 2006 and December 31, 2005, we had accrued $3.4 million and $3.5 million, respectively, for environmental remediation. As these matters continue toward final resolution, amounts in excess of those already provided may be necessary to discharge our obligations for these sites. Such amounts, depending on their amount and timing, could be material to reported net income in the particular quarter or period in which they are recorded. In addition, the ultimate resolution of these matters, either individually or in the aggregate, could be material to the consolidated financial statements. AlixPartners Engagement We engaged AlixPartners during the third quarter of 2005 to assist in the restructuring plans of the Engine & Power Train business. These plans include focusing on improving profitability and customer service. We believe the participation by AlixPartners will allow the Company to effect this change in a shorter time frame than it otherwise could have achieved. The plan includes eliminating the significant duplicate capacity, among other cost reduction efforts. During the first quarter of 2006, the Company recognized fees of $9.0 million related to the AlixPartners engagement. LIQUIDITY AND CAPITAL RESOURCES Our primary liquidity needs are to fund capital expenditures, service indebtedness, and support working capital requirements. Our principal sources of liquidity are cash flows from operating activities and borrowings under available credit facilities. A substantial portion of our operating income is generated by foreign operations. As a result, we are dependent on the earnings and cash flows of and the combination of dividends, distributions and advances from our foreign operations to provide the funds necessary to meet our obligations in each of our legal jurisdictions. There are no significant restrictions on the ability of our subsidiaries to pay dividends or make other distributions. Cash Flow For the first quarter 2006, cash used by operations amounted to $44.5 million, reflecting both an operating loss and net investments in working capital items. This represented an improvement of $22.9 Page 25 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS million compared to the first quarter 2005, primarily as a result of better management of working capital over the respective quarters as sales were more in line with expectations. Cash used in investing activities was $13.0 million in the first quarter 2006 versus $28.7 million for the same period of 2005. Of the overall decrease, $8.7 million was related to lower capital expenditures due to significant new product expansions in India and Brazil in the prior years, and $9.0 million related to proceeds received from the sale of assets during 2006. Included in such sales were the sale of the Company's 7% interest in Kulthorn Kirby Public Company Limited stock for $4.7 million and the sale of the Company's former Douglas, Georgia manufacturing facility for $3.5 million. In addition, during the first quarter, the Company acquired a small Australian-based company, which owned patents related to the manufacturing of certain types of electric motors, which are applicable to both our Electrical Components and Compressor segments. The entire purchase price was allocated to intangible assets. Cash flows from financing activities provided cash of $24.0 million in the first quarter of 2006 as compared to using $47.4 million in the quarter of 2005. During 2005, we used existing cash balances to prepay $50 million of our then Senior Guaranteed Notes in order to remain within our debt covenants at March 31, 2005. During the first quarter 2006, the remaining balance of these Senior Guaranteed Notes, our Revolving Credit Facility and our outstanding Industrial Revenue Bonds were replaced by a new financing package that included a $275 million First Lien Credit Agreement and a $100 million Second Lien Credit Agreement. Capitalization In addition to cash provided by operating activities, we use a combination of our revolving credit arrangement under our First Lien Credit Agreement, long-term debt under our Second Lien Credit Agreement, and foreign bank debt to fund our capital expenditures and working capital requirements. For the three months ended March 31, 2006 and March 31, 2005, our average outstanding debt balance was $372.5 million and $363.6 million, respectively. The weighted average long-term interest rate, including the effect of hedging activities, was 7.4% and 4.6% for the respective periods. Among other factors, the change in the weighted average, long-term interest rate for the respective periods reflects the increase in the borrowing rate applicable to our new borrowing arrangements of 8.8% as compared to the original interest rate of 4.6% under our Senior Guaranteed Notes. The Company may also utilize long-term financing arrangements in connection with state investment incentive programs. Accounts Receivable Sales Certain of our Brazilian and Asian subsidiaries periodically sell their accounts receivable with financial institutions. Such receivables are factored with recourse to us and, in most cases, are excluded from accounts receivable in our consolidated balance sheets. The amount of sold receivables excluded from our