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TECUA > SEC Filings for TECUA > Form 10-Q on 7-Nov-2012All Recent SEC Filings

Show all filings for TECUMSEH PRODUCTS CO

Form 10-Q for TECUMSEH PRODUCTS CO


7-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
CAUTIONARY STATEMENTS RELATING TO FORWARD LOOKING STATEMENTS
This Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") should be read in conjunction with the MD&A and the cautionary statements and discussion of risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2011 and the information contained in the Consolidated Financial Statements and Notes to Consolidated Statements in Part 1, Item 1 of this report.
This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act that are subject to the safe harbor provisions created by that Act. In addition, forward-looking statements may be made orally in the future by or on behalf of us. Forward-looking statements can be identified by the use of terms such as "expects," "should," "may," "believes," "anticipates," "will," and other future tense and forward-looking terminology, or by the fact that they appear under the caption "Outlook." Our forward-looking statements generally relate to our future performance, including our anticipated operating results and liquidity sources and requirements, our business strategies and goals, and the effect of laws, rules, regulations, new accounting pronouncements and outstanding litigation, on our business, operating results, and financial condition.
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) current and future global or regional economic conditions, including housing starts, and the condition of credit markets, which may magnify other risk factors; ii) loss of, or substantial decline in sales to, any of our key customers; iii) our ability to maintain adequate liquidity in total and within each foreign operation; iv) our ability to restructure or reduce our costs and increase productivity and quality and develop successful new products in a timely manner; v) actions of competitors in highly competitive markets with intense competition; vi) the ultimate cost of defending and resolving legal and environmental matters, including any liabilities resulting from the regulatory antitrust investigations commenced by the United States Department of Justice Antitrust Division and the Secretariat of Economic Law of the Ministry of Justice of Brazil both of which could preclude commercialization of products or adversely affect profitability and/or civil litigation related to such investigations; vii) availability and volatility in the cost of materials, particularly commodities, including steel and copper, whose cost can be subject to significant variation; viii) financial market changes, including fluctuations in foreign currency exchange rates and interest rates; ix) significant supply interruptions or cost increases; x) potential political and economic adversities that could adversely affect anticipated sales and production in Brazil; xi) potential political and economic adversities that could adversely affect anticipated sales and production in India, including potential military conflict with neighboring countries; xii) local governmental, environmental, trade and energy regulations; xiii) increased or unexpected warranty claims; xiv) the extent of any business disruption caused by work stoppages initiated by organized labor unions; xv) the extent of any business disruption that may result from the restructuring and realignment of our manufacturing operations and personnel or system implementations, the ultimate cost of those initiatives and the amount of savings actually realized; xvi) the success of our ongoing effort to bring costs in line with projected production levels and product mix;
xvii) weather conditions affecting demand for replacement products; xviii) the effect of terrorist activity and armed conflict. 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. For more information regarding these and other uncertainties and factors that could cause our actual results to differ materially from what we have anticipated in our forward-looking statements or otherwise could materially adversely affect our business, financial condition, or operating results, see our most recently filed Annual Report on Form 10-K, Part I, Item 1A, "Risk Factors."

EXECUTIVE SUMMARY
In addition to the relative competitiveness of our products, our business is significantly influenced by several specific economic factors: the strength of the overall global economy, which can have a significant impact on our sales; our product costs, especially the price of copper and steel; and the relative value against the U.S. Dollar of those foreign currencies of countries where we operate.
Economy
Our sales depend significantly on worldwide economic conditions and the demand for the products in which our products are used. Global economic weakness and uncertainty continue to impact our financial results, and are part of the reason for lower sales, and difficulty in managing inventory levels in the first nine months of 2012. Sales decreased in the first nine months of 2012 compared to the first nine months of 2011 primarily due to unfavorable foreign currency impacts, lower volumes and unfavorable changes in sales mix for compressors used in North American commercial refrigeration and air conditioning applications, and price decreases for compressors used in household refrigeration and freezer (R&F) applications, partially offset by higher volumes and favorable changes in sales mix for compressors used in commercial refrigeration and R&F

