Attached files
file | filename |
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EX-32 - UCI Holdco, Inc. | v192916_ex32.htm |
EX-31.1 - UCI Holdco, Inc. | v192916_ex31-1.htm |
EX-31.2 - UCI Holdco, Inc. | v192916_ex31-2.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
DC 20549
FORM
10-Q
R
|
QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For
the quarterly period ended June 30, 2010
¨
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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: 333-147178
UCI
INTERNATIONAL, INC.
(Exact
Name of Registrant as Specified in Its Charter)
Delaware
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||
(State
or Other Jurisdiction of
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16-1760186
|
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Incorporation
or Organization)
|
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(I.R.S.
Employer Identification No.)
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14601
Highway 41 North
|
||
Evansville,
Indiana
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47725
|
|
(Address
of Principal Executive Offices)
|
|
(Zip
Code)
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(812)
867-4156
(Registrant’s
Telephone Number, Including Area Code)
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 ¨ No R (Note: As a
voluntary filer not subject to the filing requirements, the registrant has filed
all reports under Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months.)
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes ¨ No ¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large
accelerated filer
¨
|
Accelerated
filer
¨
|
Non-accelerated
filer R
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Smaller
Reporting Company
¨
|
(Do
not check if a smaller reporting company)
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes ¨ No R
The
registrant had 2,863,460 shares of its $0.01 par value common stock outstanding
as of August 11, 2010, 225,560 of which were held by
non-affiliates.
UCI
International, Inc.
Index
Part
I FINANCIAL INFORMATION
|
|||
Item
1.
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Consolidated
Financial Statements (unaudited)
|
||
Condensed
consolidated balance sheets — June 30, 2010 and December 31,
2009
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3
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Condensed
consolidated income statements — Three and six months ended June 30, 2010
and 2009
|
4
|
||
Condensed
consolidated statements of cash flows — Six months ended June 30, 2010 and
2009
|
5
|
||
Condensed
consolidated statements of changes in equity (deficit) — Six months ended
June 30, 2010 and 2009
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6
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Notes
to condensed consolidated financial statements
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7
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Item
2.
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Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
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22
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Item
3.
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Quantitative
and Qualitative Disclosures About Market Risk
|
40
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Item
4.
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Controls
and Procedures
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42
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Part
II OTHER INFORMATION
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Item
1.
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Legal
Proceedings
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43
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Item
1A.
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Risk
Factors
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43
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Item
2.
|
Unregistered
Sales of Equity Securities and Use of Proceeds
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54
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Item
3.
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Default
Upon Senior Securities
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54
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Item
4.
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Reserved
|
54
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Item
5.
|
Other
Information
|
54
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Item
6.
|
Exhibits
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55
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Signatures
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56
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Exhibits
|
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2
PART
I
FINANCIAL
INFORMATION
Item
1. Financial Statements
UCI
International, Inc.
Condensed
Consolidated Balance Sheets
(in
thousands)
June
30,
2010
|
December
31,
2009
|
|||||||
(unaudited)
|
(audited)
|
|||||||
Assets
|
||||||||
Current
assets
|
||||||||
Cash
and cash equivalents
|
$ | 174,186 | $ | 131,942 | ||||
Accounts
receivable, net
|
257,517 | 261,210 | ||||||
Inventories,
net
|
134,234 | 133,058 | ||||||
Deferred
tax assets
|
33,018 | 31,034 | ||||||
Other
current assets
|
16,696 | 23,499 | ||||||
Total
current assets
|
615,651 | 580,743 | ||||||
Property,
plant and equipment, net
|
140,034 | 149,753 | ||||||
Goodwill
|
241,461 | 241,461 | ||||||
Other
intangible assets, net
|
65,899 | 68,030 | ||||||
Deferred
financing costs, net
|
2,612 | 3,164 | ||||||
Restricted
cash
|
16,790 | 9,400 | ||||||
Other
long-term assets
|
7,061 | 6,304 | ||||||
Total
assets
|
$ | 1,089,508 | $ | 1,058,855 | ||||
Liabilities and equity
|
||||||||
Current
liabilities
|
||||||||
Accounts
payable
|
$ | 113,055 | $ | 111,898 | ||||
Short-term
borrowings
|
6,184 | 3,460 | ||||||
Current
maturities of long-term debt
|
232 | 17,925 | ||||||
Accrued
expenses and other current liabilities
|
124,077 | 108,147 | ||||||
Total
current liabilities
|
243,548 | 241,430 | ||||||
Long-term
debt, less current maturities
|
736,217 | 720,202 | ||||||
Pension
and other postretirement liabilities
|
71,594 | 70,802 | ||||||
Deferred
tax liabilities
|
8,780 | 8,785 | ||||||
Other
long-term liabilities
|
5,740 | 6,672 | ||||||
Total
liabilities
|
1,065,879 | 1,047,891 | ||||||
Contingencies
— Note J
|
||||||||
Equity
|
||||||||
UCI
International, Inc. shareholder’s equity
|
||||||||
Common
stock
|
29 | 29 | ||||||
Additional
paid in capital
|
279,714 | 279,485 | ||||||
Retained
deficit
|
(222,326 | ) | (237,858 | ) | ||||
Accumulated
other comprehensive loss
|
(33,788 | ) | (32,502 | ) | ||||
Total
UCI International, Inc. shareholder’s equity
|
23,629 | 9,154 | ||||||
Noncontrolling
interest — Note O
|
— | 1,810 | ||||||
Total
equity
|
23,629 | 10,964 | ||||||
Total
liabilities and equity
|
$ | 1,089,508 | $ | 1,058,855 |
The
accompanying notes are an integral part of these statements.
3
UCI
International, Inc.
Condensed Consolidated Income
Statements (unaudited)
(in
thousands)
Three Months Ended
June 30,
|
Six Months Ended June 30,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Net
sales
|
$ | 236,198 | $ | 217,422 | $ | 466,502 | $ | 437,284 | ||||||||
Cost
of sales
|
176,228 | 169,698 | 349,304 | 350,140 | ||||||||||||
Gross
profit
|
59,970 | 47,724 | 117,198 | 87,144 | ||||||||||||
Operating
(expense) income
|
||||||||||||||||
Selling
and warehousing
|
(15,077 | ) | (14,086 | ) | (29,372 | ) | (28,384 | ) | ||||||||
General
and administrative
|
(11,123 | ) | (11,218 | ) | (22,673 | ) | (23,779 | ) | ||||||||
Amortization
of acquired intangible assets
|
(1,336 | ) | (1,481 | ) | (2,671 | ) | (2,961 | ) | ||||||||
Restructuring
gains (costs), net (Note B)
|
(344 | ) | 598 | (2,380 | ) | 393 | ||||||||||
Patent
litigation costs (Note J)
|
(74 | ) | — | (1,038 | ) | — | ||||||||||
Operating
income
|
32,016 | 21,537 | 59,064 | 32,413 | ||||||||||||
Other expense | ||||||||||||||||
Interest
expense, net
|
(14,935 | ) | (15,243 | ) | (29,726 | ) | (30,947 | ) | ||||||||
Management
fee expense
|
(500 | ) | (500 | ) | (1,000 | ) | (1,000 | ) | ||||||||
Miscellaneous,
net
|
(1,352 | ) | (1,669 | ) | (2,303 | ) | (3,154 | ) | ||||||||
Income
(loss) before income taxes
|
15,229 | 4,125 | 26,035 | (2,688 | ) | |||||||||||
Income
tax (expense) benefit
|
(6,315 | ) | (1,680 | ) | (10,540 | ) | 475 | |||||||||
Net
income (loss)
|
8,914 | 2,445 | 15,495 | (2,213 | ) | |||||||||||
Less:
Loss attributable to noncontrolling interest
|
(2 | ) | (75 | ) | (37 | ) | (379 | ) | ||||||||
Net
income (loss) attributable to UCI International, Inc.
|
$ | 8,916 | $ | 2,520 | $ | 15,532 | $ | (1,834 | ) | |||||||
Earnings
(loss) per share:
|
||||||||||||||||
Basic
|
$ | 3.11 | $ | 0.88 | $ | 5.42 | $ | (0.64 | ) | |||||||
Diluted
|
$ | 3.04 | $ | 0.87 | $ | 5.29 | $ | (0.64 | ) |
The
accompanying notes are an integral part of these statements.
4
UCI
International, Inc.
Condensed Consolidated Statements of
Cash Flows (unaudited)
(in
thousands)
Six Months ended June 30,
|
||||||||
2010
|
2009
|
|||||||
Cash
flows from operating activities
|
||||||||
Net
income (loss) attributable to UCI International, Inc.
|
$ | 15,532 | $ | (1,834 | ) | |||
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
||||||||
Depreciation
and amortization of other intangible assets
|
17,704 | 18,805 | ||||||
Amortization
of deferred financing costs and debt discount
|
1,526 | 1,568 | ||||||
Non-cash
interest expense on UCI International Notes
|
15,219 | 14,381 | ||||||
Deferred
income taxes
|
(2,403 | ) | (813 | ) | ||||
Other
non-cash, net
|
2,361 | (1,246 | ) | |||||
Changes
in operating assets and liabilities:
|
||||||||
Accounts
receivable
|
1,863 | 12,510 | ||||||
Inventories
|
(4,525 | ) | 22,395 | |||||
Other
current assets
|
7,280 | 126 | ||||||
Accounts
payable
|
3,857 | 617 | ||||||
Accrued
expenses and other current liabilities
|
16,566 | 10,137 | ||||||
Other
long-term assets
|
812 | (165 | ) | |||||
Other
long-term liabilities
|
766 | 1,575 | ||||||
Net
cash provided by operating activities
|
76,558 | 78,056 | ||||||
Cash
flows from investing activities
|
||||||||
Capital
expenditures
|
(11,741 | ) | (7,530 | ) | ||||
Proceeds
from sale of property, plant and equipment
|
114 | 2,436 | ||||||
Proceeds
from sale of joint venture interest (net of transaction costs and cash
sold)
|
272 | — | ||||||
Increase
in restricted cash
|
(7,390 | ) | (9,400 | ) | ||||
Net
cash used in investing activities
|
(18,745 | ) | (14,494 | ) | ||||
Cash
flows from financing activities
|
||||||||
Issuances
of debt
|
9,619 | 6,543 | ||||||
Debt
repayments
|
(24,708 | ) | (26,177 | ) | ||||
Net
cash used in financing activities
|
(15,089 | ) | (19,634 | ) | ||||
Effect
of currency exchange rate changes on cash
|
(480 | ) | 102 | |||||
Net
increase in cash and cash equivalents
|
42,244 | 44,030 | ||||||
Cash
and cash equivalents at beginning of year
|
131,942 | 46,655 | ||||||
Cash
and cash equivalents at end of period
|
$ | 174,186 | $ | 90,685 |
The
accompanying notes are an integral part of these statements.
5
UCI
International, Inc.
Condensed Consolidated Statements of
Changes in Equity (Deficit) (unaudited)
(in
thousands)
UCI
International, Inc. Shareholder’s Equity
|
||||||||||||||||||||||||||||
Common
Stock
|
Additional
Paid
In
Capital
|
Retained
Deficit
|
Accumulated
Other
Comprehensive
Income
(Loss)
|
Noncontrolling
Interest
|
Total
Shareholders’
Equity
(Deficit)
|
Comprehensive
Income
|
||||||||||||||||||||||
Balance
at January 1, 2009
|
$ | 29 | $ | 279,141 | $ | (247,060 | ) | $ | (39,600 | ) | $ | 2,490 | $ | (5,000 | ) | |||||||||||||
Recognition
of stock based compensation expense
|
220 | 220 | ||||||||||||||||||||||||||
Comprehensive
income
|
||||||||||||||||||||||||||||
Net
loss
|
(1,834 | ) | (379 | ) | (2,213 | ) | $ | (1,834 | ) | |||||||||||||||||||
Other
comprehensive income
|
||||||||||||||||||||||||||||
Foreign
currency adjustment (after $111 of income tax cost)
|
703 | 703 | 703 | |||||||||||||||||||||||||
Pension
liability (after $1,505 of income tax cost)
|
2,434 | 2,434 | 2,434 | |||||||||||||||||||||||||
Total
comprehensive income
|
$ | 1,303 | ||||||||||||||||||||||||||
Balance
at June 30, 2009
|
$ | 29 | $ | 279,361 | $ | (248,894 | ) | $ | (36,463 | ) | $ | 2,111 | $ | (3,856 | ) | |||||||||||||
Balance
at January 1, 2010
|
$ | 29 | $ | 279,485 | $ | (237,858 | ) | $ | (32,502 | ) | $ | 1,810 | $ | 10,964 | ||||||||||||||
Recognition
of stock based compensation expense
|
229 | 229 | ||||||||||||||||||||||||||
Sale
of joint venture
|
(1,773 | ) | (1,773 | ) | ||||||||||||||||||||||||
Comprehensive income | ||||||||||||||||||||||||||||
Net
income (loss)
|
15,532 | (37 | ) | 15,495 | $ | 15,532 | ||||||||||||||||||||||
Other
comprehensive income
|
||||||||||||||||||||||||||||
Foreign
currency adjustment (after $19 of income tax benefit)
|
(1,666 | ) | (1,666 | ) | (1,666 | ) | ||||||||||||||||||||||
Pension
liability (after $234 of income tax cost)
|
380 | 380 | 380 | |||||||||||||||||||||||||
Total
comprehensive income
|
$ | 14,246 | ||||||||||||||||||||||||||
Balance
at June 30, 2010
|
$ | 29 | $ | 279,714 | $ | (222,326 | ) | $ | (33,788 | ) | $ | — | $ | 23,629 |
The
accompanying notes are an integral part of these statements.
6
UCI
International, Inc.
Notes
to Condensed Consolidated Financial Statements (unaudited)
NOTE A — GENERAL AND BASIS OF
FINANCIAL STATEMENT PRESENTATION
General
UCI
International, Inc., formerly known as UCI Holdco, Inc., was incorporated on
March 8, 2006 as a holding company for UCI Acquisition Holdings, Inc. (“UCI
Acquisition”) and United Components, Inc. UCI International, Inc. owns all of
the common stock of United Components, Inc. through its wholly-owned subsidiary
UCI Acquisition. UCI International, Inc., UCI Acquisition and United Components,
Inc. are corporations formed at the direction of The Carlyle Group (“Carlyle”).
At June 30, 2010, affiliates of The Carlyle Group owned 90.8% of UCI
International, Inc.’s common stock while the remainder was owned by members of
UCI International, Inc.’s board of directors and certain current and former
employees. The senior management and board of directors of UCI International,
Inc. are also the senior management and board of directors of United Components,
Inc.
All
operations of UCI International, Inc. are conducted by United Components,
Inc. United Components, Inc. operates in one business segment through
its subsidiaries. United Components, Inc. manufactures and distributes vehicle
parts primarily servicing the vehicle replacement parts market in North America
and Europe.
Basis
of Presentation
The
accompanying unaudited condensed consolidated financial statements include the
accounts of UCI International, Inc., its wholly-owned subsidiaries and a 51%
owned joint venture (see Note O). All significant intercompany accounts and
transactions have been eliminated. In these notes to the financial statements,
the term “UCI International” refers to UCI International, Inc. and its
subsidiaries, including UCI Acquisition and its subsidiaries. The term “UCI”
refers to United Components, Inc. and its subsidiaries.
The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by accounting principles generally accepted in the United States (“U.S.
GAAP”) for complete financial statements.
The
December 31, 2009 consolidated balance sheet has been derived from the audited
financial statements included in UCI International’s annual report on Form 10-K
for the year ended December 31, 2009. The financial statements at June 30, 2010
and for the three and six months ended June 30, 2010 and 2009 are unaudited. In
the opinion of UCI International’s management, these financial statements
include all adjustments necessary for a fair presentation of the financial
position and results of operations for such periods.
The
preparation of financial statements in conformity with U.S. GAAP requires
management to make estimates and assumptions in determining the reported amounts
of assets and liabilities at the date of the financial statements and the
reported amounts of sales and expenses during the reporting period. The
estimates and assumptions include estimates of the collectability of accounts
receivable and the realizability of inventory, goodwill and other intangible
assets. They also include estimates of cost accruals, environmental liabilities,
warranty and other product returns, insurance reserves, income taxes, pensions
and other postretirement benefits and other factors. Management has exercised
reasonableness in deriving these estimates; however, actual results could differ
from these estimates.
These
financial statements should be read in conjunction with the financial statements
and notes thereto included in UCI International’s annual report on Form 10-K for
the year ended December 31, 2009.
7
UCI
International, Inc.
Notes
to Condensed Consolidated Financial Statements (unaudited)
Operating
results for the three and six months ended June 30, 2010 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2010.
Income
Statement Reclassification
Certain
engineering expenses totaling $0.5 million and $1.4 million for the three and
six months ended June 30, 2009 were presented in general and administrative
expenses. These engineering expenses have been reclassified to cost of sales in
the condensed consolidated income statements for the three and six months ended
June 30, 2009 in order to conform to the current year presentation.
Recently
Adopted Accounting Guidance
On
January 1, 2010, UCI International adopted changes issued by the Financial
Accounting Standards Board (“FASB”) to accounting for variable interest
entities. These changes require an enterprise to perform an analysis to
determine whether the enterprise’s variable interest or interests give it a
controlling financial interest in a variable interest entity; to require ongoing
reassessments of whether an enterprise is the primary beneficiary of a variable
interest entity; to eliminate the solely quantitative approach previously
required for determining the primary beneficiary of a variable interest entity;
to add an additional reconsideration event for determining whether an entity is
a variable interest entity when any changes in facts and circumstances occur
such that holders of the equity investment at risk, as a group, lose the power
from voting rights or similar rights of those investments to direct the
activities of the entity that most significantly impact the entity’s economic
performance; and to require enhanced disclosures that will provide users of
financial statements with more transparent information about an enterprise’s
involvement in a variable interest entity. The adoption of these changes had no
impact on UCI International’s financial statements.