balance sheet was $35.2 million and $32.1 million as of March 31, 2006 and December 31, 2005, respectively. We cannot provide any assurances that these facilities will be available or utilized in the future. Page 26 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS Adequacy of Liquidity Sources Historically, cash flows from operations and borrowing capacity under previous credit facilities were sufficient to meet our long-term debt maturities, projected capital expenditures and anticipated working capital requirements; however, the negative results experienced during 2005 deteriorated to the point where we were not able to remain in compliance with the covenants of the Senior Guaranteed Notes and the Revolving Credit Facility as amended as of August 5, 2005. Accordingly, on February 6, 2006, we replaced the Senior Guaranteed Notes, Revolving Credit Agreement and Industrial Revenue Bonds with a new financing package that included a $275 million first Lien Credit Agreement and a $100 million Second Lien Credit Agreement. The agreements provide for security interests in substantially all of the Company's assets and specific financial covenants related to EBITDA, capital expenditures, and fixed charge coverage. Additionally, under the terms of the agreements, no dividends can be paid prior to December 31, 2006 and minimum amounts of credit availability are required before dividends can be paid thereafter. In addition, subsequent to March 31, 2006, proceeds from the sale of Little Giant Pump Company were used to repay portions of the new debt arrangements. Approximately, 63% of the proceeds was applied against the First Lien borrowing and 37% against the Second Lien borrowing. After giving effect to the repayments, the weighted average annual interest rate of these borrowings was 8.8%. The Company continues to monitor its future expected results in relationship to the financial covenants specified under the terms of the respective borrowing arrangements and the amount of availability of funds provided by the computation of borrowing base. Based upon proceeds provided by the sale of Little Giant and the total availability of funds, we believe the Company has sufficient liquidity to complete its turnaround plans; however, should operating performance fall short of plan, the Company may not remain in compliance with the covenants under the agreements, or have sufficient availability of funds. In this scenario, the Company would need to obtain amendments to the borrowing arrangements. SIGNIFICANT ACCOUNTING POLICIES AND CRITICAL ACCOUNTING ESTIMATES Some of our accounting policies require management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates and assumptions are subject to an inherent degree of uncertainty. They are based on our historical experience, the terms of existing contracts, our evaluation of trends in the industry, information provided by our customers and suppliers, and information available from other outside sources, as appropriate. Actual results in these areas could differ from our estimates. For a discussion of our significant accounting policies and critical accounting estimates, see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Significant Accounting Policies and Critical Accounting Estimates," and Note 1, "Accounting Policies," to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2005. Although not mentioned at December 31, 2005, we regard the recoverability of our deferred tax assets as a critical accounting estimate. We are required to estimate whether recoverability of our deferred tax assets is more likely than not based on forecasts of taxable earnings in the related tax jurisdiction. We use historical and projected future operating results, based upon approved business plans, including a review of the eligible carry-forward period, tax planning opportunities and other relevant Page 27 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS considerations. Examples of evidence that we consider when making judgments about the deferred tax valuation includes tax law changes, a history of cumulative losses, and variances in future projected profitability. Full valuation allowances will be maintained against deferred tax assets in the U.S. and other foreign countries until sufficient positive evidence exists to reduce or eliminate them. Valuation allowances may be established against remaining foreign deferred tax assets in Brazil (aggregating approximately $5.1 million) if negative evidence (such as a continuation of losses recognized during 2006) results in a determination that it is no longer more likely than not that the assets will be realized. As discussed in the Significant Accounting Policies and Critical Accounting Estimates sections of the Form 10-K for the year ended December 31, 2005, the Company traditionally conducts its annual assessment of impairment for goodwill in the fourth quarter by comparing the carrying value of the Company's reporting units to their fair value. Fair value of the Company's goodwill and other intangible assets is estimated based upon a present value technique using discounted future cash flows, forecasted out over a six year period, with residual growth rates forecasted at 3.0% thereafter. The Company