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applications, and price increases for compressors used in commercial refrigeration and air conditioning applications. Exclusive of the effects of currency translation, sales in the first nine months of 2012 were approximately 2.6% higher compared to the first nine months of 2011. In our air conditioning application markets, volume decreases are primarily due to the temporary shutdown of a plant by one of our major Brazilian customers, which resumed operations in the middle of the third quarter. Commodities
Due to the high content of copper and steel in compressor products, our results of operations are very sensitive to the prices of these commodities. The average market costs for the types of copper and steel used in our products decreased in the third quarter of 2012 as compared to the third quarter of 2011, with copper decreasing by 14.2% and steel decreasing by 3.8%. After consideration of our hedge positions, our average cost of copper in the third quarter of 2012 was 10.8% lower in our results of operations when compared to the third quarter of 2011, primarily due to market price reductions. Extreme volatilities create substantial challenges to our ability to control the cost of our products, as the final product cost can depend greatly on our ability to secure optimally priced futures contracts.
Any increase in steel prices may have a particularly negative impact on our product costs, as there is currently no well-established global market for hedging against increases in the price of steel. Although we have been successful in securing a few contracts to help mitigate the risk of the rising steel market, this market is not very liquid and is only available against our purchases of steel in the U.S.
Based upon the expected increase in sales of the new Mini and Midi platform products, we are utilizing more aluminum in our motors in 2012. While aluminum is currently not as volatile as copper and steel, we have proactively executed some futures contracts and options for aluminum to help mitigate the risk of rising aluminum prices.
We have been proactive in addressing the volatility of commodity costs, including executing futures contracts, as of September 30, 2012, that cover approximately 64.5%, 4.8% and 46.1% of our remaining anticipated copper, steel and aluminum, respectively, usage in 2012. As of September 30, 2012, we have executed futures contracts that cover approximately 15.5% of our projected 2013 aluminum usage. However; continued volatility of commodity costs could nonetheless have an adverse effect on our results of operations both in the near and long term as our anticipated needs are not 100% hedged.
We expect to continue our approach of mitigating the effect of short term swings through the appropriate use of hedging instruments, price increases and modified pricing structures with our customers, where available, to allow us to recover our costs in the event that the prices of commodities escalate. Due to competitive markets for our finished products, we are typically not able to quickly recover product cost increases through price increases or other cost savings. For a discussion of the risks to our business associated with commodity price risk fluctuations, refer to "Quantitative and Qualitative Disclosures about Market Risk" in Part I, Item 3 of this report. Currency Exchange
The compressor industry and our business in particular are characterized by global and regional markets that are served by manufacturing locations positioned throughout the world. Most of our manufacturing presence is in international locations. During the first nine months of 2012 and 2011, approximately 79% and 80%, respectively, of our compressor sales activity took place outside the United States, primarily in Brazil, Europe, and India. As a result, our consolidated financial results are sensitive to changes in foreign currency exchange rates, including the Brazilian Real, the Euro and the Indian Rupee. Our Brazilian and European manufacturing and sales presence is significant and changes in the Brazilian Real and the Euro have been significant to our results of operations when comparing them to prior periods. During the first nine months of 2012, the Brazilian Real weakened against the U.S. Dollar by 8.3%, the Euro weakened against the U.S. Dollar by 0.8% and the Indian Rupee strengthened against the U.S. Dollar by 0.3%. For a discussion of the risks to our business associated with currency fluctuations, refer to "Quantitative and Qualitative Disclosures about Market Risk" in Part I, Item 3 of this report. Liquidity
Challenges remain with respect to our ability to generate appropriate levels of liquidity solely from cash flows from operations, particularly uncertainties related to future sales levels, global economic conditions, currency exchange rates and commodity pricing as discussed above. In the first nine months of 2012, cash from operating activities provided $4.3 million of cash, which included $17.1 million from payables and accrued expenses partially offset by $14.8 million and $2.7 million used for receivables and inventories, respectively.
In the first nine months of 2012, we benefited from the following non-recurring cash inflows: an IRS tax refund of $5.8 million and $1.3 million in interest related to the refund, $2.9 million from the sale of proceeds from a future potential settlement of a lawsuit involving our Brazilian location and $1.7 million from a mutual release agreement.