Effective
January 1, 2010, UCI International adopted changes issued by the FASB on
January 6, 2010, for a scope clarification to the FASB’s previously-issued
guidance on accounting for noncontrolling interests in consolidated financial
statements. These changes clarify the accounting and reporting guidance for
noncontrolling interests and changes in ownership interests of a consolidated
subsidiary. An entity is required to deconsolidate a subsidiary when the entity
ceases to have a controlling financial interest in the subsidiary. Upon
deconsolidation of a subsidiary, an entity recognizes a gain or loss on the
transaction and measures any retained investment in the subsidiary at fair
value. The gain or loss includes any gain or loss associated with the difference
between the fair value of the retained investment in the subsidiary and its
carrying amount at the date the subsidiary is deconsolidated. In contrast, an
entity is required to account for a decrease in its ownership interest of a
subsidiary that does not result in a change of control of the subsidiary as an
equity transaction. See Note O for a discussion of the disposition of
UCI International’s 51% owned joint venture.
8
UCI
International, Inc.
Notes
to Condensed Consolidated Financial Statements (unaudited)
NOTE B — RESTRUCTURING GAINS
(COSTS)
UCI
International incurred costs related to the company’s capacity consolidation
activities which are reported in the income statement in “Restructuring gains
(costs).” The components of restructuring gains (costs) are as
follows (in millions):
Three Months ended June
30,
|
Six Months ended June 30,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Costs
to maintain land and building held for sale
|
$ | — | $ | — | $ | (0.2 | ) | $ | (0.2 | ) | ||||||
Curtailment
and settlement losses
|
(0.2 | ) | (0.1 | ) | (0.5 | ) | (0.1 | ) | ||||||||
Severance
costs
|
(0.1 | ) | — | (0.1 | ) | — | ||||||||||
Disposition
of investment in joint venture
|
— | — | (1.6 | ) | — | |||||||||||
Gain
on sale of building, net of moving costs
|
— | 1.4 | — | 1.4 | ||||||||||||
Asset
impairments
|
— | (0.7 | ) | — | (0.7 | ) | ||||||||||
$ | (0.3 | ) | $ | 0.6 | $ | (2.4 | ) | $ | 0.4 |
2010
Activities
In the
three and six months ended June 30, 2010, UCI International recorded pension
curtailment and settlement losses and other severance costs related to headcount
reductions at its Mexican subsidiaries. Additionally, UCI
International recorded a non-cash charge of $1.6 million related to the sale of
the company’s interest in a 51% owned joint venture in the six months ended June
30, 2010 (see Note O).
2009
Capacity Consolidation and European Realignment Actions
In the
three months ended June 30, 2009, UCI International implemented restructuring
plans to further align UCI International’s cost structure with customers’
spending and current market conditions. The restructuring plans targeted excess
assembly and aluminum casting capacity and restructuring costs of the plan
included workforce reductions, facility closures, consolidations and
realignments.
UCI
International idled a Mexican aluminum casting operation in the three months
ended June 30, 2009 and consolidated the capacity into its Chinese casting
operation. During that period, UCI International also relocated a small amount
of filter manufacturing capacity which resulted in the idling of certain
equipment with no alternative use. In connection with these capacity
consolidations, UCI International recorded asset impairments of $0.7 million and
incurred post employment benefit plans curtailment costs of $0.1
million.
In order
to accommodate expected growth in Europe, UCI International’s Spanish
distribution operation was relocated to a new leased facility resulting in the
idling and subsequent sale of an owned facility. UCI International recognized a
gain of $1.5 million on the sale of this facility in the three months ended June
30, 2009. UCI International incurred other costs of $0.1 million associated with
the relocation of the facility.
NOTE C — SALES OF
RECEIVABLES
UCI
International has factoring agreements arranged by four customers with eight
banks. Under these agreements, UCI International has the ability to
sell undivided interests in certain of its receivables to the banks which in
turn have the right to sell an undivided interest to a financial institution or
other third party. UCI International enters into these relationships at its
discretion as part of its overall customer agreements and cash management
activities. Pursuant to these relationships, UCI International sold $79.7
million and $62.9 million of receivables during the three months ended June 30,
2010 and 2009, respectively, and $135.8 million and $122.8 million for the six
months ended June 30, 2010 and 2009, respectively.
9
UCI
International, Inc.
Notes
to Condensed Consolidated Financial Statements (unaudited)
If
receivables had not been factored, $128.6 million and $121.5 million of
additional receivables would have been outstanding at June 30, 2010 and December
31, 2009, respectively. UCI International retained no rights or interest, and
has no obligations, with respect to the sold receivables. UCI International does
not service the receivables after the sales.
The sales
of receivables were accounted for as sales and were removed from the balance
sheet at the time of the sales. The costs of the sales were discounts deducted
by the factoring companies. These costs were $1.4 million and $1.7 million in
the three months ended June 30, 2010 and 2009, respectively, and $2.3 million
and $3.2 million for the six months ended June 30, 2010 and 2009, respectively.
These costs are recorded in the income statements in “Miscellaneous,
net.”
NOTE D —
INVENTORIES
The
components of inventory are as follows (in millions):
June
30,
2010
|
December
31,
2009
|
|||||||
Raw
materials
|
$ | 52.6 | $ | 47.5 | ||||
Work
in process
|
25.0 | 27.6 | ||||||
Finished
products
|
72.9 | 73.1 | ||||||
Valuation
reserves
|
(16.3 | ) | (15.1 | ) | ||||
$ | 134.2 | $ | 133.1 |
NOTE E — RESTRICTED
CASH
During
the six months ended June 30, 2010, UCI International posted $7.4 million of
cash to collateralize a letter of credit required to appeal the judgment in the
patent litigation discussed in more detail in Note J. During the six
months ended June 30, 2009, UCI International also posted $9.4 million of cash
to collateralize a letter of credit required by its workers compensation
insurance carrier. This cash totaling $16.8 million is recorded as
“Restricted cash” as a component of long-term assets on UCI International’s
balance sheet at June 30, 2010. This cash is invested in highly liquid, high
quality government securities and is not available for general operating
purposes as long as the letters of credit remain outstanding or until
alternative collateral is posted.
10
UCI
International, Inc.
Notes
to Condensed Consolidated Financial Statements (unaudited)
NOTE F — ACCRUED EXPENSES AND OTHER
CURRENT LIABILITIES
“Accrued
expenses and other current liabilities” consists of the following (in
millions):
June
30,
2010
|
December
31,
2009
|
|||||||
Salaries
and wages
|
$ | 3.9 | $ | 3.1 | ||||
Bonuses
and profit sharing
|
4.4 | 6.1 | ||||||
Vacation
pay
|
4.5 | 4.4 | ||||||
Product
returns
|
48.4 | 42.1 | ||||||
Rebates,
credits and discounts due customers
|
15.3 | 13.6 | ||||||
Insurance
|
10.1 | 9.8 | ||||||
Taxes
payable
|
12.4 | 7.0 | ||||||
Interest
|
2.8 | 2.4 | ||||||
Other
|
22.3 | 19.6 | ||||||
$ | 124.1 | $ | 108.1 |
NOTE G — PRODUCT RETURNS
LIABILITY
The
liability for product returns is included in “Accrued expenses and other current
liabilities.” This liability includes accruals for estimated parts returned
under warranty and for parts returned because of customer excess quantities. UCI
International provides warranties for its products’ performance and warranty
periods vary by part. In addition to returns under warranty, UCI International
allows its customers to return quantities of parts that the customer determines
to be in excess of its current needs. Customer rights to return excess
quantities vary by customer and by product category. Generally, these returns
are contractually limited to 3% to 5% of the customer’s purchases in the
preceding year. While UCI International does not have a contractual obligation
to accept excess quantity returns from all customers, common practice for UCI
International and the industry is to accept periodic returns of excess
quantities from on-going customers. If a customer elects to cease purchasing
from UCI International and change to another vendor, it is industry practice for
the new vendor, and not UCI International, to accept any inventory returns
resulting from the vendor change and any subsequent inventory
returns. UCI International routinely monitors returns data and
adjusts estimates based on this data.
Changes
in UCI International’s product returns accrual were as follows (in
millions):
Six Months Ended June 30,
|
||||||||
2010
|
2009
|
|||||||
Beginning
of year
|
$ | 42.1 | $ | 32.0 | ||||
Cost
of unsalvageable parts
|
(24.5 | ) | (24.5 | ) | ||||
Reductions
to sales
|
30.8 | 27.2 | ||||||
End
of period
|
$ | 48.4 | $ | 34.7 |
11
UCI
International, Inc.
Notes
to Condensed Consolidated Financial Statements (unaudited)
NOTE H — PENSION
The
following are the components of net periodic pension expense (in
millions):
Three Months Ended June
30,
|
Six Months Ended June 30,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Service
cost
|
$ | 1.1 | $ | 1.1 | $ | 2.2 | $ | 2.2 | ||||||||
Interest
cost
|
3.4 | 3.3 | 6.7 | 6.6 | ||||||||||||
Expected
return on plan assets
|
(3.7 | ) | (3.6 | ) | (7.3 | ) | (7.3 | ) | ||||||||
Amortization
of prior service cost and unrecognized loss
|
0.2 | 0.1 | 0.4 | 0.3 | ||||||||||||
Curtailment
and settlement losses
|
0.2 | 0.2 | 0.5 | 0.2 | ||||||||||||
$ | 1.2 | $ | 1.1 | $ | 2.5 | $ | 2.0 |
The
curtailment and settlement losses shown in the above table were incurred as a
result of headcount reductions that were made in connection with the activities
discussed in Note B.
NOTE I — DEBT
UCI
International’s debt is summarized as follows (in millions):
June
30,
2010
|
December
31,
2009
|
|||||||
UCI
short-term borrowings
|
$ | 6.2 | $ | 3.5 | ||||
UCI
capital lease obligations
|
0.8 | 0.9 | ||||||
UCI
term loan
|
172.3 | 190.0 | ||||||
UCI
senior subordinated notes
|
230.0 | 230.0 | ||||||
UCI
International floating rate senior PIK notes
|
339.2 | 324.1 | ||||||
Unamortized
debt issuance costs
|
(5.9 | ) | (6.9 | ) | ||||
742.6 | 741.6 | |||||||
Less:
|
||||||||
UCI
short-term borrowings
|
6.2 | 3.5 | ||||||
UCI
term loan
|
— | 17.7 | ||||||
UCI
current maturities
|
0.2 | 0.2 | ||||||
Long-term
debt
|
$ | 736.2 | $ | 720.2 |
UCI
International’s floating rate senior PIK notes (the “UCI International
Notes”) — The
UCI International Notes are due in 2013. Interest on the UCI International Notes
will be paid by issuing new notes until December 2011 and therefore, will not
affect UCI International’s cash flow through 2011. Thereafter, all interest will
be payable in cash. Commencing on March 15, 2012, and each quarter
thereafter, UCI International is required to redeem for cash a portion of each
note, to the extent required to prevent the UCI International Notes from
being treated as an applicable high yield discount obligation.
The UCI
International Notes are unsecured and will rank pari passu with any future
senior indebtedness of UCI International and will rank senior to any future
subordinated indebtedness of UCI International. The UCI International Notes are
effectively subordinated to future secured indebtedness to the extent of the
value of the collateral securing such indebtedness and to all existing and
future indebtedness and other liabilities of UCI International’s
subsidiaries (other than indebtedness or other liabilities owed to UCI
International, Inc., excluding its subsidiaries).
12
UCI
International, Inc.
Notes
to Condensed Consolidated Financial Statements (unaudited)
The UCI
International Notes indenture contains covenants that restrict UCI
International’s ability to: incur or guarantee additional debt; pay dividends or
redeem stock; make certain investments; sell assets; merge or consolidate with
other entities; and enter into transactions with affiliates. Management believes
that as of June 30, 2010, UCI International was and is in compliance with
such covenants.
UCI’s
senior credit facility — The senior credit facility includes a term loan
pursuant to which, as a result of previous prepayments there are no scheduled
repayments before December 2011. Mandatory prepayments of the term loan are
required, however, when UCI generates Excess Cash Flow as defined in the senior
credit facility. UCI generated Excess Cash Flow in the year ending December 31,
2009, resulting in a mandatory prepayment of $17.7 million which was made on
April 1, 2010 reducing the amount outstanding under the term loan to $172.3
million. The term loan matures in June 2012.
The
senior credit facility requires UCI to maintain certain financial covenants and
requires mandatory prepayments under certain events as defined in the agreement.
The facility also includes certain negative covenants restricting or limiting
UCI’s ability to, among other things: declare dividends or redeem stock; prepay
certain debt; make loans or investments; guarantee or incur additional debt;
make certain capital expenditures; engage in acquisitions or other business
combinations; sell assets; and alter UCI’s business. UCI believes that, as of
June 30, 2010, it is in compliance with all of these covenants.
UCI’s
senior subordinated notes (the “Notes”) — The Notes bear interest at 9
3/8% payable in arrears semi-annually on June 15 and December 15 of each year.
The Notes are unsecured and rank equally in right of payment with any of UCI’s
future senior subordinated indebtedness. They are subordinated to indebtedness
and other liabilities of UCI’s subsidiaries that are not guarantors of the
Notes. They are guaranteed on a full and unconditional and joint and several
basis by UCI’s domestic subsidiaries. There are no principal payments required
under the Notes until they mature on June 15, 2013.
UCI’s
short-term borrowings — At June 30, 2010, short-term borrowings included
$0.9 million of a Spanish subsidiary’s notes payable and $5.3 million of Chinese
subsidiaries’ notes payable to foreign credit institutions. At December 31,
2009, short-term borrowings included $0.3 million of a Spanish subsidiary’s
notes payable and $3.2 million of Chinese subsidiaries’ notes payable to foreign
credit institutions. The Spanish subsidiary’s notes payable are collateralized
by certain accounts receivable related to the amounts financed. The Chinese
subsidiaries’ notes payable are secured by receivables.
NOTE J —
CONTINGENCIES
Insurance
Reserves
UCI
International purchases insurance policies for workers’ compensation, automobile
and product and general liability. These policies include high deductibles for
which UCI International is responsible. These deductibles are estimated and
recorded as expenses in the period incurred. Estimates of these expenses are
updated each quarter, and the expenses are adjusted accordingly. These estimates
are subject to substantial uncertainty because of several factors that are
difficult to predict, including actual claims experience, regulatory changes,
litigation trends and changes in inflation. Estimated unpaid losses for which
UCI International is responsible are included in the balance sheet in “Accrued
expenses and other current liabilities.”
13
UCI
International, Inc.
Notes
to Condensed Consolidated Financial Statements (unaudited)
Environmental;
Health and Safety
UCI
International is subject to a variety of federal, state, local and foreign
environmental; health and safety laws and regulations, including those governing
the discharge of pollutants into the air or water, the management and disposal
of hazardous substances or wastes, and the cleanup of contaminated sites. UCI
International or its predecessors have been identified as a potentially
responsible party, or is otherwise currently responsible, for contamination at
five sites. One of these sites is a former facility in Edison, New Jersey (the
“New Jersey Site”), where a state agency has ordered UCI International to
continue with the monitoring and investigation of chlorinated solvent
contamination. The New Jersey Site has been the subject of litigation to
determine whether a neighboring facility was responsible for contamination
discovered at the New Jersey Site. A judgment has been rendered in that
litigation to the effect that the neighboring facility is not responsible for
the contamination. UCI International is analyzing what further investigation and
remediation, if any, may be required at the New Jersey Site. We are also
responsible for a portion of chlorinated solvent contamination at a previously
owned site in Solano County, California (the “California Site”), where UCI
International, at the request of the regional water board, is investigating and
analyzing the nature and extent of the contamination and is conducting some
remediation. Based on currently available information, management believes that
the cost of the ultimate outcome of the environmental matters related to the New
Jersey Site and the California Site will not exceed the $1.3 million accrued at
June 30, 2010 by a material amount, if at all. However, because all
investigation and analysis has not yet been completed and due to inherent
uncertainty in such environmental matters, it is possible that the ultimate
outcome of these matters could have a material adverse effect on results for a
single quarter.
In
addition to the two matters discussed above, UCI International or its
predecessors have been named as a potentially responsible party at a third-party
waste disposal site in Calvert City, Kentucky (the “Kentucky Site”). UCI
International estimates settlement costs at $0.1 million for this site. Also,
UCI International is involved in regulated remediation at two of its
manufacturing sites (the “Manufacturing Sites”). The combined cost of the
remaining remediation at such Manufacturing Sites is $0.2 million. UCI
International anticipates that the majority of the $0.3 million reserved for
settlement and remediation costs will be spent in the next year. To date, the
expenditures related to the Kentucky Site and the Manufacturing Sites have been
immaterial.
Antitrust
Litigation
UCI and
its wholly-owned subsidiary, Champion Laboratories, Inc. (“Champion”), were
named as two of multiple defendants in 23 complaints originally filed in the
District of Connecticut, the District of New Jersey, the Middle District of
Tennessee and the Northern District of Illinois alleging conspiracy violations
of Section 1 of the Sherman Act, 15 U.S.C. § 1, related to aftermarket oil, air,
fuel and transmission filters. Eight of the complaints also named The Carlyle
Group as a defendant, but those plaintiffs voluntarily dismissed Carlyle from
each of those actions without prejudice. Champion, but not UCI, was also named
as a defendant in 13 virtually identical actions originally filed in the
Northern and Southern Districts of Illinois, and the District of New Jersey. All
of these complaints are styled as putative class actions on behalf of all
persons and entities that purchased aftermarket filters in the U.S. directly
from the defendants, or any of their predecessors, parents, subsidiaries or
affiliates, at any time during the period from January 1, 1999 to the present.