uses management business plans and projections as the basis for expected future cash flows. In evaluating such business plans for reasonableness in the context of their use for predicting discounted cash flows in its valuation model, the Company evaluates whether there is a reasonable basis for differences between actual results of the preceding year and projected results for the upcoming years. This methodology can potentially yield significant improvements in growth rates in the first few years of forecast data, due to multiple factors such as improved efficiencies or incremental sales volume opportunities that are deemed to be reasonably likely to be achieved. In the India reporting unit of the Compressor Group, the goodwill analysis performed at the end of 2005 projected growth rates of approximately 35.0% and 29.0% in 2007 and 2008 respectively, before moderating to a 3.0% residual growth rate. For the reporting unit within the Electrical Components Group, the rates were approximately 10.0% and 9.0% in 2007 and 2008, thereafter adjusting to 3.0%, and the Europe reporting unit of the Compressor Group projected growth rates of approximately 5.0% in 2007 and 2008, adjusted to 3.0% thereafter. Assumptions in estimating future cash flows are subject to a high degree of judgment and complexity. The Company makes every effort to forecast these future cash flows as accurately as possible with the information available at the time the forecast is developed. However, changes in the assumptions and estimates may affect the carrying value of goodwill, and could result in additional impairment charges in future periods. Factors that have the potential to create variances between forecasted cash flows and actual results include but are not limited to (i) fluctuations in sales volumes, which can be driven by multiple external factors, including weather conditions affecting demand; (ii) product costs, particularly commodities such as copper; (iii) currency exchange fluctuations; (iv) acceptance of the Company's pricing actions undertaken in response to rapidly changing commodity prices and other product costs; and (v) interest rate fluctuations. Refer to "Cautionary Statements Relating to Forward-Looking Statements" in Item 2 for other factors that have the potential to impact estimates of future cash flows. Discount rates utilized in the goodwill valuation analysis are derived from published resources such as Ibbotson. The rates utilized were 9.25% at December 31, 2005 for all business units for which goodwill is currently recorded. Page 28 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS Operating profit (loss) as a percentage of sales revenue is also a key assumption in the fair value calculation. The range of assumptions used incorporates the anticipated results of the Company's ongoing productivity improvements over the life of the forecast model. The Europe reporting unit forecasted operating profit percentages ranging from 1.3% up to 3.9%. The India reporting unit forecasted a range of 0.8% to 6.2%, and the reporting unit within the Electrical Components Group with goodwill forecasted a range of 5.3% to 7.9%. Based on the goodwill analysis performed for the year ended December 31, 2005, changes of 1.0% in the discount rate utilized would increase (decrease) the fair value calculated for the respective business units as follows:
Change in Change in valuation valuation with 1.0% with 1.0% decrease in increase in discount rate discount rate ------------- ------------- Compressor Segment - Europe $14.8 ($10.6) Compressor Segment - India 24.1 (17.3) Electrical Components Segment 71.8 (52.2)
For the Europe business unit within the Compressor segment, if the discount rate were to increase by 1.0%, the fair value of the business unit would decrease by approximately $11 million. Such an increase in the discount rate would result in the need for management to perform a step 2 analysis on this business unit and could result in an impairment. Other than the addition of the disclosure of the policies regarding income taxes and goodwill noted above, there have been no significant changes to our significant accounting policies or critical accounting estimates during the first six months of 2006. Recently Issued Accounting Pronouncements Inventory Costs The Financial Accounting Standards Board ("FASB") issued SFAS No. 151, "Inventory Costs -- an amendment of ARB No. 43, Chapter 4." This statement clarifies the requirement that abnormal inventory-related costs be recognized as current-period charges and requires that the allocation of fixed production overheads to inventory conversion costs be based on the normal capacity of the production facilities. The provisions of this statement are to be applied prospectively to inventory costs incurred during fiscal years beginning after June 15, 2005. The Company's adoption of this pronouncement during the first quarter of 2006 did not have a material effect. OUTLOOK Information in this "Outlook" section should be read in conjunction with the cautionary language and discussion of risks included below. Page 29 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS The outlook for the remainder of 2006 is subject to the same variables that negatively