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We expect to receive cash inflows from recoverable non-income taxes through the end of 2014. Based on the historical payment patterns and applicable foreign currency exchange rates as of September 30, 2012, we expect to recover approximately $16.6 million of the $39.0 million outstanding refundable taxes in the next twelve months. Out of the $16.6 million current portion of the refundable non-income taxes, $11.3 million relates to our Brazilian location. The Brazilian tax authorities will not commit to an actual date of payment and the timing of receipt may be different than planned if the Brazilian authorities change their pattern of payment or past practices.
During the first nine months of 2012, we received $4.3 million relating to recoverable non-income taxes at our Brazilian location. Additionally, we have approximately $15.0 million of our refundable non-income taxes being held in an interest bearing court appointed cash account until resolution of an unrelated social security tax matter, and is reflected as "Deposits" on our balance sheet. The timing of resolution of this tax dispute is uncertain and might take several years to resolve. The actual amounts received as expressed in U.S. Dollars will vary depending on the exchange rate at the time of receipt or future reporting date.
We realize that we may not generate cash flow from operating activities unless further restructuring activities are implemented or sales or economic conditions improve. Additional restructuring actions may be necessary and might include changing our current footprint, consolidation of facilities, other reductions in manufacturing capacity, further reductions in our workforce, sale of assets and other restructuring activities. These actions could result in significant restructuring or asset impairment charges, severance costs, losses on asset sales and use of cash. Accordingly, these restructuring activities could have a significant effect on our consolidated financial position, operating profit, cash flows and future operating results. Cash required by these restructuring activities might be provided by our cash balances and the cash proceeds from the sale of assets. If such restructuring activities are undertaken, there is a risk that the costs of the restructuring and cash required will exceed the benefits received from such activities.
We have a Revolving Credit and Security Agreement with PNC. Subject to the terms and conditions of the agreement, PNC has agreed to provide us with up to a $45.0 million revolving line of credit, including up to $10.0 million in letters of credit, subject to a borrowing base formula, lender reserves and PNC's reasonable discretion. At September 30, 2012, our borrowings under this facility totaled $10.1 million, and we have an additional $6.0 million of borrowing capacity under the borrowing base formula after giving effect to our fixed charge coverage ratio covenant and $3.4 million in outstanding letters of credit.
We also continue to maintain various credit facilities or factoring arrangements in most other jurisdictions in which we operate. While we believe that current cash balances and, when available, borrowings under available credit facilities and cash inflows related to non-income tax refunds will produce adequate liquidity to implement our business strategy over the foreseeable future, there can be no assurance that such amounts will ultimately be adequate if sales or economic conditions deteriorate. We anticipate that we will restrict non-essential uses of our cash balances until cash production from normal operations improves.

RESULTS OF OPERATIONS
Three Months Ended September 30, 2012 vs. Three Months Ended September 30, 2011
A summary of our operating results as a percentage of net sales is shown below:
                                                  Three Months Ended September 30,
(In Millions)                            2012             %             2011            %
Net sales                            $     208.6         100.0  %   $    198.3         100.0  %
Cost of sales                             (190.4 )       (91.3 )%       (193.3 )       (97.5 )%
Gross profit                                18.2           8.7  %          5.0           2.5  %
Selling and administrative expenses        (25.6 )       (12.3 )%        (26.7 )       (13.5 )%
Other income, net                            4.7           2.3  %          4.4           2.2  %
Impairments, restructuring charges,
and other items                             (0.6 )        (0.3 )%         (0.3 )        (0.1 )%
Operating (loss)                            (3.3 )        (1.6 )%        (17.6 )        (8.9 )%
Interest expense                            (2.5 )        (1.2 )%         (2.4 )        (1.2 )%
Interest income                              0.3           0.1  %          1.0           0.5  %
(Loss) from continuing operations
before taxes                                (5.5 )        (2.7 )%        (19.0 )        (9.6 )%
Tax benefit                                  1.6           0.8  %         (1.7 )        (0.8 )%
(Loss) from continuing operations    $      (3.9 )        (1.9 )%   $    (20.7 )       (10.4 )%