Each case seeks damages, including statutory treble damages, an injunction
against future violations, costs and attorney’s fees. UCI and Champion were also
named as two of multiple defendants in 17 similar complaints originally filed in
the District of Connecticut, the Northern District of California, the Northern
District of Illinois and the Southern District of New York by plaintiffs who
claim to be indirect purchasers of aftermarket filters. Two of the complaints
also named The Carlyle Group as a defendant, but the plaintiffs in both of those
actions voluntarily dismissed Carlyle without prejudice. Champion, but not UCI,
was also named in 3 similar actions originally filed in the Eastern District of
Tennessee, the Northern District of Illinois and the Southern District of
California. These complaints allege conspiracy violations of Section 1 of the
Sherman Act and/or violations of state antitrust, consumer protection and unfair
competition law. They are styled as putative class actions on behalf of all
persons or entities who acquired indirectly aftermarket filters manufactured
and/or distributed by one or more of the defendants, their agents or entities
under their control, at any time between January 1, 1999 and the present; with
the exception of three cases which each allege a class period from January 1,
2002 to the present, and one complaint which alleges a class period from the
“earliest legal permissible date” to the present. The complaints seek damages,
including statutory treble damages, an injunction against future violations,
disgorgement of profits, costs and attorney’s fees.
14
UCI
International, Inc.
Notes
to Condensed Consolidated Financial Statements (unaudited)
On August
18, 2008, the Judicial Panel on Multidistrict Litigation (“JPML”) issued an
order transferring the U.S. direct and indirect purchaser aftermarket filters
cases to the Northern District of Illinois for coordinated and consolidated
pretrial proceedings before the Honorable Robert W. Gettleman pursuant to 28
U.S.C. §1407. On November 26, 2008, all of the direct purchaser plaintiffs filed
a Consolidated Amended Complaint. This complaint names Champion as one of
multiple defendants, but it does not name UCI. The complaint is styled as a
putative class action and alleges conspiracy violations of Section 1 of the
Sherman Act. The direct purchaser plaintiffs seek damages, including statutory
treble damages, an injunction against future violations, costs and attorney’s
fees. On February 2, 2009, Champion filed its answer to the direct purchasers’
Consolidated Amended Complaint.
On
December 1, 2008, all of the indirect purchaser plaintiffs, except Gasoline and
Automotive Service Dealers of America (“GASDA”), filed a Consolidated Indirect
Purchaser Complaint. This complaint names Champion as one of multiple
defendants, but it does not name UCI. The complaint is styled as a putative
class action and alleges conspiracy violations of Section 1 of the Sherman Act
and violations of state antitrust, consumer protection and unfair competition
law. The indirect purchaser plaintiffs seek damages, including statutory treble
damages, penalties and punitive damages where available, an injunction against
future violations, disgorgement of profits, costs and attorney’s fees. On
February 2, 2009, Champion and the other defendants jointly filed a motion to
dismiss the Consolidated Indirect Purchaser Complaint. On November 5, 2009, the
Court granted the motion in part, and denied it in part. The Court directed the
indirect purchaser plaintiffs to file an amended complaint conforming to the
order. On November 30, 2009, the indirect purchasers filed an amended complaint.
On December 17, 2009, the indirect purchasers filed a motion for leave to file a
second amended complaint. On December 22, 2009, the Court granted the motion for
leave, but gave defendants permission to move to dismiss the second amended
complaint. Defendants’ filed that motion to dismiss on January 19, 2010. On
April 2, 2010, the Court granted the motion in part, and denied it in
part. On
June 30, 2010, the indirect purchasers filed a third amended complaint.
Champion’s answer to the third amended complaint was filed on July 30,
2010.
On
February 2, 2009, Champion, UCI and the other defendants jointly filed a motion
to dismiss the GASDA complaint. On April 13, 2009, GASDA voluntarily dismissed
UCI from its case without prejudice. On November 5, 2009, the Court granted
defendants’ motion to dismiss.
Pursuant to a stipulated
agreement between the parties, all defendants produced limited initial discovery
on January 30, 2009. Since December 10, 2009, the parties have propounded
nine sets of discovery requests on each other and have served subpoenas on 20
third parties. On June 20, 2010, the Court granted the parties’ joint motion for
an extension of the deadline for the substantial completion of the production of
documents to September 20, 2010. Pursuant to the Court’s second case management
order, the parties will meet and confer to discuss the scheduling of depositions
to take place after September 20, 2010. On July 16, 2010, the Court ordered that
any plaintiff seeking certification of a class shall file their motions for
class certification and any related expert reports by February 25, 2011. Expert
discovery on merits-related issues will follow the court’s ruling on plaintiffs’
motions for class certification.
15
UCI
International, Inc.
Notes
to Condensed Consolidated Financial Statements (unaudited)
On
January 12, 2009, Champion, but not UCI, was named as one of ten defendants in a
related action filed in the Superior Court of California, for the County of Los
Angeles on behalf of a purported class of direct and indirect purchasers of
aftermarket filters. On March 5, 2009, one of the defendants filed a notice of
removal to the U.S. District Court for the Central District of California, and
then subsequently requested that the JPML transfer this case to the Northern
District of Illinois for coordinated pre-trial proceedings, which the JPML
granted. On February 25, 2010, the plaintiff filed a Consolidated Second Amended
Class Action Complaint in the Northern District of Illinois on behalf of a
purported class of California gasoline retailers who indirectly purchase filters
from defendants for resale.
Champion,
but not UCI, was also named as one of five defendants in a class action filed in
Quebec, Canada. This action alleges conspiracy violations under the Canadian
Competition Act and violations of the obligation to act in good faith (contrary
to art. 6 of the Civil Code of Quebec) related to the sale of aftermarket
filters. The plaintiff seeks joint and several liability against the five
defendants in the amount of $5.0 million in compensatory damages and $1.0
million in punitive damages. The plaintiff is seeking authorization to have the
matter proceed as a class proceeding, which motion has not yet been ruled
on.
Champion,
but not UCI, was also named as one of 14 defendants in a class action filed on
May 21, 2008, in Ontario, Canada. This action alleges civil conspiracy,
intentional interference with economic interests, and conspiracy violations
under the Canadian Competition Act related to the sale of aftermarket filters.
The plaintiff seeks joint and several liability against the 14 defendants in the
amount of $150 million in general damages and $15 million in punitive damages.
The plaintiff is also seeking authorization to have the matter proceed as a
class proceeding, which motion has not yet been ruled on.
On July
30, 2008, the Office of the Attorney General for the State of Florida issued
Antitrust Civil Investigative Demands to Champion and UCI requesting documents
and information related to the sale of oil, air, fuel and transmission filters.
We are cooperating with the Attorney General’s requests. On April 16, 2009, the
Florida Attorney General filed a complaint against Champion and eight other
defendants in the Northern District of Illinois. The complaint alleges
violations of Section 1 of the Sherman Act and Florida law related to the sale
of aftermarket filters. The complaint asserts direct and indirect purchaser
claims on behalf of Florida governmental entities and Florida consumers. It
seeks damages, including statutory treble damages, penalties, fees, costs and an
injunction. The Florida Attorney General action is being coordinated with the
rest of the filters cases pending in the Northern District of Illinois before
the Honorable Robert W. Gettleman.
On June
10, 2010, the Office of the Attorney General for the State of Washington issued
an Antitrust Civil Investigative Demand to Champion requesting documents and
information related to the sale of oil, air, fuel and transmission filters. We
are cooperating with the Attorney General’s requests.
The
Antitrust Division of the Department of Justice (DOJ) investigated the
allegations raised in these suits and certain current and former employees of
the defendants, including Champion, testified pursuant to subpoenas. On January
21, 2010, DOJ sent a letter to counsel for Champion stating that “the Antitrust
Division’s investigation into possible collusion in the replacement auto filters
industry is now officially closed.”
We intend
to vigorously defend against these claims.
16
UCI
International, Inc.
Notes
to Condensed Consolidated Financial Statements (unaudited)
Value-Added
Tax Receivable
UCI
International’s Mexican operation has outstanding receivables denominated in
Mexican pesos in the amount of $2.2 million, net of allowances, from the Mexican
Department of Finance and Public Credit. The receivables relate to refunds of
Mexican value-added tax, to which UCI International believes it is entitled in
the ordinary course of business. The local Mexican tax authorities have rejected
UCI International’s claims for these refunds, and UCI International has
commenced litigation in the regional federal administrative and tax courts to
order the local tax authorities to process these refunds. During the
three months ended June 30, 2010, UCI International recorded a $1.4 million
provision due to uncertainties of collection of these receivables.
Patent
Litigation
Champion
is a defendant in litigation with Parker-Hannifin Corporation pursuant to which
Parker-Hannifin claims that certain of Champion’s products infringe a
Parker-Hannifin patent. On December 11, 2009, following trial, a jury verdict
was reached, finding in favor of Parker-Hannifin with damages of approximately
$6.5 million. On May 3, 2010, the court entered a partial judgment in this
matter, awarding Parker-Hannifin $6.5 million in damages and a permanent
injunction. Both parties have filed post-trial motions. Parker-Hannifin is
seeking treble damages and attorneys’ fees. Champion is seeking a judgment as a
matter of law on the issues of infringement and patent invalidity. Champion
continues to vigorously defend this matter; however, there can be no assurance
with respect to the outcome of litigation. Champion recorded a $6.5 million
liability in the financial statements for this matter included in “Accrued
expenses and other current liabilities” at June 30, 2010. In the three and six
months ended June 30, 2010, Champion incurred post-trial costs of $0.1 million
and $1.0 million, respectively. These costs are included in the income
statements in “Patent litigation costs”.
In order
to appeal the judgment in this matter, during the three months ended June 30,
2010 UCI International posted a letter of credit in the amount of $7.4
million. The issuer of the letter of credit required UCI
International to cash collateralize the letter of credit. This cash
is recorded as “Restricted cash” and is a component of long-term assets on the
balance sheet at June 30, 2010.
Other
Litigation
UCI
International is subject to various other contingencies, including routine legal
proceedings and claims arising out of the normal course of business. These
proceedings primarily involve commercial claims, product liability claims,
personal injury claims and workers’ compensation claims. The outcome of these
lawsuits, legal proceedings and claims cannot be predicted with certainty.
Nevertheless, UCI International believes that the outcome of any currently
existing proceedings, even if determined adversely, would not have a material
adverse effect on UCI International’s financial condition or results of
operations.
NOTE
K—EARNINGS (LOSS) PER SHARE
UCI
International presents both basic and diluted earnings per share
(“EPS”) amounts. Basic EPS is calculated by dividing net income by the
weighted average number of common shares outstanding during the reporting
period. Diluted EPS is calculated by dividing net income by the weighted average
number of common shares and common equivalent shares outstanding during the
reporting period calculated using the treasury stock method for stock options.
The treasury stock method assumes that UCI International uses the proceeds from
the exercise of options to repurchase common stock at the average market price
during the period. No market currently exists for UCI International’s common
stock. UCI International estimates the average market price of its common stock
by using the estimated fair value of UCI International as determined using
periodic outside third-party valuations adjusted for subsequent changes using
the S&P 500 as an index. The
assumed proceeds under the treasury stock method include the purchase price that
the optionee will pay in the future, compensation cost for future service that
UCI International has not yet recognized and any tax benefits that would be
credited to additional paid-in capital when the exercise generates a tax
deduction. If there would be a shortfall resulting in a charge to additional
paid-in capital, such amount would be a reduction to the proceeds.
The terms
of UCI International’s restricted stock agreements provide that the shares of
restricted stock vest only upon a change of control, as defined, of UCI
International. Due to the uncertainty surrounding the ultimate vesting of the
restricted stock, these contingently issuable shares are excluded from the
computation of basic EPS and diluted EPS.
17
UCI
International, Inc.
Notes
to Condensed Consolidated Financial Statements (unaudited)
The
following table reconciles the numerators and denominators used to calculate
basic EPS and diluted EPS and presents basic EPS and diluted EPS (in thousands,
except per share data):
Three Months Ended June
30,
|
Six Months Ended June 30,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Net
income (loss) attributable to UCI International, Inc.
|
$ | 8,916 | $ | 2,520 | $ | 15,532 | $ | (1,834 | ) | |||||||
Weighted
Average Shares of Common Stock Outstanding:
|
||||||||||||||||
Basic
weighted average shares of common stock outstanding
|
2,863 | 2,861 | 2,864 | 2,861 | ||||||||||||
Dilutive
effect of stock-based awards
|
73 | 33 | 72 | — | ||||||||||||
Diluted
weighted average shares of common stock outstanding
|
2,936 | 2,894 | 2,936 | 2,861 | ||||||||||||
Earnings
Per Share:
|
||||||||||||||||
Basic
earnings per share
|
$ | 3.11 | $ | 0.88 | $ | 5.42 | $ | (0.64 | ) | |||||||
Diluted
earnings per share
|
$ | 3.04 | $ | 0.87 | $ | 5.29 | $ | (0.64 | ) |
Options
to purchase 4 thousand shares of common stock at a weighted average
exercise price of $81.90 per share were not included in the computation of
diluted EPS for the three and six months ended June 30, 2010 because they
were anti-dilutive. Options to purchase 52 thousand shares
of common stock at a weighted average exercise price of $26.31 and 117 thousand
shares of common stock at a weighted average exercise price of $14.55 were not
included in the computation of diluted EPS for the three and six months ended
June 30, 2009, respectively, because they were anti-dilutive.
NOTE L — GEOGRAPHIC
INFORMATION
UCI
International had the following net sales by country (in millions):
Three Months Ended June 30,
|
Six Months Ended June 30,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
United
States
|
$ | 200.2 | $ | 184.9 | $ | 396.2 | $ | 375.6 | ||||||||
Canada
|
8.6 | 7.3 | 15.6 | 13.8 | ||||||||||||
Mexico
|
5.9 | 6.4 | 11.9 | 12.3 | ||||||||||||
United
Kingdom
|
4.4 | 3.5 | 7.3 | 5.3 | ||||||||||||
France
|
2.6 | 2.4 | 5.5 | 4.3 | ||||||||||||
Germany
|
1.5 | 1.1 | 3.2 | 2.3 | ||||||||||||
China
|
0.6 | 0.5 | 2.2 | 2.3 | ||||||||||||
Spain
|
1.1 | 1.1 | 2.1 | 1.9 | ||||||||||||
Other
|
11.3 | 10.2 | 22.5 | 19.5 | ||||||||||||
$ | 236.2 | $ | 217.4 | $ | 466.5 | $ | 437.3 |
18
UCI
International, Inc.
Notes
to Condensed Consolidated Financial Statements (unaudited)
Net
long-lived assets by country are as follows (in millions):
June
30,
2010
|
December
31,
2009
|
|||||||
United
States
|
$ | 195.7 | $ | 194.2 | ||||
China
|
24.6 | 29.7 | ||||||
Mexico
|
8.4 | 8.9 | ||||||
Spain
|
3.7 | 3.8 | ||||||
Goodwill
|
241.5 | 241.5 | ||||||
$ | 473.9 | $ | 478.1 |
NOTE M — OTHER
INFORMATION
At June
30, 2010, 5,000,000 shares of common stock were authorized and 2,863,460 were
issued and outstanding. The par value of each share of common stock is $0.01 per
share.
Cash
payments for interest and income taxes (net of refunds) are as follows (in
millions):
Three Months Ended
June 30,
|
Six Months Ended June 30,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Interest
|
$ | 11.9 | $ | 12.7 | $ | 12.7 | $ | 15.3 | ||||||||
Income
taxes (net of refunds)
|
3.6 | 0.6 | 4.0 | 1.0 |
UCI International sells vehicle parts
to a wide base of customers. Sales are primarily to automotive aftermarket
customers. UCI International has outstanding receivables owed by these customers
and to date has experienced no significant collection problems. Sales to a
single customer, AutoZone, approximated 30% and 29% of total net sales for the
six months ended June 30, 2010 and 2009, respectively. No other customer
accounted for more than 10% of total net sales for six months ended June 30,
2010 and 2009.
NOTE N — FAIR VALUE
ACCOUNTING
The
accounting guidance on fair value measurements uses the term “inputs” to broadly
refer to the assumptions used in estimating fair values. It distinguishes
between (i) assumptions based on market data obtained from independent third
party sources (“observable inputs”) and (ii) UCI International’s assumptions
based on the best information available (“unobservable inputs”). The accounting
guidance requires that fair value valuation techniques maximize the use of
“observable inputs” and minimize the use of “unobservable inputs.” The fair
value hierarchy consists of the three broad levels listed below. The highest
priority is given to Level 1, and the lowest is given to Level 3.
Level 1 —
|
Quoted
market prices in active markets for identical assets or
liabilities
|
Level 2 —
|
Inputs
other than Level 1 inputs that are either directly or indirectly
observable
|
Level 3 —
|
Unobservable
inputs developed using UCI International’s estimates and assumptions,
which reflect those that market participants would use when valuing an
asset or liability
|
The
determination of where an asset or liability falls in the hierarchy requires
significant judgment.
19
UCI
International, Inc.
Notes
to Condensed Consolidated Financial Statements (unaudited)
Assets
measured at fair value on a nonrecurring basis
During
the six months ended June 30, 2010 and 2009, no assets were adjusted to their
fair values on a nonrecurring basis.
Fair
value of financial instruments
Cash equivalents - The
carrying amount of cash equivalents ($163.6 million at June 30, 2010 and $122.7
million at December 31, 2009) approximates fair value because the original
maturity is less than 90 days.
Restricted cash – The
carrying amount of restricted cash ($16.8 million at June 30, 2010 and $9.4
million at December 31, 2009) approximates fair value because the original
maturity is less than 90 days.
The
following table summarizes the valuation of cash equivalents and restricted cash
measured at fair value in the June 30, 2010 and December 31, 2009 balance sheets
(in millions):
Fair Value Measurements using
Quoted Prices in Active Markets for
Identical Assets
(Level 1)
|
||||||||
June
30, 2010
|
December
31, 2009
|
|||||||
Cash
equivalents
|
$
|
163.6
|
$
|
122.7
|
||||
Restricted
cash
|
$
|
16.8
|
$
|
9.4
|
Trade accounts receivable -
The carrying amount of trade receivables approximates fair value because of
their short outstanding terms.