impacted the Company throughout 2005. Commodity costs, key currency rates, weather and the overall growth rates of the respective economies around the world are all important to future performance. Overall, the Company does not expect these factors to become any more favorable during the year. In fact, certain key commodities, including copper, aluminum, and steel have risen precipitously in recent months. From January 1, 2006 through April 28, 2006, the prices of copper and aluminum have increased approximately 60% and 21%, respectively. The Company expects 2006 results to reflect only those actions it has been taking to reduce costs and, potentially, the benefits of new product introductions, to the extent they are accepted in the market, and has not assumed any improvements from currencies or commodity costs. Given the recent escalation in commodity costs, realization of net improvement in total results, which is largely expected in the latter half of the year, will greatly depend on the Company's ability to pass on to its customers the cost of these sizeable commodity price increases, which are hedged to a lesser extent in the later months of the year. With respect to each of the Company's segments, results in the Compressor Group are expected to lag the results of 2005 throughout the year. The Electrical Components Group, which has demonstrated monthly year over year improvement since August of 2005, is expected to continue its improvement through 2006. The Engine and Power Train business has taken several major steps to eliminate overcapacity and costs that will benefit 2006, with the most significant improvements expected in the fourth quarter of the year. The Company will continue to focus its efforts on improving the profitability and competitiveness of its worldwide operations. It is likely that additional production relocation and consolidation initiatives will take place during 2006 that could have an effect on the consolidated financial position and future results of operations of the Company. In addition, the Company continues to evaluate potential acquisitions, joint ventures and dispositions that could improve the overall competitiveness and financial position of the Company and enhance its product offerings. Such transactions could also have an effect on future results of operations. CAUTIONARY STATEMENTS RELATING TO FORWARD-LOOKING STATEMENTS This discussion contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act that are subject to the safe harbor provisions created by that Act. In addition, forward-looking statements may be made orally in the future by or on behalf of us. Forward-looking statements can be identified by the use of terms such as "expects," "should," "may," "believes," "anticipates," "will," and other future tense and forward-looking terminology, or by the fact that they appear under the caption "Outlook." Readers are cautioned that actual results may differ materially from those projected as a result of certain risks and uncertainties, including, but not limited to, i) changes in business conditions and the economy in general in both foreign and domestic markets; ii) the effect of terrorist activity and armed conflict; iii) weather conditions affecting demand for air conditioners, lawn and garden products, portable power generators and snow throwers; iv) the success of our ongoing effort to bring costs in line with projected production levels and product mix; v) financial market changes, including fluctuations Page 30 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS in interest rates and foreign currency exchange rates; vi) economic trend factors such as housing starts; vii) emerging governmental regulations; viii) availability and cost of materials, particularly commodities, including steel, copper and aluminum, whose cost can be subject to significant variation; ix) actions of competitors; x) the ultimate cost of resolving environmental and legal matters; xi) our ability to profitably develop, manufacture and sell both new and existing products; xii) the extent of any business disruption that may result from the restructuring and realignment of our manufacturing operations or system implementations, the ultimate cost of those initiatives and the amount of savings actually realized; xiii) potential political and economic adversities that could adversely affect anticipated sales and production in Brazil; xiv) potential political and economic adversities that could adversely affect anticipated sales and production in India, including potential military conflict with neighboring countries; xv) our ability to reduce a substantial amount of costs in the Engine & Power Train group associated with excess capacity, and xvi) the ongoing financial health of major customers. These forward-looking statements are made only as of the date of this report, and we undertake no obligation to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise. Page 31 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to risk during the normal course of business from credit risk associated with accounts receivable and from changes in interest rates, commodity prices, and foreign currency exchange rates. The exposure to these risks is managed through a combination