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Net sales in the third quarter of 2012 increased $10.3 million, or 5.2%, versus the same period of 2011. Excluding the decrease in sales due to the effect of unfavorable changes in foreign currency translation of $22.6 million, net sales increased by 16.6% compared to the third quarter of 2011, primarily due to net volume and mix increases and net price increases.
Sales of compressors used in commercial refrigeration and aftermarket applications represented 59% of our total sales and increased 1.7% compared to the third quarter of 2011 to $123.0 million. This increase was primarily driven by higher volumes and favorable changes in sales mix of $10.1 million and price increases of $0.7 million, partially offset by unfavorable changes in currency exchange rates of $8.8 million. We have acquired new customers in the European market as a result of a European competitor that ceased production earlier in 2012.
Sales of compressors used in household refrigeration and freezer ("R&F") applications represented 20% of our total sales and increased 13.2% compared to the third quarter of 2011 to $41.2 million. This increase is primarily due to higher volumes and favorable changes in sales mix of $13.4 million, partially offset by unfavorable changes in currency exchange rates of $7.3 million and price decreases of $1.2 million. Volume increases are primarily the result of new business with one major customer at our Indian operations. Sales of compressors for air conditioning applications and all other applications represented 21% of our total sales and increased 8.6% compared to the third quarter of 2011 to $44.4 million. This increase is primarily due to higher volumes and favorable changes in sales mix of $8.7 million and price increases of $1.2 million, partially offset by unfavorable currency exchange rate changes of $6.5 million. Volume increases are primarily the result of increased demand by one of our major Brazilian customers, which had shut down one of its plants in March 2012 and has resumed its operations in the second half of the third quarter, as well as increased demand in the Middle East, partially offset by reduced sales due to increased competition and soft market conditions in North America.
Gross profit increased $13.2 million, from $5.0 million in the third quarter of 2011 to $18.2 million. Our gross profit margin increased from 2.5% to 8.7% in the third quarter of 2011 and 2012, respectively. The increase in gross profit in 2012 was primarily attributable to favorable changes in other material and manufacturing costs of $5.7 million, favorable changes in commodity costs of $5.3 million, favorable changes in currency exchange effects of $2.4 million and price increases of $0.7 million. These increases were partially offset by unfavorable changes in other expenses of $0.7 million and unfavorable changes in volume and sales mix of $0.2 million.
Selling and administrative ("S&A") expenses decreased by $1.1 million from $26.7 million in the third quarter of 2011 to $25.6 million in the third quarter of 2012. As a percentage of net sales, S&A expenses were 12.3% in the third quarter of 2012 compared to 13.5% in the third quarter of 2011. This decrease was due to declines of $0.8 million for other payroll expenses, $0.5 million for professional services and $0.2 in other miscellaneous expenses, partially offset by an increase of $0.4 million for our incentive plan. We record expense related to our incentive plan when we estimate that it is more likely than not that we will achieve the threshold level of performance as outlined by the incentive plan awards. As of September 30, 2012, we estimate that it is more likely than not that we will achieve the threshold level of performance. As a result, during the third quarter of 2012, we recorded $0.2 million of compensation expense for phantom share awards and $0.2 million compensation expense for the cash portion of the plan.
Other income, net, increased $0.3 million from $4.4 million in the third quarter of 2011 to $4.7 million in the third quarter of 2012. This increase is primarily due to $1.2 million for net amortization of gains primarily for our postretirement benefits primarily due to the curtailment of these benefits, (see Note 5, "Pension and Other Postretirement Benefit Plans", for additional information), $1.3 million favorable change in foreign currency exchange rates, $0.6 million increase in miscellaneous other income and $0.2 million from an Indian government incentive, partially offset by a non-recurring gain on sales of assets of $3.0 million which occurred in the third quarter of 2011. We recorded $0.6 million of expense in impairments, restructuring charges, and other items in the third quarter of 2012 compared to $0.3 million of expense in the same period of 2011. In the third quarter of 2012, this expense included $0.6 million related to severance costs associated with a reduction in force at our Brazilian ($0.5 million) and French ($0.1 million) locations. (See Note 10, "Impairments, Restructuring Charges and Other Items", for additional information).
Interest expense was $2.5 million in the third quarter of 2012 compared to $2.4 million in the same period of 2011.
Interest income was $0.3 million in the third quarter of 2012 compared to $1.0 million in the third quarter of 2011, primarily due to a decline in the interest rate on a judicial deposit in Brazil related to recoverable non-income taxes that is being held in an interest bearing court appointed cash account. For the third quarter of 2012, we recorded a tax benefit of $1.6 million from continuing operations. This tax benefit is comprised of a U.S. federal tax benefit of $1.4 million and $0.2 million in foreign tax benefit. The $1.7 million income tax expense from continuing operations for the third quarter of 2011 is comprised of $2.1 million in foreign tax expense, partially offset by a U.S. federal tax benefit of $0.4 million.