Trade accounts payable - The
carrying amount of trade payables approximates fair value because of their short
outstanding terms.
Short-term borrowings - The
carrying value of these borrowings equals fair value because their interest
rates reflect current market rates.
Long-term debt - The fair
value of the $172.3 million of UCI’s term loan borrowings under the senior
credit facility at June 30, 2010 was $162.9 million. The fair value of the
$190.0 million of UCI’s term loan borrowings under the senior credit facility at
December 31, 2009 was $176.7 million. The estimated fair value of the term loan
was based on information provided by an independent third party who participates
in the trading market for debt similar to the term loan. Due to the infrequency
of trades, this input is considered to be a Level 2 input.
The fair
value of UCI’s $230 million Notes, at June 30, 2010 and December 31, 2009
was $230.0 million and $221.1 million, respectively. The estimated fair value of
the Notes was based on bid/ask prices, as reported by a third party bond pricing
service. Due to the infrequency of trades of the Notes, these inputs are
considered to be Level 2 inputs.
20
UCI
International, Inc.
Notes
to Condensed Consolidated Financial Statements (unaudited)
The fair
value of the UCI International Notes at June 30, 2010 and December 31, 2009
was $327.8 million and $274.2 million, respectively. The estimated fair value of
these notes is based on the bid/ask prices, as reported by a third party bond
pricing service. Due to the infrequency of trades of these notes, these inputs
are considered to be Level 2 inputs.
NOTE O — JOINT VENTURE
SALE
In May
2010, UCI International completed the sale of its entire 51% interest in its
Chinese joint venture to its joint venture partner, Shandong Yanzhou Liancheng
Metal Products Co. Ltd. (“LMC”). The sale price was approximately $0.9 million,
plus the assumption of certain liabilities due UCI International of
approximately $2.4 million, less estimated transaction costs. Cash
proceeds at closing, net of transaction costs and cash sold, was $0.3
million. UCI International recorded a non-cash charge of $1.6 million
($1.2 million after tax). The following table summarizes the net book value of
the joint venture at the date of sale, proceeds of the sale and the resultant
loss (in millions):
Current
assets (excluding cash sold of $0.3 million)
|
$ | 3.9 | ||
Long-lived
assets
|
5.1 | |||
Current
liabilities
|
(2.6 | ) | ||
Noncurrent
liabilities
|
(0.3 | ) | ||
Noncontrolling
interest
|
(1.8 | ) | ||
Net
book value of joint venture investment sold
|
4.3 | |||
Less
proceeds:
|
||||
Liabilities
assumed by LMC
|
2.4 | |||
Cash
proceeds (net of transaction costs and cash sold)
|
0.3 | |||
Loss
on sale of joint venture interest
|
$ | 1.6 |
In
connection with the sale, UCI International entered into a long-term supply
agreement pursuant to which LMC will supply certain components to UCI
International. As part of this long-term supply agreement, LMC will purchase
from UCI International all the aluminum necessary to produce aluminum parts to
be supplied under the agreement.
21
Item 2. Management’s Discussion and
Analysis of Financial Condition and Results of
Operations
The
following discussion of our financial condition and results of operations must
be read together with the “Item 1. Business” and “Item 7. Management’s
Discussion & Analysis of Financial Condition and Results of Operations”
sections of our 2009 Form 10-K filed March 19, 2010 and the financial statements
included herein.
Forward-Looking
Statements
This
Quarterly Report on Form 10-Q for the period ended June 30, 2010 contains
forward-looking statements. The words “believe,” “expect,” “anticipate,”
“intend,” “estimate” and other expressions that are predictions of or indicate
future events and trends and that do not relate to historical matters identify
forward-looking statements. You should not place undue reliance on these
forward-looking statements. Although forward-looking statements reflect
management’s good faith beliefs, reliance should not be placed on
forward-looking statements because they involve known and unknown risks,
uncertainties and other factors, which may cause the actual results, performance
or achievements to differ materially from anticipated future results,
performance or achievements expressed or implied by such forward-looking
statements. Forward-looking statements speak only as of the date the statements
are made. We undertake no obligation to publicly update or revise any
forward-looking statement, whether as a result of new information, future
events, changed circumstances or otherwise. These forward-looking statements are
subject to numerous risks and uncertainties, including, but not limited
to:
|
•
|
growth
of, or changes in, the light and heavy-duty vehicle
aftermarket;
|
|
•
|
maintaining
existing sales levels with our current customers while attracting new
ones;
|
|
•
|
operating
in international markets and expanding into adjacent markets while
strengthening our market share in our existing
markets;
|
|
•
|
the
impact of general economic conditions in the regions in which we do
business;
|
|
•
|
increases
in costs of fuel, transportation and utilities costs and in the costs of
labor, employment and healthcare;
|
|
•
|
general
industry conditions, including competition, consolidation, pricing
pressure and product, raw material and energy
prices;
|
|
•
|
disruptions
in our supply chain;
|
|
•
|
initiating
effective cost cutting initiatives;
|
|
•
|
the
introduction of new and improved products or manufacturing
techniques;
|
|
•
|
the
impact of governmental laws and regulations and the outcome of legal
proceedings;
|
|
•
|
our
debt levels and restrictions in our debt
agreements;
|
|
•
|
changes
in exchange rates and currency
values;
|
|
•
|
capital
expenditure requirements;
|
|
•
|
access
to capital markets;
|
|
•
|
protecting
our intellectual property rights;
|
|
•
|
our
loss of key personnel or our inability to hire additional qualified
personnel; and
|
|
•
|
the
risks and uncertainties described under “Risk Factors” in Part II, Item
1.A. of this Quarterly Report on Form 10-Q and this “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations.”
|
We derive
many of our forward-looking statements from our operating budgets and forecasts,
which are based upon many detailed assumptions. While we believe that our
assumptions are reasonable, we caution that it is very difficult to predict the
impact of known factors, and it is impossible for us to anticipate all factors
that could affect our actual results. Important factors that could cause actual
results to differ materially from our expectations are disclosed under “Risk
Factors” in Part II, Item 1.A. of this Quarterly Report on Form
10-Q.
22
Overview
We are a
leading supplier to the light and heavy-duty vehicle aftermarket for replacement
parts, supplying a broad range of filtration, fuel delivery systems, vehicle
electronics and cooling systems products. We believe that we maintain a leading
market position in each of our four product lines, including the #1 market
position by revenue in both fuel delivery systems and cooling systems in the
North American light vehicle aftermarket. Approximately 88% of our 2009 net
sales were generated from sales to a diverse group of aftermarket customers,
including some of the largest and fastest growing companies in our industry. We
sell into multiple sales channels, including retailers, wholesale distributors,
dealers and the heavy-duty vehicle market. Our principal end-markets include
light vehicles, commercial vehicles and construction, mining, agricultural,
marine and other industrial equipment. We have one of the most comprehensive
product lines in the aftermarket, offering approximately 47,000 part numbers
that we deliver at an industry leading average fill rate of approximately
98%.
Aftermarket
sales generally are tied to the regular replacement cycle or the natural wearing
cycle of a vehicle part; accordingly, we expect industry growth will be heavily
influenced by the following key factors: increasing global vehicle population,
aging of vehicle population, increasing vehicle miles driven and growing
heavy-duty aftermarket.
The
following is a discussion of the key line items included in our financial
statements for the periods presented below under the heading “Results of
Operations.” These are the measures that management utilizes most to assess our
results of operations and anticipate future trends and risks in our
business.
Net
Sales
Net sales
includes the gross selling price of our products sold to our customers, less
provisions for warranty costs, estimated sales returns, customer allowances and
cash discounts. In addition, up-front costs to obtain exclusive contracts and
other new business changeover costs are recorded as a reduction to gross sales
in arriving at net sales. Recording such provisions as a reduction to gross
sales is customary in our industry. Provisions for sales returns, customer
allowances and warranty costs are recorded at the time of sale based upon
historical experience, current trends and our expectations regarding future
experience. Adjustments to such sales returns, allowances and warranty costs are
made as new information becomes available.
Because
most of our sales are to the aftermarket, we believe that our sales are
primarily driven by the number of vehicles on the road, the average age of those
vehicles, the average number of miles driven per year, the mix of light trucks
to passenger cars on the road and the relative strength of our sales channels.
Historically, our sales have not been materially adversely affected by market
cyclicality, as we believe that our aftermarket sales are less dependent on
economic conditions than our sales to OEMs, due to the generally
non-discretionary nature of vehicle maintenance and repair. While many vehicle
maintenance and repair expenses are non-discretionary in nature, high gasoline
prices and difficult economic conditions can lead to a reduction in miles
driven, which then results in increased time intervals for routine maintenance
and vehicle parts lasting longer before needing replacement. Historic highs in
crude oil prices experienced in 2008 and corresponding historic highs in retail
gasoline prices at the pump impacted consumers’ driving and vehicle maintenance
habits. In addition, we believe consumers’ driving and vehicle maintenance
habits have been impacted by the generally weak economic conditions experienced
in the latter part of 2008 and through 2009. These factors, together with lower
heavy-duty aftermarket sales due to weakness in the transportation segment in
2008 and 2009, and lower OEM sales due to the significant decline in new vehicle
production, resulted in the downward trend in sales starting in the third
quarter of 2008 through the first half of 2009. More recently, our retail
channel sales have increased reflecting the growth of our retail customer base.
Additionally, heavy-duty channel sales and OEM channel sales in the six months
ended June 30, 2010 increased 12.8% and 44.0%, respectively, over the six months
ended June 30, 2009 suggesting signs of recovery in the transportation
sector.
23
Sales in
the North American light vehicle aftermarket have grown at a compounded average
annual growth rate of approximately 3.3% from 1999 through 2009. However,
aftermarket sales grew by only 0.1% in 2008 and are estimated to have declined
by 1.2% in 2009. A key metric in measuring aftermarket performance is miles
driven. For 2008, the U.S. Department of Energy reported a decrease in miles
driven of 3.2% (equaling 96 billion fewer miles). This was the first annual
decrease in miles driven since 1980. We believe that high gasoline prices and
generally weak economic conditions adversely affected our sales during the
second half of 2008 and into 2009. During 2009, retail gasoline prices were
significantly lower than the historic highs experienced at the beginning of the
third quarter of 2008. Despite the lower retail gasoline prices, the negative
trend in miles driven continued in the first quarter of 2009 (a 2.7% decrease
over the comparable quarter in 2008) due to the ongoing weak economic
conditions. The negative trend reversed in the last three quarters of 2009 as
miles driven exceeded the comparable 2008 quarters. For the full year of
2009, miles driven increased 0.2% from 2008. Miles driven during the
first six months of 2010 increased 0.2% from the first six months of
2009.
While the
conditions described above have adversely affected our sales, other trends
resulting from the current economic conditions may have a positive impact on
sales in the future. Specifically, with new car sales remaining at low levels,
consumers are keeping their cars longer, resulting in an increased demand for
replacement parts as consumers repair their increasingly older
cars.
Management
believes that we have leading market positions in our primary product lines and
we continue to expand our product and service offerings to meet the needs of our
customers. We believe that a key competitive advantage is that we have one of
the most comprehensive product offerings in the vehicle replacement parts
market, consisting of approximately 47,000 parts. This product breadth, along
with our extensive manufacturing and distribution capabilities, product
innovation, and reputation for quality and service, makes us a leader in our
industry.
However,
it is also important to note that in 2009, 2008 and 2007, approximately 30%, 29%
and 28%, respectively, of our total net sales were derived from our business
with AutoZone. Our failure to maintain a healthy relationship with AutoZone
would result in a significant decrease in our net sales. Even if we maintain our
relationship, this sales concentration with one customer increases the potential
impact to our business that could result from any changes in the economic terms
of this relationship.
Cost
of Sales
Cost of
sales includes all costs of manufacturing required to bring a product to a
ready-for-sale condition. Such costs include direct and indirect materials (net
of vendor consideration), direct and indirect labor costs (including pension,
postretirement and other fringe benefits), supplies, utilities, freight,
depreciation, insurance and other costs. Cost of sales also includes all costs
to procure, package and ship products that we purchase and resell.
During
much of 2008, the cost of commodities, including steel, aluminum, iron, plastic
and other petrochemical products, packaging materials and media, increased
significantly compared to 2007. Energy costs also increased significantly during
this period. These higher costs affected the prices we paid for raw materials
and for purchased component parts and finished products. Due to our inventory
being accounted for on the first-in, first-out method, a time lag of
approximately three months exists from the time we experience cost increases
until these increases flow through cost of sales. As a result of this time
lag, our results for the first quarter of 2009 were negatively impacted by the
higher cost of materials purchased in the latter part of 2008. During 2009,
general market prices for most commodities decreased from 2008 levels in
reaction to global economic conditions and uncertainties regarding short-term
demand. This decrease in most commodities during 2009 had a favorable impact on
our results for the six months ended June 30, 2010 in relation to the six months
ended June 30, 2009. A recovering economy, however, would likely increase
the demand for many of the commodities used in our business. While we have
been, and expect to continue to be, able to obtain sufficient quantities of
these commodities to satisfy our needs, increased demand from current levels for
these commodities could result in cost increases and may make procurement more
difficult in the future.
In
addition to the adverse impact of increasing commodities and energy costs, we
have been adversely affected by changes in foreign currency exchange rates,
primarily relating to the Mexican peso. Our Mexican operations source a
significant amount of inventory from the United States. During the period
September 30, 2008 through March 31, 2009, the U.S. dollar
strengthened against the Mexican peso by approximately 33%. During the period
March 31, 2009 through June 30, 2010, the U.S. dollar weakened against
the Mexican peso by approximately 12%, partially offsetting the trend
experienced in the prior six months. A strengthening U.S. dollar against the
Mexican peso means that our Mexican operations must pay more pesos to obtain
inventory from the United States.
24
Generally,
we attempt to mitigate the effects of cost increases and currency changes via a
combination of design changes, material substitution, global resourcing efforts
and increases in the selling prices for our products. With respect to pricing,
it should be noted that, while the terms of supplier and customer contracts and
special pricing arrangements can vary, generally a time lag exists between when
we incur increased costs and when we might recover a portion of the higher costs
through increased pricing. This time lag typically spans a fiscal quarter or
more, depending on the specific situation. During 2008, we secured customer
price increases that offset a portion of the cost increase we experienced in
2008. However, because of reductions from 2008 highs in both energy costs and
the costs of certain commodities used in our operations, we have not been able
to retain the entire effect of customer price increases secured in 2008. We
continue to pursue efforts to mitigate the effects of any cost increases;
however, there are no assurances that we will be entirely successful. To the
extent that we are unsuccessful, our profit margins will be adversely affected
and even if we are successful, our gross margin percentages will
decline. Because of uncertainties regarding future commodities and
energy prices, and the success of our mitigation efforts, it is difficult to
estimate the impact of commodities and energy costs on future operating
results.
We
implemented a number of cost savings initiatives in late 2008 and throughout
2009 to align our cost structure with current business levels. Cost savings
initiatives included workforce reductions in both direct and indirect
manufacturing headcounts. Also, we implemented wages freezes and suspended
certain matching contributions to defined contribution and profit sharing plans,
as well as instituted tight controls over discretionary
spending. These cost savings actions helped offset the adverse impact
of higher material costs and lower sales volumes.
Selling
and Warehousing Expenses
Selling
and warehousing expenses primarily include sales and marketing, warehousing and
distribution costs. Our major cost elements include salaries and wages, pension
and fringe benefits, depreciation, advertising and information technology
costs.
General
and Administrative Expenses
General
and administrative expenses primarily include executive, accounting and
administrative personnel salaries and fringe benefits, professional fees,
pension benefits, insurance, provision for doubtful accounts, rent and
information technology costs.
Critical
Accounting Policies and Estimates
The
methods, estimates and judgments we use in applying our most critical accounting
policies have a significant impact on the results we report in our financial
statements. We evaluate our estimates and judgments on an on-going basis. We
base our estimates on historical experience and on assumptions that we believe
to be reasonable under the circumstances. Our experience and assumptions form
the basis for our judgments about the carrying value of assets and liabilities
that are not readily apparent from other sources. Actual results may vary from
what we anticipate, and different assumptions or estimates about the future
could change our reported results.
We
believe the following accounting policies are the most critical in that they
significantly affect our financial statements, and they require our most
significant estimates and complex judgments.
Revenue
Recognition
We record
sales when title and risk of loss transfers to the customer, the sale price is
fixed and determinable, and the collection of the related accounts receivable is
reasonably assured.
25
Where we
have sales rebate programs with some of our customers, we estimate amounts due
under these sales rebate programs when the sales are recorded. Net sales
relating to any particular shipment are based upon the amounts invoiced for the
shipped goods less estimated future rebate payments. These estimates are based
upon our historical experience, current trends and our expectations regarding
future experience. Revisions to these estimates are recorded in the period in
which the facts that give rise to the revision become known.
Additionally,
we have agreements with our customers that provide for sales discounts,
marketing allowances, return allowances and performance incentives. Any
discount, allowance or incentive is treated as a reduction to sales, based on
estimates of the criteria that give rise to the discount, allowance or
incentive, such as sales volume and marketing spending. We routinely review
these criteria and our estimating process and make adjustments as facts and
circumstances change. Historically, we have not found material differences
between our estimates and actual results.
In order
to obtain exclusive contracts with certain customers, we may incur up-front
costs or assume the cost of returns of products sold by the previous supplier.
These costs are capitalized and amortized over the life of the contract. The
amortized amounts are recorded as a reduction to gross sales.
New
business changeover costs also can include the costs related to removing a new
customer’s inventory and replacing it with our inventory, commonly referred to
as a “stocklift.” Stocklift costs are recorded as a reduction to gross sales
when incurred.