of normal operating and financing activities which include the use of derivative financial instruments in the form of foreign currency forward exchange contracts and commodity forward purchasing contracts. Fluctuations in commodity prices and foreign currency exchange rates can be volatile, and the Company's risk management activities do not totally eliminate these risks. Consequently, these fluctuations can have a significant effect on results. A discussion of the Company's policies and procedures regarding the management of market risk and the use of derivative financial instruments was provided in its Annual Report on Form 10-K in Item 7A and in Notes 1 and 12 of the Notes to Consolidated Financial Statements. The Company does not utilize financial instruments for trading or other speculative purposes. There have been no changes in these policies or procedures during the first quarter of 2006. The Company is subject to foreign currency exchange exposure for operations whose assets and liabilities are denominated in currencies other than U.S. Dollars. On a normal basis, the Company does not attempt to hedge the foreign currency translation fluctuations in the net investments in its foreign subsidiaries. The Company does, from time to time, enter into short-term forward exchange contracts to sell or purchase foreign currencies at specified rates based on estimated foreign currency cash flows. Company policy allows local management to hedge known receivables or payables and forecasted cash flows up to a year in advance. It is the policy of the Company not to purchase financial and/or derivative instruments for speculative purposes. At March 31, 2006 and December 31, 2005, the Company held foreign currency forward contracts with a total notional value of $127.5 million and $173.0 million, respectively. The Company uses commodity forward purchasing contracts to help control the cost of traded commodities, primarily copper and aluminum, used as raw material in the production of motors, electrical components and engines. Company policy allows local management to contract commodity forwards for a limited percentage of projected raw material requirements up to one year in advance. Commodity contracts at most of the Company's divisions and subsidiaries are essentially purchase contracts designed to fix the price of the commodities during the operating cycle. The Company's practice has been to accept delivery of the commodities and consume them in manufacturing activities. At March 31, 2006 and December 31, 2005, the Company held a total notional value of $33.8 million and $61.8 million, respectively, in commodity forward purchasing contracts. The majority of these contracts were not recorded on the balance sheet as they did not require an initial cash outlay and do not represent a liability until delivery of the commodities is accepted; however, commodity contracts at the Company's French compressor subsidiary are essentially derivative financial instruments designed to hedge the fluctuation in commodity pricing and, as such, are subject to the provisions of SFAS No. 133, as amended by SFAS 149. The Company is subject to interest rate risk, primarily associated with its borrowings of $403 million at March 2006. The Company's $275 million First Lien Credit Agreement and $100 million Second Lien Credit agreement are variable-rate debt. The Company has entered into variable to fixed interest rate swaps with notional amounts totaling $100 million. The Company's remaining borrowings consists of variable-rate borrowings by its foreign subsidiaries. This resulted in 25% of the Company's total debt at March 31, 2006 being fixed-rate. While changes in interest rates impact the fair value of the fixed rate debt, there is no impact to earnings and cash flow because the Company intends to hold these obligations to maturity unless refinancing conditions are favorable. Alternatively, while changes in Page 32 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK interest rates do not affect the fair value of the Company's variable-interest rate debt, they do affect future earnings and cash flows. A 1% increase in interest rates would increase interest expense for the year by approximately $3.0 million. Page 33 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 4 CONTROLS AND PROCEDURES Disclosure Controls and Procedures The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to the Company's management, including its President and Chief Executive Officer and Vice President, Treasurer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. As of the end of the fiscal quarter covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company's Disclosure Committee and management, including the President and Chief Executive Officer and the Company's Vice President, Treasurer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon such evaluation, the Company's President and Chief Executive Officer along with the Company's Vice President, Treasurer and Chief Financial Officer concluded that because of the material weaknesses discussed below, which still exist as of March 31, 2006, the Company's disclosure controls and procedures were not effective as of March 31, 2006. Notwithstanding the material