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Net loss from continuing operations for the quarter ended September 30, 2012 was $3.9 million, or $0.22 per share, as compared to a net loss of $20.7 million, or $1.12 per share, in the same period of 2011. The change was primarily related to the sales and gross profit increases as well as other factors discussed above. Nine Months Ended September 30, 2012 vs. Nine Months Ended September 30, 2011 A summary of our operating results as a percentage of net sales is shown below:

                                                  Nine Months Ended September 30,
(In Millions)                            2012            %             2011            %
Net sales                            $    656.3         100.0  %   $    690.0         100.0  %
Cost of sales                            (604.9 )       (92.2 )%       (651.1 )       (94.4 )%
Gross profit                               51.4           7.8  %         38.9           5.6  %
Selling and administrative expenses       (81.4 )       (12.4 )%        (79.4 )       (11.5 )%
Other income, net                          18.6           2.8  %         12.8           1.9  %
Impairments, restructuring charges,
and other items                            42.4           6.5  %         (5.7 )        (0.8 )%
Operating income (loss)                    31.0           4.7  %        (33.4 )        (4.8 )%
Interest expense                           (7.9 )        (1.2 )%         (7.9 )        (1.1 )%
Interest income                             2.8           0.4  %          1.9           0.2  %
Income (loss) from continuing
operations before taxes                    25.9           3.9  %        (39.4 )        (5.7 )%
Tax benefit                                 7.2           1.1  %          1.3           0.2  %
Net income (loss) from continuing
operations                           $     33.1           5.0  %   $    (38.1 )        (5.5 )%

Net sales in the first nine months of 2012 decreased $33.7 million, or 4.9%, versus the same period of 2011. Excluding the decrease in sales due to the effect of unfavorable changes in foreign currency translation of $51.6 million, net sales increased by 2.6% compared to the first nine months of 2011, primarily as a result of net volume and mix increases and net price increases. Sales of compressors used in commercial refrigeration and aftermarket applications represented 60% of our total sales and decreased 1.8% compared to the first nine months of 2011 to $395.4 million. This decrease was primarily driven by unfavorable changes in currency exchange rates of $22.4 million, partially offset by net higher volumes and favorable changes in sales mix of $9.3 million and price increases of $6.6 million. The volume increase is mainly attributable to increases in regional demands for these types of products in India and Brazil, partially offset by increased competition and soft market conditions in North America.
Sales of compressors used in household refrigeration and freezer ("R&F") applications represented 22% of our total sales and decreased 1.4% compared to the first nine months of 2011 to $142.9 million. This decrease was primarily due to unfavorable changes in currency exchange rates of $18.7 million and price decreases of $4.8 million, partially offset by higher volumes and favorable changes in sales mix of $20.6 million. Volume increases are primarily the result of new business with one major customer at our Indian operations. Sales of compressors for air conditioning applications and all other applications represented 18% of our total sales and decreased 17.1% compared to the first nine months of 2011 to $118.0 million. This decrease is primarily due to lower volumes and unfavorable changes in sales mix of $15.8 million and $10.5 million of unfavorable currency exchange rate changes partially offset by price increases of $2.0 million. Volume decreases are primarily due to the temporary shutdown of a plant by one of our major Brazilian customers, which resumed operations in the middle of the third quarter, as well as continued competition from Asian supply sources in this market and customers reducing their inventory levels based upon forecasted demands as this market remains soft. Gross profit increased by $12.5 million, or 32.1%, from $38.9 million in the first nine months of 2011 to $51.4 million in the first nine months of 2012. Our gross profit margin increased from 5.6% to 7.8% in the first nine months of 2011 and 2012 respectively. The increase in gross profit in the first nine months of 2012 was primarily attributable to favorable changes in commodity costs of $7.3 million, favorable changes in currency exchange effects of $4.4 million, price increases of $3.8 million and favorable changes in other material and manufacturing costs of $2.3 million. These increases were partially offset by unfavorable changes in volume and sales mix of $4.6 million and increased other expenses of $0.7 million.
Selling and administrative ("S&A") expenses increased by $2.0 million from $79.4 million in the first nine months of 2011 to $81.4 million in the first nine months of 2012. As a percentage of net sales, S&A expenses were 12.4% in the first nine

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