Product
Returns
Our
customers have the right to return parts that are covered under our standard
warranty within stated warranty periods. Our customers also have the right, in
varying degrees, to return excess quantities of product. Credits for parts
returned under warranty and parts returned because of customer excess quantities
are estimated and recorded at the time of the related sales. These estimates are
based on historical experience, current trends and our expectations regarding
future experience. Revisions to these estimates are recorded in the period in
which the facts that give rise to the revision become known. Any significant
increase in the amount of product returns above historical levels could have a
material adverse effect on our financial results.
Inventory
We record
inventory at the lower of cost or market. Cost is principally determined using
standard cost or average cost, which approximates the first-in, first-out
method. Estimated market value is based on assumptions for future demand and
related pricing. If actual market conditions are less favorable than those
projected by management, reductions in the value of inventory may be
required.
Impairment of Intangible
Assets
Goodwill
is subject to annual review unless conditions arise that require a more frequent
evaluation. The review for impairment is based on a two-step accounting test.
The first step is to compare the estimated fair value with the recorded net book
value (including the goodwill). If the estimated fair value is higher than the
recorded net book value, no impairment is deemed to exist and no further testing
is required. If, however, the estimated fair value is below the recorded net
book value, then a second step must be performed to determine the goodwill
impairment required, if any. In this second step, the estimated fair value from
the first step is used as the purchase price in a hypothetical acquisition.
Purchase business combination accounting rules are followed to determine a
hypothetical purchase price allocation to the reporting unit’s assets and
liabilities. The residual amount of goodwill that results from this hypothetical
purchase price allocation is compared to the recorded amount of goodwill, and
the recorded amount is written down to the hypothetical amount, if
lower.
26
We
perform our annual goodwill impairment review in the fourth quarter of each year
using discounted future cash flows, unless conditions exist that would require a
more frequent evaluation. Management retains the services of an independent
valuation company in order to assist in evaluating the estimated fair value of
the Company. The process of evaluating the potential impairment of goodwill
is subjective because it requires the use of estimates and assumptions as to
future cash flows of the Company, discount rates commensurate with the risks
involved in the assets, future economic and market conditions, competition,
customer relations, pricing, raw material costs, production costs, selling,
general and administrative costs, and income and other taxes. Although we base
cash flow forecasts on assumptions that are consistent with plans and estimates
we use to manage the Company, there is significant judgment in determining the
cash flows.
Trademarks
with indefinite lives are tested for impairment on an annual basis in the fourth
quarter, unless conditions arise that would require a more frequent evaluation.
In assessing the recoverability of these assets, projections regarding estimated
discounted future cash flows and other factors are made to determine if
impairment has occurred. If we conclude that there has been impairment, we will
write down the carrying value of the asset to its fair value.
Each
year, we evaluate those trademarks with indefinite lives to determine whether
events and circumstances continue to support the indefinite useful lives. We
have concluded that events and circumstances continue to support the indefinite
lives of these trademarks.
Retirement
Benefits
Pension
obligations are actuarially determined and are affected by assumptions including
discount rate, life expectancy, annual compensation increases and the expected
rate of return on plan assets. Changes in the discount rate, and differences
between actual results and assumptions, will affect the amount of pension
expense we recognize in future periods.
Postretirement
health obligations are actuarially determined and are based on assumptions
including discount rate, life expectancy and health care cost trends. Changes in
the discount rate, and differences between actual results and assumptions, will
affect the amount of expense we recognize in future periods.
Insurance
Reserves
Our
insurance policies for workers’ compensation, automobile, product and general
liability include high deductibles (up to $0.5 million) for which we are
responsible. Deductibles for which we are responsible are recorded in accrued
expenses. Estimates of such losses involve substantial uncertainties including
litigation trends, the severity of reported claims and incurred but not yet
reported claims. External actuaries are used to assist us in estimating these
losses.
Environmental
Expenditures
Our
expenditures for environmental matters fall into two categories. The first
category is routine compliance with applicable laws and regulations related to
the protection of the environment. The costs of such compliance are based on
actual charges and do not require significant estimates.
The
second category of expenditures is for matters related to investigation and
remediation of contaminated sites. The impact of this type of expenditure
requires significant estimates by management. The estimated cost of the ultimate
outcome of these matters is included as a liability in our June 30, 2010
balance sheet. This estimate is based on all currently available information,
including input from outside legal and environmental professionals, and numerous
assumptions. Management believes that the ultimate outcome of these matters will
not exceed the $1.6 million accrued at June 30, 2010 by a material amount,
if at all. However, because all investigation and site analysis has not yet been
completed and because of the inherent uncertainty in such environmental matters
and any related litigation, there can be no assurance that the ultimate outcome
of these matters will not be significantly different than our
estimates.
27
Stock-Based
Compensation
We
recognize compensation expense for employee stock option grants using the
non-substantive vesting period approach, in which the expense (net of estimated
forfeitures) is recognized ratably over the requisite service period based on
the grant date fair value. The fair value of new stock options is estimated on
the date of grant using the Black-Scholes option pricing model. Determining the
fair value of stock options at the grant date requires judgment, including
estimates for the average risk-free interest rate, dividend yield and
volatility. These assumptions may differ significantly between grant dates
because of changes in the actual results of these inputs that occur over
time.
The terms
of our restricted stock agreement provide that the shares of restricted stock
vest only upon a change of control of UCI International, Inc., as defined in our
equity incentive plan. Due to the uncertainty surrounding the ultimate vesting
of the restricted stock, no stock-based compensation expense has been recorded.
When a change in control becomes probable, expense equal to the fair value of
the stock at that time will be recorded.
Results
of Operations
The
following table is UCI International’s unaudited condensed consolidated income
statements for the three months and six months ended June 30, 2010 and 2009. The
amounts are presented in thousands of dollars.
Three Months Ended
June 30,
|
Six Months Ended June 30,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Net
sales
|
$ | 236,198 | $ | 217,422 | $ | 466,502 | $ | 437,284 | ||||||||
Cost
of sales
|
176,228 | 169,698 | 349,304 | 350,140 | ||||||||||||
Gross
profit
|
59,970 | 47,724 | 117,198 | 87,144 | ||||||||||||
Operating
(expense) income
|
||||||||||||||||
Selling
and warehousing
|
(15,077 | ) | (14,086 | ) | (29,372 | ) | (28,384 | ) | ||||||||
General
and administrative
|
(11,123 | ) | (11,218 | ) | (22,673 | ) | (23,779 | ) | ||||||||
Amortization
of acquired intangible assets
|
(1,336 | ) | (1,481 | ) | (2,671 | ) | (2,961 | ) | ||||||||
Restructuring
gains (costs), net
|
(344 | ) | 598 | (2,380 | ) | 393 | ||||||||||
Patent
litigation costs
|
(74 | ) | — | (1,038 | ) | — | ||||||||||
Operating
income
|
32,016 | 21,537 | 59,064 | 32,413 | ||||||||||||
Other
expense
|
||||||||||||||||
Interest
expense, net
|
(14,935 | ) | (15,243 | ) | (29,726 | ) | (30,947 | ) | ||||||||
Management
fee expense
|
(500 | ) | (500 | ) | (1,000 | ) | (1,000 | ) | ||||||||
Miscellaneous,
net
|
(1,352 | ) | (1,669 | ) | (2,303 | ) | (3,154 | ) | ||||||||
Income
(loss) before income taxes
|
15,229 | 4,125 | 26,035 | (2,688 | ) | |||||||||||
Income
tax (expense) benefit
|
(6,315 | ) | (1,680 | ) | (10,540 | ) | 475 | |||||||||
Net
income (loss)
|
8,914 | 2,445 | 15,495 | (2,213 | ) | |||||||||||
Less:
Loss attributable to noncontrolling interest
|
(2 | ) | (75 | ) | (37 | ) | (379 | ) | ||||||||
Net
income (loss) attributable to UCI International, Inc.
|
$ | 8,916 | $ | 2,520 | $ | 15,532 | $ | (1,834 | ) |
Three Months Ended June 30, 2010
compared with the Three Months Ended June 30, 2009
Net
Sales
Net sales
of $236.2 million in the second quarter of 2010 increased $18.8 million, or
8.6%, compared to net sales in the second quarter of 2009. In connection with
obtaining new business, net sales included reductions of $0.3 million in the
second quarter of 2010 and $1.1 million in the second quarter of
2009. These reductions resulted from accepting returns of inventory
of our customers’ previous suppliers. Excluding the effects of
obtaining new business from both quarters, sales were 8.2% higher in the second
quarter of 2010 compared to the second quarter of 2009.
28
Automotive
aftermarket net sales, which comprised approximately 86% of our net sales in the
second quarter of 2010, increased approximately 7.0% compared to the second
quarter of 2009. Within the automotive aftermarket channel, our retail channel
net sales increased approximately 5.2%, our traditional channel net sales
increased approximately 3.0%, our OES channel net sales increased approximately
19.3% and our heavy duty channel net sales increased approximately 20.7%. The
increased net sales in our retail, traditional and OES channels primarily
reflect the sales growth experienced by our customer base. The increased net
sales in our heavy duty channel resulted from a general improved market trend in
the transportation sector. Our OEM channel sales in the second
quarter of 2010 increased approximately 45.0% over the second quarter of 2009
also due to the recovery from the difficult economic environment in
2009.
Gross
Profit
Gross
profit, as reported, was $60.0 million for the second quarter of 2010 and $47.7
million for the second quarter of 2009. Both periods included special
items which are presented in the following table along with a comparison of
adjusted gross profit after excluding these special items. Adjusted
gross profit is a non-GAAP financial measurement of our performance which is not
in accordance with, or a substitute for, GAAP measures. It is intended to
supplement the presentation of our financial results that are prepared in
accordance with GAAP. We use adjusted gross profit as presented to evaluate and
manage our operations internally.
Three Months Ended June 30,
|
||||||||
2010
|
2009
|
|||||||
(in
millions)
|
||||||||
Gross
profit, as reported
|
$ | 60.0 | $ | 47.7 | ||||
Add
back special items:
|
||||||||
New
business changeover and sales commitment costs
|
0.3 | 1.1 | ||||||
Allowance
for disputed non-trade receivable
|
1.4 | — | ||||||
Severance
costs
|
— | 0.3 | ||||||
Costs
to establish additional manufacturing in China
|
— | 0.1 | ||||||
Adjusted
gross profit
|
$ | 61.7 | $ | 49.2 |
The $0.3
million and the $1.1 million of “new business changeover and sales commitment
costs” in the second quarter of 2010 and second quarter of 2009, respectively,
were up-front costs incurred to obtain new business and to extend existing
long-term sales commitments.
During
the three months ended June 30, 2010, we recorded a $1.4 million provision due
to uncertainties of collection of refunds of Mexican value-added tax from the
Mexican Department of Finance and Public Credit. See further
discussion under Contingencies – Valued-Added Tax Receivable.
The $0.3
million of “severance costs” in the second quarter of 2009 related to actions
taken to further align our cost structure with customers’ spending and current
market conditions. The actions included, among other actions,
workforce reductions with related severance costs.
The $0.1
million of “costs to establish additional manufacturing in China” in the second
quarter of 2009 related to start-up costs to establish two new factories in
China.
Excluding
the adverse effects of these special items, adjusted gross profit increased to
$61.7 million in the second quarter of 2010 from $49.2 million in the second
quarter of 2009, and the related gross margin percentage increased to 26.1% in
the second quarter of 2010 from 22.5% in the second quarter of
2009. The adjusted gross margin percentage is based on sales before
the effects of obtaining new business, which are discussed in the net sales
comparison above.
29
Higher
sales volume in the second quarter of 2010 was a significant factor in our gross
profit increase year over year. The 2010 results were also positively affected
by the favorable effects of cost reduction initiatives implemented to align our
cost structure with our customers’ spending and current market conditions, lower
commodity and energy costs and favorable trends in our insurance costs. The cost
reduction initiatives included workforce reductions and other employee cost
saving actions, as well as the institution of tight controls over discretionary
spending. Partially offsetting these factors were the effects of
customer price concessions and higher estimated product returns.
Selling and Warehousing
Expenses
Selling
and warehousing expenses were $15.1 million in the second quarter of 2010, $1.0
million higher than the second quarter of 2009. Selling and warehousing expenses
were 6.4% of net sales in the second quarter of 2010 and 6.5% in the 2009
quarter. Shipping and warehousing expenses increased $0.3 million to
support the increased sales volume. Selling and marketing expenses
increased $0.7 million related to higher variable selling costs associated with
our higher sales volume and investments in our growth initiatives including
staffing and other costs.
General and Administrative
Expenses
General
and administrative expenses were $11.1 million in the second quarter of 2010,
$0.1 million lower than the second quarter of 2009. This reduction includes the
favorable effect of lower employee expenses in the second quarter of 2010 due to
headcount reductions in 2009, inclusive of severance related to the headcount
reductions, lower legal and other professional fees (excluding legal fees
related to our antitrust litigation) and cost control
initiatives. Largely offsetting these items were $2.1 million of
higher costs incurred in connection with our antitrust litigation (discussed in
Note J to the financial statements included in this Form 10-Q) and higher
incentive compensation.
Restructuring Gains (Costs),
Net
In the
three months ended June 30, 2010, we recorded $0.2 million of pension
curtailment and settlement losses and $0.1 million of severance related to
headcount reductions at our Mexican subsidiaries.
In the
three months ended June 30, 2009, we implemented restructuring plans to further
align our cost structure with customers’ spending and current market conditions.
The restructuring plans targeted excess assembly and aluminum casting capacity
and restructuring costs of the plan included workforce reductions, facility
closures, consolidations and realignments.
We idled
a Mexican aluminum casting operation in the three months ended June 30, 2009 and
consolidated the capacity into our Chinese casting operation. During that
period, we also relocated a small amount of filter manufacturing capacity which
resulted in idling a small amount of equipment with no alternative use. In
connection with the capacity consolidation, we recorded asset write-offs of $0.7
million and incurred post employment benefit plans curtailment costs of $0.1
million.
In order
to accommodate expected growth in Europe, our Spanish distribution operation was
relocated to a new leased facility resulting in the idling and subsequent sale
of an owned facility. We recognized a gain of $1.5 million on the sale of this
facility. We incurred other costs of $0.1 million associated with the relocation
of the facility.
These
costs related to our capacity consolidation activities are reported in the
income statement in “Restructuring gains (costs) net.”
Interest Expense,
Net
Net
interest expense was $0.3 million lower in the second quarter of 2010 compared
to the second quarter of 2009. This decrease was due to lower interest rates on
our variable debt in the second quarter of 2010 and lower average borrowings of
approximately $2.4 million during the second quarter of 2010 as compared to the
second quarter of 2009. Average borrowings were lower in the second
quarter of 2010 resulting from both the $17.7 million mandatory prepayment on
our term loan in April 2010 and the repayment of revolver credit facility
borrowings of $20.0 million in June 2009. These lower borrowings were
largely offset by the increased outstanding balance of the UCI International
Notes due to the quarterly payment of interest through the issuance of new
notes.
30
Miscellaneous,
Net
Miscellaneous
expense which consists of costs associated with the sale of receivables was $0.3 million lower in
the second quarter of 2010 compared to the second quarter of 2009 due to lower
selling costs, partially offset by higher sales of receivables in 2010 versus
2009.
Income
Tax Expense
Income
tax expense in the second quarter of 2010 was $4.6 million higher than in the
second quarter of 2009, due to higher pre-tax income in the 2010 quarter and a
higher effective tax rate. The effective tax rate for the second
quarter of 2010 was 41.5% compared to 40.7% for the second quarter of
2009. The higher effective tax rate relates primarily to higher
foreign income taxes, partially offset by increased special manufacturing
deductions allowable in the U.S.
Net Income
Due to
the factors described above, we reported a net income of $8.9 million for the
second quarter of 2010 and $2.4 million for the second quarter of
2009.
Net Income Attributable to UCI
International, Inc.
After
deducting losses attributable to a noncontrolling interest, net income
attributable to UCI International, Inc. was $8.9 million in the second quarter
of 2010 compared to $2.5 million in the second quarter of 2009.
Six
Months Ended June 30, 2010 compared with the Six Months Ended June 30,
2009
Net
Sales
Net sales
of $466.5 million for the six months ended June 30, 2010 increased $29.2
million, or 6.7%, compared to net sales for the six months ended June 30, 2009.
In connection with obtaining new business, net sales included reductions of $0.9
million in the six months ended June 30, 2010 and $3.5 million in the six months
ended June 30, 2009. Excluding the effects of obtaining new business from both
six month periods, net sales were 6.0% higher in the first half of 2010 compared
to the first half of 2009.
Automotive
aftermarket net sales, which comprised approximately 86% of our net sales in the
six months ended June 30, 2010, increased approximately 4.7% compared to the six
months ended June 30, 2009. Within the automotive aftermarket channel, our
retail channel net sales increased approximately 5.0%, our traditional channel
net sales increased approximately 2.0%, our OES channel net sales increased
approximately 4.7% and our heavy duty channel net sales increased approximately
12.8%. The increased net sales in our retail, traditional and OES channels
primarily reflect the sales growth experienced by our customer base. The
increased net sales in our heavy duty channel resulted from a general improved
market trend in the transportation sector. Our OEM channel sales in
the six months ended June 30, 2010 increased approximately 44.0% over the six
months ended June 30, 2009 due to recovery from the difficult economic
environment in 2008 and early 2009.
31
Gross
Profit
Gross
profit, as reported, was $117.2 million for the first half of 2010 and $87.1
million for the first half of 2009. Both periods included special items which
are presented in the following table along with a comparison of adjusted gross
profit after excluding these special items. Adjusted gross profit is
a non-GAAP financial measurement of our performance which is not in accordance
with, or a substitute for, GAAP measures. It is intended to supplement the
presentation of our financial results that are prepared in accordance with GAAP.
We use adjusted gross profit as presented to evaluate and manage our operations
internally.