weaknesses, management believes that the financial statements included in this report fairly state in all material respects our financial condition, results of operations and cash flows for the periods presented. As outlined in management's amended annual report as of December 31, 2005: 1) The Company did not maintain effective controls over user access rights to certain financial application systems which could affect accounts receivable and revenue, inventory and cost of goods sold, and accounts payable and other financial statement accounts at a number of its locations. Specifically, the control deficiencies demonstrated an inadequate design of access security policies and segregation of duties requirements as well as a lack of independent monitoring of user access to financial application programs and data. These control deficiencies, when aggregated, could result in misstatements of the aforementioned financial statement accounts that would result in a material misstatement of the Company's consolidated financial statements that would not be prevented or detected. Accordingly, management has determined that this control deficiency represents a material weakness. 2) The Company did not maintain effective controls over the completeness and accuracy of interim income taxes. Specifically, the Company did not maintain effective controls to ensure the completeness and accuracy of (i) state income tax expense associated with a division accounted for as a discontinued operation in 2006, (ii) the effective tax rates applied to foreign operations, and (iii) the allocation of federal income tax expense between continuing and discontinued operations. This control deficiency resulted in the restatement of the Company's 2005 quarterly consolidated financial statements, the consolidated financial statements for the first and second quarters of 2006 and adjustments to the consolidated financial statements for the third quarter of 2006, affecting accrued liabilities, tax expense (benefit), and income from discontinued operations, net of tax. Additionally, this control deficiency could result in a misstatement of the aforementioned accounts that would result in a material misstatement of the Company's interim and annual consolidated financial statements that Page 34 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 4 CONTROLS AND PROCEDURES would not be prevented or detected. Accordingly, management has determined that this control deficiency represents a material weakness. These material weaknesses continued to exist at March 31, 2006. Management's Remediation Plans The Company has implemented additional controls to remediate the material weakness related to user access rights. These controls include, but are not limited to, additional levels of reviews of transactions, additional reviews of changes to financial applications and data by those with access to both, and reassignment of responsibilities to provide for better segregation of duties. While specific efforts have been undertaken to address the segregation of duties and system access issues within each of the affected locations, the Company has not completed its process to verify the adequacy of the measures taken and ensure these steps had completely addressed the previously identified concerns. The Company has also made progress with respect to its implementation of a common, global ERP system, which represents the long-term solution to these deficiencies as well as a significant improvement to the overall internal control structure of the Company. The system implementation includes improved controls over access to financial application programs and data, independent monitoring of users having unrestricted access to financial application programs and data, and provides for improved segregation of duties. On April 1, 2006, five of nine locations, scheduled for implementation during 2006, went live. All remaining locations are expected to go live before the end of 2007. With respect to the completeness and accuracy of the calculation of interim income taxes, the Company has corrected its methodologies to comply with generally accepted accounting principles. The company has also instituted additional review procedures relating to these processes that includes additional management reviews and review by our outside tax advisors prior to the finalization of the income tax provision for the period. While management has enhanced internal control processes around the calculation of interim income taxes, management has not performed an assessment of these controls and cannot conclude that the material weakness has been remediated. Changes In Internal Control Over Financial Reporting As noted above, the Company is in the process of implementing a new global ERP system. Location implementations began in the first quarter of 2005 and the Company's remaining locations are expected to go live during 2006 and 2007. During this time period, there will be significant changes in internal controls over financial reporting at the operations affected. The Company believes it has designed adequate controls into the new system and will begin testing their application at each location after their respective go-live dates. There have been no changes in