Six
Months Ended June 30,
|
||||||||
2010
|
2009
|
|||||||
(amounts
in millions)
|
||||||||
Gross
profit, as reported
|
$ | 117.2 | $ | 87.1 | ||||
Add
back special items:
|
||||||||
New
business changeover and sales commitment costs
|
0.9 | 3.5 | ||||||
Allowance
for disputed non-trade receivable
|
1.4 | — | ||||||
Severance
costs
|
— | 0.6 | ||||||
Costs
to establish additional manufacturing in China
|
— | 0.2 | ||||||
Adjusted
gross profit
|
$ | 119.5 | $ | 91.4 |
The $0.9
million and the $3.5 million of “new business changeover and sales commitment
costs” in the six months ended June 30, 2010 and 2009, respectively, were
up-front costs incurred to obtain new business and to extend existing long-term
sales commitments.
During
the six months ended June 30, 2010, we recorded a $1.4 million provision due to
uncertainties of collection of refunds of Mexican value-added tax from the
Mexican Department of Finance and Public Credit. See further
discussion under Contingencies – Valued-Added Tax Receivable.
The $0.6
million of “severance costs” in the six months ended June 30, 2009 related to
actions taken to further align our cost structure with customers’ spending and
current market conditions. The actions included, among other actions,
workforce reductions with related severance costs.
The $0.2
million of “costs to establish additional manufacturing in China” in the six
months ended June 30, 2009 related to start-up costs to establish two new
factories in China.
Excluding
the adverse effects of these special items, adjusted gross profit increased to
$119.5 million in the six months ended June 30, 2010 from $91.4 million in the
six months ended June 30, 2009, and the related gross margin percentage
increased to 25.6% in the six months ended June 30, 2010 from 20.7% in the six
months ended June 30, 2009. The adjusted gross margin percentage is based on
sales before the effects of obtaining new business, which are discussed in the
net sales comparison above.
Higher
net sales volume in the six months ended June 30, 2010 was a significant factor
in our gross profit increase year over year. The 2010 results were also
positively affected by the favorable effects of cost reduction initiatives to
align our cost structure with our customers’ spending and current market
conditions, lower commodity and energy costs and favorable exchange rates. The
cost reduction initiatives included workforce reductions and other employee cost
saving actions, as well as the institution of tight controls over discretionary
spending. Partially offsetting these factors were the effects of
price concessions and higher product returns.
Selling and Warehousing
Expenses
Selling
and warehousing expenses were $29.4 million in the six months ended June 30,
2010, $1.0 million higher than the six months ended June 30, 2009. Shipping and
warehousing expenses increased $0.5 million to support the increased sales
volume. Selling and marketing expenses increased $0.5 million related
to higher variable selling costs associated with our higher sales volume and
investments in our growth initiatives including staffing and other
costs. Selling and warehousing expenses were 6.3% of net sales in the
six months ended June 30, 2010 and 6.5% in the six months ended June 30,
2009. The improvement in selling and warehousing expenses as a
percentage of net sales despite the increased spending level is the result of
the cost reduction actions taken during 2009.
32
General and Administrative
Expenses
General
and administrative expenses were $22.7 million in the six months ended June 30,
2010; $1.1 million lower than the six months ended June 30, 2009. This reduction
includes the favorable effect of lower employee expenses in the six months ended
June 30, 2010 due to headcount reductions in 2009, inclusive of severance
related to the headcount reductions, lower legal and professional fees
(excluding legal fees related to our antitrust litigation) and cost control
initiatives. Partially offsetting these items were $2.5 million of
higher costs incurred in connection with our antitrust litigation (discussed in
Note J to the financial statements included in this Form 10-Q) and higher
incentive compensation.
Restructuring Gains (Costs),
Net
In the
six months ended June 30, 2010, we incurred $0.2 million of costs for the
maintenance and security of land and a building that is held for sale. Also in
the six months ended June 30, 2010, we recorded $0.5 million of pension
curtailment and settlement losses and $0.1 million of severance related to
headcount reductions at our Mexican subsidiaries. During this period,
we also recorded a non-cash charge of $1.6 million related to the disposition of
our interest in a 51% owned joint venture.
In the
six months ended June 30, 2009, we implemented restructuring plans to further
align our cost structure with customers’ spending and current market conditions.
The restructuring plans targeted excess assembly and aluminum casting capacity
and restructuring costs of the plan included workforce reductions, facility
closures, consolidations and realignments.
We idled
a Mexican aluminum casting operation in the six months ended June 30, 2009 and
consolidated the capacity into our Chinese casting operation. During that
period, we also relocated a small amount of filter manufacturing capacity which
resulted in the idling of certain equipment with no alternative use. In
connection with this capacity consolidation, we recorded asset impairments of
$0.7 million and incurred post employment benefit plans curtailment costs of
$0.1 million.
In order
to accommodate expected growth in Europe, our Spanish distribution operation was
relocated to a new leased facility resulting in the idling and subsequent sale
of an owned facility. We recognized a gain of $1.5 million on the sale of this
facility. We incurred other costs of $0.1 million associated with the relocation
of the facility.
These
costs related to our capacity consolidation activities are reported in the
income statement in “Restructuring gains (costs) net.”
Interest Expense,
Net
Net
interest expense was $1.2 million lower in the six months ended June 30, 2010
compared to the six months ended June 30, 2009. This decrease is due
to lower interest rates on our variable debt in the six months ended June 30,
2010 as compared to the six months ended June 30, 2009, partially offset by
higher average borrowings of $3.2 million during the six months ended June 30,
2010. The increased outstanding balance of the UCI
International Notes due to the quarterly payment of interest through the
issuance of new notes more than offset the lower level of borrowings under UCI’s
senior credit facility resulting from both the $17.7 million mandatory
prepayment on our term loan made in April 2010 and the repayment of revolver
credit facility borrowings of $20.0 million in June 2009.
Miscellaneous,
Net
Miscellaneous
expense which consists of costs associated with the sale of receivables was $0.9 million lower in
the six months ended June 30, 2010 compared to the six months ended June 30,
2009 due to lower selling costs, partially offset by higher sales of receivables
in 2010 versus 2009.
33
Income Tax (Expense)
Benefit
Income
tax expense in the six months ended June 30, 2010 was $11.0 million higher than
in the six months ended June 30, 2009 due to higher pre-tax income in the 2010
quarter. The effective tax rate for the six months ended June 30,
2010 was 40.5% compared to 17.7% for the six months ended June 30,
2009. The difference in tax rates relates primarily to foreign income
taxes.
Net
Income (Loss)
Due to
the factors described above, we reported a net income of $15.5 million in the
six months ended June 30, 2010 compared to a net loss of $2.2 million in the six
months ended June 30, 2009.
Net
Income (Loss) Attributable to UCI International, Inc.
After
deducting losses attributable to a noncontrolling interest, net income
attributable to UCI International, Inc. was $15.5 million in the six months
ended June 30, 2010 compared to a net loss attributable to UCI International,
Inc. of $1.8 million in the six months ended June 30, 2009.
Liquidity
and Capital Resources
Net
Cash Provided by Operating Activities
Six Months Ended June 30,
2010
Net cash
provided by operating activities for the six months ended June 30, 2010 was
$76.6 million. Net income, excluding non-cash income and expense items, was
$49.9 million. A decrease in accounts receivable resulted in a generation of
cash of $1.9 million. The decrease in accounts receivable was primarily due to
an increase in net sales, partially offset by increased factoring of accounts
receivable during the six months ended June 30, 2010. Factored accounts
receivable totaled $128.6 million and $121.5 million at June 30, 2010 and
December 31, 2009, respectively. An increase in inventory resulted in a use of
cash of $4.5 million. The increase in inventory was due primarily to
inventory builds to support the higher sales levels. An increase in accounts
payable resulted in a generation of cash of $3.9 million due primarily to the
higher inventory levels. Changes in all other assets and liabilities netted to a
$25.4 million increase in cash. This change primarily related to the timing of
tax payments ($9.7 million), increases in product returns and other amounts due
customers ($8.0 million), decreases in prepaid insurance ($1.3 million) and
changes in other assets and accrued expenses.
Six Months Ended June 30,
2009
Net cash
provided by operating activities for the six months ended June 30, 2009 was
$78.1 million. Net income, excluding non-cash income and expense items, was
$30.9 million. A decrease in accounts receivable and inventory resulted in a
generation of cash of $12.5 million and $22.4 million, respectively. The
decrease in accounts receivable was primarily due to increased factoring of
accounts receivable during the six months ended June 30, 2009, partially offset
by an increase in sales of $15.4 million in the six months ended June 30, 2009,
as compared to the third and fourth quarters of 2008, and the impact of the
higher mix of retail and traditional channel sales in relation to OEM / OES
channel sales. Accounts receivable dating terms with OEM and OES customers are
significantly shorter than retail and traditional customers. As a result of the
higher mix of retail and traditional channel sales, gross account receivable
days sales outstanding has increased. Factored accounts receivable totaled
$135.6 million and $80.1 million at June 30, 2009 and December 31, 2008,
respectively. The decrease in inventory was due to (i) focused efforts to reduce
inventory investments through improved inventory turns, (ii) higher sales in the
three months ended June 30, 2009 over the fourth quarter of 2008 and (iii)
reduced material costs resulting from decreases in costs of certain commodities
used in our operations experienced in the latter part of 2008 and in the first
half of 2009. An increase in accounts payable resulted in a generation of cash
of $0.6 million. The increase in accounts payable was due to initiatives with
our vendors to reduce our working capital investment levels, which offset
reductions in accounts payable related to the significantly lower inventory
balances at June 30, 2009 compared to December 31, 2008. Changes in
all other assets and liabilities netted to a $11.7 million increase in cash.
This amount consisted primarily of timing of payment of employee-related accrued
liabilities, including salaries and wages and insurance, and timing of product
returns and customer rebates and credits.
34
Net Cash Used in Investing
Activities
Historically,
net cash used in investing activities has been for capital expenditures,
including routine expenditures for equipment replacement and efficiency
improvements, offset by proceeds from the disposition of property, plant and
equipment. Capital expenditures for the six months ended June 30, 2010 and June
30, 2009 were $11.7 million and $7.5 million, respectively, used primarily for
cost reduction and maintenance activities. The higher capital
expenditures in 2010 are primarily the result of funding specific targeted cost
reduction opportunities as part of the Product Source Optimization, or PSO,
initiative. See further discussion of our PSO initiative under
“Management’s Action Plan and Outlook.”
Proceeds
from the sale of property, plant and equipment for the six months ended June 30,
2010 and June 30, 2009 were $0.1 million and $2.4 million, respectively.
Proceeds from the sale of our joint venture interest in China, net of
transaction costs and cash sold totaled approximately $0.3
million. See Note O to the condensed consolidated financial
statements. During the six months ended June 30, 2009, our Spanish
operation was relocated to a new leased facility in order to accommodate
expected growth in the European market resulting in the idling of an owned
facility. Proceeds for the six months ended June 30, 2009 primarily related to
the sale of this facility in Spain.
During
the six months ended June 30, 2010, we posted $7.4 million of cash to
collateralize a letter of credit required to appeal the judgment in the patent
litigation discussed in more detail under “Contingencies.” During the
six months ended June 30, 2009, we posted $9.4 million of cash to collateralize
a letter of credit required by our workers compensation insurance
carrier. This cash totaling $16.8 million is recorded as “Restricted
cash” as a component of long-term assets on our balance sheet at June 30, 2010.
This cash is invested in highly liquid, high quality government securities and
is not available for general operating purposes as long as the letters of credit
remain outstanding or until alternative collateral is posted.
Net
Cash Used in Financing Activities
Net cash
used in financing activities in the six months ended June 30, 2010 was $15.1
million compared to $19.6 million in the six months ended June 30,
2009.
Borrowings
of $9.6 and $6.5 million during the six months ended June 30, 2010 and 2009,
respectively, consisted solely of short-term borrowings payable to foreign
credit institutions.
During
the six months ended June 30, 2010, we made the $17.7 million mandatory
prepayment on the term loan of UCI’s senior credit facility. Additionally,
during the six months ended June 30, 2010, our Spanish and Chinese subsidiaries
repaid short-term notes borrowings to foreign credit institutions in the amount
of $6.9 million.
During
the six months ended June 30, 2009, we repaid the $20.0 million of outstanding
borrowings under UCI’s revolving credit facility. Additionally, during the
six months ended June 30, 2009, our Spanish and Chinese subsidiaries repaid
short-term notes borrowings to foreign credit institutions in the amount of $5.9
million.
35
Current
Debt Capitalization and Scheduled Maturities
At June
30, 2010 and December 31, 2009, UCI International had $174.2 million and $131.9
million of cash and cash equivalents, respectively. Outstanding debt was as
follows (in millions):
June 30,
|
December 31,
|
|||||||
2010
|
2009
|
|||||||
UCI
short-term borrowings
|
$ | 6.2 | $ | 3.5 | ||||
UCI
capitalized lease obligations
|
0.8 | 0.9 | ||||||
UCI
term loan
|
172.3 | 190.0 | ||||||
UCI
senior subordinated notes
|
230.0 | 230.0 | ||||||
UCI
International floating rate senior PIK notes
|
339.2 | 324.1 | ||||||
Amount
of debt requiring repayment
|
748.5 | 748.5 | ||||||
Unamortized
debt discount
|
(5.9 | ) | (6.9 | ) | ||||
$ | 742.6 | $ | 741.6 |
Below is
a schedule of required future repayments of all debt outstanding on June 30,
2010. The amounts are presented in millions of dollars.
Remainder
of 2010
|
$ | 4.8 | ||
2011
|
29.0 | |||
2012
|
249.4 | |||
2013
|
465.1 | |||
2014
|
0.1 | |||
Thereafter
|
0.1 | |||
$ | 748.5 |
Short-term
borrowings are routine short-term borrowings by our foreign
operations.
Because
of previous prepayments of UCI’s term loan, UCI does not have any required
repayments of the UCI senior credit facility term loans until December 2011. The
term loan matures in June 2012. UCI’s $230.0 million senior subordinated notes
are due in 2013.
The UCI
International Notes are due in 2013. Interest on the UCI International Notes
will be paid in kind by issuing new notes until December 2011 and therefore will
not affect our cash flow through 2011. Thereafter, all interest will be payable
in cash. On March 15, 2012, and each quarter thereafter, we are required to
redeem for cash a portion of each note, to the extent required to prevent
the UCI International Notes from being treated as an applicable high yield
discount obligation. In the schedule above, the $104.2 million of UCI
International Notes that were issued in lieu of cash interest through
June 30, 2010 have been included in the 2012 debt repayment amount.
Depending on the circumstances, a portion of this $104.2 million may be paid
after 2012.
The terms
of UCI’s senior credit facility permit us to repurchase from time to time up to
$75.0 million in aggregate principal amount of senior subordinated notes. As of
August 11, 2010, neither we nor UCI had repurchased any of the senior
subordinated notes, although we or UCI may, under appropriate market conditions,
do so in the future through cash purchases or exchange offers, in open market,
privately negotiated or other transactions. Similarly, we may from time to time
seek to repurchase or retire the UCI International Notes. We will evaluate any
such transactions in light of then-existing market conditions, taking into
account contractual restrictions, our current liquidity and prospects for future
access to capital. The amounts involved may be material.
36
Our
significant debt service obligation is an important factor when assessing our
liquidity and capital resources. At our June 30, 2010 debt level and borrowing
rates, annual interest expense, including amortization of deferred financing
costs and debt discount, was approximately $60.1 million. An increase of
0.25 percentage points (25 basis points) on our variable interest rate debt
would increase our annual interest cost by $1.3 million.
Covenant
Compliance
UCI’s
senior credit facility requires us to maintain certain financial covenants and
requires mandatory prepayments under certain events as defined in the agreement.
Also, the facility includes certain negative covenants restricting or limiting
our ability to, among other things: declare dividends or redeem stock; prepay
certain debt; make loans or investments; guarantee or incur additional debt;
make capital expenditures; engage in acquisitions or other business
combinations; sell assets; and alter our business. In addition, the senior
credit facility contains the following financial covenants: a maximum leverage
ratio and a minimum interest coverage ratio. The financial covenants are
calculated on a trailing four consecutive quarters basis. As of June 30, 2010,
UCI was in compliance with all of these covenants.
UCI’s
covenant compliance levels and actual ratios for the quarter ended June 30, 2010
were as follows:
Covenant
Compliance Level
|
Actual
Ratio |
|||||
Minimum
Credit Agreement Adjusted EBITDA to interest expense ratio
|
3.00x
|
6.03x
|
||||
Maximum
total debt to Credit Agreement Adjusted EBITDA ratio
|
3.75x
|
2.52x
|
For the
quarter ending September 30, 2010 through the remainder of the term of the
senior credit facility, the minimum Credit Agreement Adjusted EBITDA to interest
expense ratio covenant compliance level remains at 3.00x and the maximum
leverage ratio covenant level decreases to 3.50x.
Credit
Agreement Adjusted EBITDA is used to determine UCI’s compliance with many
of the covenants contained in UCI’s senior credit facility. Credit
Agreement Adjusted EBITDA is defined as EBITDA (earnings before interest, taxes,
depreciation and amortization) further adjusted to exclude unusual items and
other adjustments permitted by the lenders in calculating covenant compliance
under UCI’s senior credit facility.
A breach
of covenants in UCI’s senior credit facility that are tied to ratios based on
Credit Agreement Adjusted EBITDA could result in a default under the facility
and the lenders could elect to declare all amounts borrowed due and payable. Any
such acceleration would also result in a default under UCI’s senior subordinated
notes.
Management’s
Action Plan and Outlook
Our
primary sources of liquidity are cash on hand, cash flow from operations and
accounts receivable factoring arrangements. At June 30, 2010, we had
$174.2 million of cash and cash equivalents on hand.
Accounts Receivable
Factoring
Factoring
of customer trade accounts receivable is a significant part of our liquidity and
is related to extended terms provided to certain customers. Subject to certain
limitations, UCI’s senior credit facility agreement permits sales of and liens
on receivables, which are being sold pursuant to non-recourse factoring
agreements between certain of our customers and a number of banks. At
June 30, 2010, we had factoring relationships arranged by four customers
with eight banks. The terms of these relationships are such that the banks are
not obligated to factor any amount of receivables. Because of the current
challenging capital markets, it is possible that these banks may not have the
capacity or willingness to fund these factoring arrangements at the levels they
have in the past, or at all, and our customers may not continue to offer such
programs in the future.
37
We sold
approximately $135.8 million and $122.8 million of receivables during the six
months ended June 30, 2010 and 2009, respectively. If receivables had not
been factored, $128.6 million and $121.5 million of additional receivables would
have been outstanding at June 30, 2010 and December 31, 2009,
respectively. If we had not factored these receivables, we would have had to
finance these receivables in some other way, renegotiate terms with customers or
reduce cash on hand. Our short-term cash projections assume a level of factored
accounts receivable in a range of $120.0 million to $135.0 million at any given
time based upon our current customer contracts.
Short-Term Liquidity
Outlook
Our
ability to make scheduled payments of principal or interest on, or to refinance,
our indebtedness or to fund capital expenditures will depend on our ability to
generate cash from operations and from factoring arrangements as discussed
previously. Such cash generation is subject to general economic, financial,
competitive, legislative, regulatory and other factors that are beyond our
control. Further, we terminated UCI’s revolving credit facility in
June 2009 as we determined that the cost to extend the facility was not
justified. The lack of a revolving credit facility may further reduce
our ability to meet liquidity needs.
Our
capital spending levels were lower in 2009 than historical spending levels. As
part of our plans to conserve cash, 2009 capital spending was limited to
expenditures necessary to maintain current operations and projects that had
short payback periods. Capital expenditures for the full year 2010 are expected
to be in the range of $30 million to $33 million. This increase over 2009
relates to funding specific targeted cost reduction opportunities as part of the
PSO initiative discussed below and incremental growth initiatives.
Based on
our forecasts, we believe that cash flow from operations and available cash and
cash equivalents will be adequate to service debt, meet liquidity needs and fund
necessary capital expenditures for the next twelve months.
Long-Term Liquidity
Outlook
As
presently structured, UCI would be the sole source of cash for the payment of
cash interest and any other payments on the UCI International Notes beginning in
2012, and we can give no assurance that the cash for those payments will be
available. In the future, we may also need to refinance all or a portion of the
principal amount of UCI’s senior subordinated notes and/or senior credit
facility borrowings, on or prior to maturity. If refinancing is necessary, there
can be no assurance that we will be able to secure such financing on acceptable
terms, or at all.
On-Going
Operational Initiatives
We
implemented a number of measures to improve the level of cash generated by our
operations in order to increase our liquidity and to align our cost structure
with our customers’ spending and current market conditions. These restructuring
activities included:
|
·
|
Employment
cost savings. We
implemented hourly and salaried workforce reductions across all overhead
and selling, general and administrative cost centers throughout 2009 and
2010 to align staffing levels with current business levels. As a result of
these reductions, we had approximately 3,850 employees at June 30,
2010 as compared to approximately 4,900 at December 31, 2008.
Additionally in 2009, we implemented wage freezes, suspended certain
matching contributions to defined contribution and profit sharing plans
and other cost reduction activities. As of June 30, 2010, the wage
freeze and suspension of certain matching contributions were still in
effect.
|
|
·
|
Additional
cost savings. In 2009, we
critically evaluated overall overhead and selling, general and
administrative discretionary spending and have instituted tight controls
over discretionary spending, requiring additional approvals for all such
spending across the Company. The same tight control over discretionary
spending has continued into
2010.
|
38
More
recently, we have launched our new PSO initiative. PSO utilizes our
existing global footprint and unique category management insights to optimize
the mix of products manufactured versus sourced, and to determine the optimal
manufacturing or vendor location. We expect that PSO will allow us to deliver a
high-quality, low-cost product by assembling certain products in the markets
where they are sold, assembling certain products specifically in low-cost
countries, and procuring certain products from selected low-cost country
suppliers.
Additionally,
we will continue to aggressively manage our investment in working capital and
our disciplined capital investment strategy.
CONTINGENCIES
Environmental;
Health and Safety
We are
subject to a variety of federal, state, local and foreign environmental; health
and safety laws and regulations, including those governing the discharge of
pollutants into the air or water, the management and disposal of hazardous
substances or wastes, and the cleanup of contaminated sites. We or our
predecessors have been identified as a potentially responsible party, or is
otherwise currently responsible, for contamination at five sites. One of these
sites is a former facility in Edison, New Jersey (the “New Jersey Site”), where
a state agency has ordered us to continue with the monitoring and investigation
of chlorinated solvent contamination. The New Jersey Site has been the subject
of litigation to determine whether a neighboring facility was responsible for
contamination discovered at the New Jersey Site. A judgment has been rendered in
that litigation to the effect that the neighboring facility is not responsible
for the contamination. We are analyzing what further investigation and
remediation, if any, may be required at the New Jersey Site. We are also
responsible for a portion of chlorinated solvent contamination at a previously
owned site in Solano County, California (the “California Site”), where we, at
the request of the regional water board, are investigating and analyzing the
nature and extent of the contamination and are conducting some remediation.
Based on currently available information, management believes that the cost of
the ultimate outcome of the environmental matters related to the New Jersey Site
and the California Site will not exceed the $1.3 million accrued at June 30,
2010 by a material amount, if at all. However, because all investigation and
analysis has not yet been completed and due to inherent uncertainty in such
environmental matters, it is possible that the ultimate outcome of these matters
could have a material adverse effect on results for a single
quarter.
In
addition to the two matters discussed above, we or our predecessors have been
named as a potentially responsible party at a third-party waste disposal site in
Calvert City, Kentucky (the “Kentucky Site”). We estimate settlement costs at
$0.1 million for this site. Also, we are involved in regulated remediation at
two of our manufacturing sites (the “Manufacturing Sites”). The combined cost of
the remaining remediation at such Manufacturing Sites is $0.2 million. We
anticipate that the majority of the $0.3 million reserved for settlement and
remediation costs will be spent in the next year. To date, the expenditures
related to the Kentucky Site and the Manufacturing Sites have been
immaterial.
Antitrust
Litigation
We are
subject to litigation and investigation related to pricing of aftermarket oil,
air, fuel and transmission filters, as described in Note J to the Consolidated
Financial Statements in Part I Item 1 of this Form 10-Q.
We intend
to vigorously defend against these claims. It is too soon to assess the possible
outcome of these proceedings. No amounts, other than ongoing defense costs, have
been recorded in the financial statements for these matters.
39
Patent
Litigation
Champion
is a defendant in litigation with Parker-Hannifin Corporation pursuant to which
Parker-Hannifin claims that certain of Champion’s products infringe a
Parker-Hannifin patent. On December 11, 2009, following trial, a jury verdict
was reached, finding in favor of Parker-Hannifin with damages of approximately
$6.5 million. On May 3, 2010, the court entered a partial judgment in this
matter, awarding Parker-Hannifin $6.5 million in damages and a permanent
injunction. Both parties have filed post-trial
motions. Parker-Hannifin is seeking treble damages and attorneys’
fees. Champion is seeking a judgment as a matter of law on the issues
of infringement and patent invalidity. Champion continues to
vigorously defend this matter; however, there can be no assurance with respect
to the outcome of litigation. Champion recorded a $6.5 million liability in the
financial statements for this matter. The $6.5 million liability for
this patent litigation is included in “Accrued expenses and other current
liabilities” at June 30, 2010. During the three and six months ended
June 30, 2010, Champion incurred post-trial costs of $0.1 million and $1.0
million, respectively.
In order
to appeal the judgment in this matter, we posted a letter of credit in the
amount of $7.4 million. The issuer of the letter of credit required
us to cash collateralize the letter of credit. This cash is recorded
as “Restricted cash” and is a component of long-term assets on the balance sheet
at June 30, 2010.
Value-Added
Tax Receivable
Our
Mexican operation has outstanding receivables denominated in Mexican pesos in
the amount of $2.2 million, net of allowances, from the Mexican Department of
Finance and Public Credit. The receivables relate to refunds of Mexican
value-added tax, to which we believe we are entitled in the ordinary course of
business. The local Mexican tax authorities have rejected our claims for these
refunds, and we have commenced litigation in the regional federal administrative
and tax courts to order the local tax authorities to process these
refunds. During the three months ended June 30, 2010, we recorded a
$1.4 million provision due to uncertainties of collection of these
receivables.
Other
Litigation
We are
subject to various other contingencies, including routine legal proceedings and
claims arising out of the normal course of business. These proceedings primarily
involve commercial claims, product liability claims, personal injury claims and
workers’ compensation claims. The outcome of these lawsuits, legal proceedings
and claims cannot be predicted with certainty. Nevertheless, we believe that the
outcome of any currently existing proceedings, even if determined adversely,
would not have a material adverse effect on our financial condition or results
of operations.
Recently
Adopted Accounting Guidance
See the
Recently Adopted Accounting Guidance section of Note A to the Consolidated
Financial Statements in Part I Item 1 of this Form 10-Q.
Item 3. Quantitative and
Qualitative Disclosures about Market Risk
Our
exposure to market risk consists of foreign currency exchange rate fluctuations
and changes in interest rates.
Foreign
Currency Exposure
Currency translation. As a
result of international operating activities, we are exposed to risks associated
with changes in foreign exchange rates, principally exchange rates between the
U.S. dollar and the Mexican peso, British pound and the Chinese yuan. The
results of operations of our foreign subsidiaries are translated into U.S.
dollars at the average exchange rates for each relevant period, except for our
Chinese subsidiaries, where cost of sales is translated primarily at historical
exchange rates. This translation has no impact on our cash flow. However, as
foreign exchange rates change, there are changes to the U.S. dollar equivalent
of sales and expenses denominated in foreign currencies. In 2009, approximately
8% of our net sales were made by our foreign subsidiaries and our total non-U.S.
net sales represented 14.7% of our total net sales. Their combined
net income was not material. While these results, as measured in U.S. dollars,
are subject to foreign exchange rate fluctuations, we do not consider the
related risk to be material to our financial condition or results of
operations.
40
Except
for the Chinese subsidiaries, the balance sheets of foreign subsidiaries are
translated into U.S. dollars at the closing exchange rates as of the relevant
balance sheet date. Any adjustments resulting from the translation are recorded
in accumulated other comprehensive income (loss) on our statements of
changes in shareholder’s equity. For our Chinese subsidiaries, non-monetary
assets and liabilities are translated into U.S. dollars at historical rates and
monetary assets and liabilities are translated into U.S. dollars at the closing
exchange rate as of the relevant balance sheet date. Adjustments resulting from
the translation of the balance sheets of our Chinese subsidiaries are recorded
in our income statements.
Currency transactions.
Currency transaction exposure arises where actual sales and purchases are made
by a company in a currency other than its own functional currency. In 2010, we
expect to source approximately $112 million of components from China. To the
extent possible, we structure arrangements where the purchase transactions are
denominated in U.S. dollars as a means to minimize near-term exposure to foreign
currency fluctuations. Since June 30, 2008, the relationship of the
U.S. dollar to the Chinese yuan has remained stable.
A
weakening U.S. dollar means that we may be required to pay more U.S. dollars to
obtain components from China, which equates to higher cost of sales. If we are
unable to negotiate commensurate price decreases from our Chinese suppliers,
these higher prices would eventually translate into higher cost of sales. In
that event we would attempt to obtain corresponding price increases from our
customers, but there are no assurances that we would be successful.
Our
Mexican operations source a significant amount of inventory from the United
States. During the period September 30, 2008 through March 31, 2009, the U.S.
dollar strengthened against the Mexican peso by approximately 33%. During the
period March 31, 2009 through June 30, 2010, the U.S. dollar weakened against
the Mexican peso by approximately 12%, partially offsetting the trend
experienced in the prior six months. A strengthening U.S. dollar against the
Mexican peso means that our Mexican operations must pay more pesos to obtain
inventory from the United States. These higher prices translate into higher cost
of sales for our Mexican operations. We are attempting to obtain corresponding
price increases from our customers served by our Mexican operations, but the
weakness in the Mexican economy has limited the ability to entirely offset the
higher cost of sales.
We will
continue to monitor our transaction exposure to currency rate changes and may
enter into currency forward and option contracts to limit the exposure, as
appropriate. Gains and losses on contracts are deferred until the transaction
being hedged is finalized. As of June 30, 2010, we had no foreign currency
contracts outstanding. We do not engage in speculative activities.
Interest
Rate Risk
We
utilize, and we will continue to utilize, sensitivity analyses to assess the
potential effect of our variable rate debt. At our June 30, 2010 debt level
and borrowing rates, annual interest expense including amortization of deferred
financing costs and debt discount would be approximately $60.1 million. If
variable interest rates were to increase by 0.25% per annum, the net impact
would be a decrease of approximately $0.8 million of our net income and cash
flow.
Treasury
Policy
Our
treasury policy seeks to ensure that adequate financial resources are available
for the development of our businesses while managing our currency and interest
rate risks. Our policy is to not engage in speculative transactions. Our
policies with respect to the major areas of our treasury activity are set forth
above.
41
Item 4. Controls and
Procedures
The
Company maintains disclosure controls and procedures that are designed to ensure
that information required to be disclosed in the Company’s Exchange Act reports
is recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission’s rules and forms and that
such information is accumulated and communicated to the Company’s management,
including its Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow for timely decisions regarding required disclosure. In
designing and evaluating the disclosure controls and procedures, management
recognizes that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives, and management is required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures.
As
required by Rule 13a-15 under the Exchange Act, management has evaluated, with
the participation of our Chief Executive Officer and Chief Financial Officer,
the effectiveness of our disclosure controls and procedures as of June 30, 2010,
the end of the period covered by this Quarterly Report on Form 10-Q. Based on
the foregoing, our Chief Executive Officer and Chief Financial Officer have
concluded, based on this evaluation, that as of June 30, 2010, the end of the
period covered by this Quarterly Report on Form 10-Q, our disclosure controls
and procedures were effective at a reasonable assurance level.
Further,
management determined that, as of June 30, 2010, there were no changes in our
internal control over financial reporting that occurred during the three months
then ended that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.
42
PART
II
OTHER
INFORMATION
Item 1. Legal
Proceedings
The
information required by this Item is incorporated by reference to Note J –
Contingencies – Environmental; Antitrust Litigation; Valued-Added Tax
Receivable; Patent Litigation; Other Litigation to the unaudited condensed
consolidated financial statements under Part I of this report.
Item 1.A. Risk
Factors
Continued
volatility in and disruption to the global economic environment may materially
and adversely affect our business, financial condition and results of
operations.
The
global economy has continued to experience a period of significant uncertainty,
characterized by very weak or negative economic growth, high unemployment,
reduced spending by consumers and businesses, the bankruptcy, failure, collapse
or sale of various businesses and financial institutions and a considerable
level of intervention from the U.S. federal government and various foreign
governments. Demand for automotive products such as ours is linked to consumer
demand for automobiles, which has been, and may continue to be, adversely
impacted by the continuing uncertain economic environment.
First,
consumers’ driving habits are impacted by deteriorating economic conditions,
leading to a reduction in miles driven thereby increasing the periods between
maintenance and repairs. In the latter part of 2008 and 2009, consumers’ driving
habits were impacted by deteriorating economic conditions. U.S. Department
of Energy statistics indicate that miles driven in the United States for the
year 2008 were 3.2% lower than for 2007. Miles driven in 2009 increased
only slightly from 2008. If total miles driven were to continue to decrease
and consumers extend the mileage interval for routine maintenance, we could
experience a decline in demand for our products due to a reduction in the need
for replacement parts. Further, as economic conditions result in a
reduction in discretionary spending for auto repair by the end users of our
products, our results of operations could be impacted.
Second,
difficult economic conditions may cause changes to the business models,
products, financial condition or consumer financing and rebate programs of the
OEMs, adversely affecting the number of cars produced and purchased. North
American light vehicle sales reached their lowest point in nearly three decades
in 2009 and the number of light vehicle registrations remained flat from 2008 to
2009. The effect of fewer cars being sold and fewer cars on the road adversely
affected the demand for our products, reducing purchases by our customers in the
aftermarket and by the OEMs.
If
economic conditions continue to deteriorate or do not show signs of improvement,
we may experience material adverse impacts to our business and operating
results.
The
current economic environment and adverse credit market conditions may
significantly affect our ability to meet liquidity needs and may materially and
adversely affect the financial soundness of our customers and
suppliers.
The
capital and credit markets have been experiencing extreme volatility and
disruption since the latter part of 2008 and as a result, the markets have
exerted downward pressure on the availability of liquidity and credit capacity
for many issuers. While currently these conditions have not materially
impaired our ability to operate our business, there can be no assurance that
there will not be a further deterioration in financial markets and confidence in
major economies, which could increase the cost of financing.
43
We need
liquidity to pay our operating expenses, interest on our debt and capital
expenditures. Without sufficient liquidity, we will be forced to curtail
our operations, and our business will suffer. Our primary sources of
liquidity are cash on hand, cash flow from operations and factoring of customer
trade accounts receivable. Subject to certain limitations, UCI’s credit
agreement for its senior credit facility permits sales of and liens on
receivables, which are being sold pursuant to factoring arrangements arranged
for us by certain customers with a number of banks. At June 30, 2010, we
had factoring relationships arranged by four customers with eight
banks. The terms of these relationships are such that the banks are not
obligated to factor any amount of receivables. Because of the current
challenging capital markets, it is possible that these banks may not have the
capacity or willingness to fund these factoring arrangements at the levels they
have in the past, or at all, or our customers could discontinue their
participation in the arrangements, which could have a material adverse impact on
our liquidity. Further, we terminated our revolving credit facility in June
2009. While we determined at the time that the cost to extend the facility
was not justified, the lack of a revolving credit facility may further reduce
our ability to meet liquidity needs.