the Company's internal controls over financial reporting that occurred during the quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. Limitations On The Effectiveness Of Controls And Procedures Page 35 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART 1. FINANCIAL INFORMATION - ITEM 4 CONTROLS AND PROCEDURES Management of the Company, including the chief executive officer and chief financial officer, does not expect that the Company's disclosure controls and procedures or internal control over financial reporting will detect or prevent all error and all fraud. A control system, no matter how well designed and implemented, can provide only reasonable, not absolute, assurance that the control system's objective will be met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues within a company are detected. In addition, projection of any evaluation of the effectiveness of internal control over financial reporting to future periods is subject to the risk that controls may become inadequate because of changes in condition, or that the degree of compliance with policies and procedures included in such controls may deteriorate. Page 36 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART II. OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Annual Meeting of Shareholders of Tecumseh Products Company was held on April 26, 2006. Proxies for the meeting were solicited pursuant to Section 14(a) of the Securities Exchange Act of 1934, and there was no solicitation in opposition to management's solicitation. (a) All of management's nominees for directors as listed in the proxy statement were elected with the following votes:
Votes Votes Director For Withheld -------- --------- -------- Peter M. Banks 4,303,096 353,124 Jon E. Barfield 4,088,770 567,450 Todd W. Herrick 4,626,030 30,190 Albert A. Koch 4,085,855 570,365 David M. Risley 4,088,825 567,395
(b) The selection of PricewaterhouseCoopers to serve as the independent auditor of Tecumseh Products Company was approved.
Votes Votes Votes For Against Abstain --------- ------- ------- Ratification of PricewaterhouseCoopers as independent accountants 4,654,519 497 1,204
ITEM 5. OTHER INFORMATION On May 5, 2006 (effective as of February 6, 2006) we entered into amendments to our First Lien Credit Agreement and Second Lien Credit Agreement to clarify that our Brazilian subsidiaries' practice of selling receivables under programs administered by the Brazilian Central Bank is permitted under each agreement's covenant limiting the indebtedness we can incur. For more detailed information, please see the copies of the amendments filed as exhibits to this report. ITEM 6. EXHIBITS
(a) Exhibit Number Description ------- ----------- 4.1 Amendment No. 1 to First Lien Credit Agreement dated May 5, 2006 by and among Tecumseh Products Company and certain Lenders and Issuers listed therein and Citicorp USA, Inc. as Administrative Agent and Collateral Agent (incorporated by reference to Exhibit 4.1 to Registrant's original Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, File No. 0-452.) 4.2 Amendment No. 1 to Second Lien Credit Agreement dated May 5, 2006 by and among Tecumseh Products Company and certain Lenders listed therein and Citicorp USA, Inc. as Administrative Agent and Collateral Agent (incorporated by reference to Exhibit 4.1 to Registrant's original Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, File No. 0-452.) 10.1 Management Incentive Plan as amended and restated on March 29, 2006, effective as of January 1, 2005 in part and as of January 1, 2006 in part (management contract or compensatory plan or arrangement) (incorporated by
Page 37 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES PART II. OTHER INFORMATION reference to Exhibit 10.1 to Registrant's original Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, File No. 0-452.) 10.2 Executive Deferred Compensation Plan adopted on March 29, 2006, effective as of January 1, 2005 (management contract or compensatory plan or arrangement) (incorporated by reference to Exhibit 10.2 to Registrant's original Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, File No. 0-452.) 10.3 Director Retention Phantom Share Plan as amended and restated on March 29, 2006, effective as of January 1, 2005 (management contract or compensatory plan or arrangement) (incorporated by reference to Exhibit 10.3 to Registrant's original Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, File No. 0-452.) 31.1 Certification of the President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of the President and Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Page 38 TECUMSEH PRODUCTS COMPANY AND SUBSIDIARIES SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. TECUMSEH PRODUCTS COMPANY (Registrant) Dated: December 19, 2006 BY: /s/ JAMES S. NICHOLSON ------------------------------------ James S. Nicholson Vice President, Treasurer and Chief Financial Officer (on behalf of the Registrant and as principal financial officer) Page 39 EXHIBIT INDEX
Exhibit No. Description of Exhibits ----------- ----------------------- 31.1 Certification of the President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of the President and Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.