In
addition to the potential liquidity risks we face, some of our customers and
suppliers are likely to experience serious cash flow problems and, as a
result, may find it difficult to obtain financing, if financing is available at
all. As a result, our customers’ need for and ability to purchase our products
or services may decrease, and our suppliers may increase their prices, reduce
their output or change their terms of sale. Any inability of customers to pay us
for our products and services, or any demands by suppliers for different payment
terms, may materially and adversely affect our earnings and cash
flow. Furthermore, our suppliers may not be successful in generating
sufficient revenue or securing alternate financing arrangements, and therefore
may no longer be able to supply goods and services to us. In that event, we
would need to find alternate sources of these goods and services, and there is
no assurance that we would be able to find such alternate sources on favorable
terms, if at all. Any such disruption in our supply chain could adversely affect
our ability to manufacture and deliver our products on a timely basis, and
thereby affect our results of operations.
Our
relationship with AutoZone creates risks associated with a concentrated net
sales source.
We
generate a large percentage of our net sales from our business with AutoZone,
but we cannot be assured that AutoZone will continue to purchase from us. Net
sales to AutoZone accounted for approximately 30% of our total net sales in
fiscal 2009 and 29% of our total net sales in 2008, respectively. Several of our
competitors are likely to pursue business opportunities with this customer and
threaten our current position. If we fail to maintain this relationship, our net
sales will be significantly diminished. Even if we maintain our relationship,
our net sales concentration as a result of this relationship increases the
potential impact to our business that could result from any changes in the
economic terms of this relationship. Any change in the terms of our sales to
this customer could have a material impact on our financial position and results
of operations. Further, to the extent AutoZone’s overall business or market
share decreases, or does not increase as anticipated, we may be adversely
impacted.
Our
contracts with our customers are generally short-term and do not require the
purchase of a minimum amount.
We do not
typically enter into firm, long-term agreements with customers for the sale of
our products. Instead, our products are sold through a series of purchase orders
based on our customers’ current or projected needs. By not entering into
long-term agreements we risk losing customers, or sales of a certain product to
any particular customer, on relatively short notice. The loss of a significant
customer, or a significant reduction in sales to a particular customer, could
have a material impact on our financial position and results of
operations.
Increases
in our raw materials and component costs or the loss of a number of our
suppliers could adversely affect our financial health.
We depend
on third parties for the raw materials and components used in our manufacturing
processes. We generally purchase our materials on the open market. However, in
certain situations we have found it advantageous to enter into long-term
contracts for certain commodities purchases. During much of 2008, the cost of
commodities, including steel, aluminum, iron, plastic and other petrochemical
products, packaging materials and media, increased significantly compared to
2007. Energy costs also increased significantly during this period. These higher
costs affected the prices we paid for raw materials and for purchased component
parts and finished products. The prices of these commodities have fluctuated
significantly in recent years and such volatility in the prices of these
commodities could increase the costs of manufacturing our products and providing
our services. We may not be able to pass on these costs to our customers and
this could have a material adverse effect on our financial condition, results of
operations or cash flows. Even in the event that increased costs can be passed
through to customers, our gross margin percentages would decline. While we
currently maintain alternative sources for steel and other raw materials, our
business is subject to the risk of additional price fluctuations and periodic
delays in the delivery of our raw materials. Any such price fluctuations or
delays, if material, could harm our profitability or operations. In addition,
the loss of a substantial number of suppliers could result in material cost
increases or reduce our production capacity. We are also significantly affected
by the cost of natural gas used for fuel and the cost of electricity. Natural
gas and electricity prices have historically been volatile.
44
We
monitor sources of supply to attempt to assure that adequate raw materials and
other supplies needed in manufacturing processes are available. However, we do
not typically enter into hedge transactions to reduce our exposure to price
risks and cannot assure you that we will be successful in passing on these
attendant costs if these risks were to materialize. In addition, if we are
unable to continue to purchase our required quantities of raw materials on
commercially reasonable terms, or at all, if we are unable to maintain or enter
into purchasing contracts for commodities, or if delivery of materials from
suppliers is delayed or non-conforming, our operations could be disrupted or our
profitability could be adversely impacted.
We
face competition in our markets.
We
operate in some very competitive and fragmented markets, and we compete against
numerous different types of businesses, some of which have greater financial or
other resources than we do. Although we have significant market positions in
each of our product lines within the aftermarket, we cannot be assured that we
will be able to maintain our current market share. In the OEM sales channel,
some of our competitors have achieved substantially greater market penetration
in many of the product lines which we offer. Competition is based on a number of
considerations, including product performance, quality of customer service and
support, timely delivery and price. Our customers increasingly demand a broad
product range, and we must continue to develop our expertise in order to
manufacture and market these products successfully. To remain competitive, we
will need to invest continuously in manufacturing, working capital, customer
service and support, marketing and our distribution networks. We cannot be
assured that we will have sufficient resources to continue to make such
investments or that we will maintain our competitive position within each of the
markets we serve. As a result of competition, we have experienced pricing
pressure. There can be no guarantee that this downward price pressure will not
continue, and we may be forced to adjust the prices of some of our products to
stay competitive, or not compete at all in some markets, possibly giving rise to
revenue loss.
The trend
toward consolidation and bankruptcies among automotive parts suppliers is
resulting in fewer, larger suppliers who benefit from purchasing and
distribution economies of scale. If we cannot achieve cost savings and
operational improvements sufficient to allow us to compete favorably in the
future with these larger companies, our financial condition and results of
operations could be adversely affected due to a reduction of, or inability to
increase, sales.
We
are subject to increasing pricing pressure from import activity, particularly
from Asia.
Price
competition from light vehicle aftermarket suppliers, particularly based in Asia
and other locations with lower production costs, have historically played a role
and may play an increasing role in the aftermarket channels in which we compete.
Pricing pressures have historically been more prevalent with respect to our
filter products than our other products. While aftermarket manufacturers in
these locations have historically competed primarily in markets for less
technologically advanced products and manufactured a limited number of products,
they are expanding their manufacturing capabilities to move toward producing a
broad range of lower cost, higher quality products and providing an expanded
product offering. Partially in response to these pressures, we opened two new
factories in China in 2008. In the future, competitors in Asia may be able to
effectively compete in our premium markets and produce a wider range of
products, which may force us to move additional manufacturing capacity offshore
and/or lower our prices, reducing our margins and/or decreasing our net
sales.
45
Our
international operations are subject to uncertainties that could affect our
operating results.
Our
business is subject to certain risks associated with doing business
internationally. Our non-U.S. sales represented approximately 14.7% of our total
net sales for the year ended December 31, 2009. In addition, we operate
seven manufacturing facilities outside of the United States. Accordingly, our
future results could be harmed by a variety of factors, including:
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fluctuations
in currency exchange rates;
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geopolitical
instability;
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exchange
controls;
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compliance
with U.S. Department of Commerce export
controls;
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tariffs
or other trade protection measures and import or export licensing
requirements;
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potentially
negative consequences from changes in tax
laws;
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fluctuations
in interest rates;
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unexpected
changes in regulatory requirements;
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differing
labor regulations;
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enforceability
of contracts in the People’s Republic of
China;
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requirements
relating to withholding taxes on remittances and other payments by
subsidiaries;
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restrictions
on our ability to own or operate subsidiaries, make investments or acquire
new businesses in these
jurisdictions;
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restrictions
on our ability to repatriate dividends from our
subsidiaries;
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exposure
to liabilities under the U.S. Foreign Corrupt Practices
Act;
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difficulty
of enforcing judgments or other remedies in foreign
jurisdictions;
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diminished
protection for intellectual property outside of the United States;
and
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the
potential for terrorism against U.S.
interests.
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In
addition, we may face obstacles in the People’s Republic of China, including a
cumbersome bureaucracy and significant political, economic and legal risks which
may adversely affect our operations in that country.
As we
continue to expand our business globally, our success will depend, in large
part, on our ability to anticipate and effectively manage these and other risks
associated with our international operations. However, any of these factors
could adversely affect our international operations and, consequently, our
operating results.
We
could be materially adversely affected by changes or imbalances in currency
exchange and other rates.
As a
result of increased international production and sourcing of components and
completed parts for resale, we are exposed to risks related to the effects of
changes in foreign currency exchange rates, principally exchange rates between
the U.S. dollar and the Chinese yuan and the U.S. dollar and the Mexican peso.
The currency exchange rate from Chinese yuan to U.S. dollars has historically
been stable, in large part due to the economic policies of the Chinese
government. However, there are no assurances that this currency exchange rate
will continue to be as stable in the future. The U.S. government has stated that
the Chinese government should reduce its influence over the currency exchange
rate and let market conditions control. Less influence by the Chinese government
will most likely result in the Chinese yuan strengthening against the U.S.
dollar. An increase in the Chinese yuan against the dollar means that we will
have to pay more in U.S. dollars for our purchases from China. If we are unable
to negotiate commensurate price decreases from our Chinese suppliers, these
higher prices would eventually translate into higher costs of sales. In that
event, we would attempt to obtain corresponding price increases from our
customers, but there are no assurances that we would be successful.
Our
Mexican operations source a significant amount of inventory from the United
States. During the period September 30, 2008 through March 31, 2009,
the U.S. dollar strengthened against the Mexican peso by approximately 33%.
During the period March 31, 2009 through June 30, 2010, the U.S. dollar
weakened against the Mexican peso by approximately 12%, partially offsetting the
trend experienced in the prior six months. A strengthening U.S. dollar against
the Mexican peso means that our Mexican operations must pay more in pesos to
obtain inventory from the United States, which translates into higher cost of
sales for the Mexican operations. We are attempting to obtain price increases
from our customers for the products sold by our Mexican operations, but there
are no assurances that we will be successful.
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We
currently do not enter into foreign exchange forward contracts to hedge certain
transactions in major currencies and even if we wished to do so in the future,
we may not be able, or it may not be cost-effective, to enter into contracts to
hedge our foreign currency exposure.
If
the North American light vehicle aftermarket adopts more expansive return
policies or practices such as extended payment terms, our cash flow and results
of operations could be harmed.
We are
subject to returns from customers, some of which may manage their excess
inventory through returns. In line with industry practices, arrangements with
customers typically include provisions that permit them to return specified
levels of their purchases. Returns have historically represented approximately
3% to 5% of our gross sales. If returns from our customers significantly
increase, for reasons such as obsolescence or changes in inventory management by
our customers, our profitability may be adversely affected. Further, certain of
our products may not be reused or resold upon return. In addition, some
customers in the North American light vehicle aftermarket are pursuing ways to
shift their costs of working capital, including extending payment terms. To the
extent customers extend payment terms, our cash flow may be adversely
affected.
The
introduction of new and improved products and services poses a potential threat
to the aftermarket for light vehicle parts.
Improvements
in technology and product quality are extending the longevity of light vehicle
parts and delaying aftermarket sales. In particular, the introduction of oil
change indicators and the use of synthetic motor oils may extend oil filter
replacement cycles. The introduction of electric, fuel cell and hybrid light
vehicles may pose a long-term risk to our business because these vehicles are
unlikely to utilize many of our existing product lines. The introduction of new
and improved service initiatives by OEMs also poses a risk to our market share
in the light vehicle replacement parts market. In particular, we face market
share risk from general automakers, which have introduced increased warranty and
maintenance service initiatives, which are gaining popularity. These service
initiatives have the potential to decrease the demand on aftermarket sales of
our products in the traditional and retail sales channels.
The
consolidation of our customers can have adverse effects on our
business.
Our
financial condition and results of operations could also be adversely affected
because the customer base for automotive parts is decreasing in both the OEM
channel and aftermarket. As a result, we are competing for business from fewer
customers. Due to the growing market share of these major customers, we have
been, and expect to continue to be, requested to reduce prices. We cannot be
certain that we will be able to generate cost savings and operational
improvements in the future that are sufficient to offset price reductions
requested by existing customers and necessary to win additional
business.
Our
lean manufacturing and other cost saving plans may not be
effective.
Our
strategy includes goals such as improvement of inventory management and customer
delivery and plant and distribution facility consolidation. While we have and
will continue to implement these strategies, there can be no assurance that we
will be able to do so successfully or that we will realize the projected
benefits of these and other cost saving plans. If we are unable to realize these
anticipated cost reductions, our financial health may be adversely affected.
Moreover, our continued implementation of cost saving plans and facilities
integration may disrupt our operations and performance.
47
It
may be difficult for us to recruit and retain the types of highly-skilled
employees we need to remain competitive.
Our
continued success depends in part on our ability to recruit, retain and motivate
highly-skilled sales, marketing and engineering personnel. Competition for
persons in our industry is intense, and we may not be able to successfully
recruit, train or retain qualified personnel. If we fail to retain and recruit
the necessary personnel, our business and our ability to obtain new customers
and retain existing customers, develop new products and provide acceptable
levels of customer service could suffer. We have entered into employment
agreements with certain of our key personnel. However, we cannot be assured that
these individuals will stay with us. If any of these persons were to leave our
company, it could be difficult to replace him or her, and our operations and
ability to manage day-to-day aspects of our business may be materially adversely
affected.
We
may be subject to work stoppages at our facilities, or our customers may be
subjected to work stoppages, either of which could negatively impact the
profitability of our business.
As of
June 30, 2010, we had approximately 3,850 employees, with union
affiliations and collective bargaining agreements at two of our facilities,
representing approximately 12% of our workforce. The bargaining agreement for
our Fairfield, Illinois plant expires in August 2010 and we are currently in the
process of renegotiating that agreement. Since 1984, we have had only one work
stoppage, which lasted for three days at our Fairfield, Illinois plant. Although
we believe that our relations with our employees are currently good, if our
unionized workers were to engage in a strike, work stoppage or other slowdown in
the future, we could experience a disruption of our operations, which could
interfere with our ability to deliver products on a timely basis and could have
other negative effects, such as decreased productivity and increased labor
costs. We may also incur increased labor costs in the event our work force
becomes more unionized or as a result of any renegotiation of our existing labor
arrangements. In addition, many of our direct and indirect customers and vendors
have unionized work forces. Strikes, work stoppages or slowdowns experienced by
these customers or vendors or their other suppliers could result in slowdowns or
closings of assembly plants that use our products or supply materials for use in
the production of our products. Organizations responsible for shipping our
products may also be impacted by occasional strikes. Any interruption in the
delivery of our products could reduce demand for our products and could have a
material adverse effect on us.
Increased
crude oil and energy prices and overall economic conditions could reduce global
demand for and use of automobiles, which could have an adverse effect on our
profitability.
Material
increases in the price of crude oil have, historically, been a contributing
factor to the periodic reduction in the global demand for and use of
automobiles. A significant increase in the price of crude oil could reduce
global demand for and use of automobiles and shift customer demand away from
larger cars and light trucks, including SUVs, which we believe have more
frequent replacement intervals for our products, which could have an adverse
effect on our profitability. For example, historic highs in crude oil
prices and corresponding historic highs in gasoline prices at the pump in 2008
impacted consumers’ driving habits. See “—Continued volatility in and
disruption to the global economic environment may materially and adversely
affect our business, financial condition and results of
operations.” Further, higher gasoline prices may result in a
reduction in discretionary spending for auto repair by the end users of our
products, which could materially adversely impact our results of
operations. A reduction in discretionary spending can also result in a
decrease in the number of new cars purchased, which adversely affects the demand
for our products by our customers in the aftermarket and by the
OEMs. Additionally, higher energy costs may increase our freight expenses
associated with the shipping of our products to customers.
Environmental,
health and safety laws and regulations may impose significant compliance costs
and liabilities on us.
We are
subject to many environmental, health and safety laws and regulations governing
emissions to air, discharges to water, the generation, handling and disposal of
waste and the cleanup of contaminated properties. Compliance with these laws and
regulations is costly. We have incurred and expect to continue to incur
significant costs to maintain or achieve compliance with applicable
environmental, health and safety laws and regulations. Moreover, if these
environmental, health and safety laws and regulations become more stringent in
the future, we could incur additional costs. We cannot assure we are in full
compliance with all environmental, health and safety laws and regulations. Our
failure to comply with applicable environmental, health and safety laws and
regulations and permit requirements could result in civil or criminal fines,
penalties or enforcement actions, third-party claims for property damage and
personal injury, requirements to clean up property or to pay for the costs of
cleanup or regulatory or judicial orders enjoining or curtailing operations or
requiring corrective measures, including the installation of pollution control
equipment or remedial actions.
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We may be
subject to liability under the Comprehensive Environmental Response,
Compensation and Liability Act and similar state or foreign laws for
contaminated properties that we currently own, lease or operate or that we or
our predecessors have previously owned, leased or operated, and sites to which
we or our predecessors sent hazardous substances. Such liability may be joint
and several so that we may be liable for more than our share of contamination,
and any such liability may be determined without regard to causation or
knowledge of contamination. We or our predecessors have been named potentially
responsible parties at contaminated sites from time to time in the past. We are
currently investigating and/or remediating, or are otherwise currently
responsible for, contamination at six sites, for which management believes it
has made adequate reserves. In addition, we occasionally evaluate
various alternatives with respect to our facilities, including possible
dispositions or closings. Investigations undertaken in connection with these
activities may lead to discoveries of contamination that must be remediated, and
closings of facilities may trigger remediation requirements that are not
applicable to operating facilities. We may also face lawsuits brought by third
parties that either allege property damage or personal injury as a result of, or
seek reimbursement for costs associated with, such contamination.
If
the products we manufacture or distribute are found to be defective, we could
incur significant costs and our reputation could be adversely
affected.
We face a
business risk of exposure to product liability claims in the event that the use
of our products has, or is alleged to have, resulted in injury, death or other
adverse effects. We currently maintain product liability insurance coverage, but
we cannot be assured that we will be able to obtain such insurance on acceptable
terms in the future, if at all, or that any such insurance will provide adequate
coverage against potential claims. Product liability claims can be expensive to
defend and can divert the attention of management and other personnel for long
periods of time, regardless of the ultimate outcome. An unsuccessful product
liability defense could have a material adverse effect on our business,
financial condition, results of operations or prospects. If one of our products
is determined to be defective, we may face substantial warranty costs and may be
responsible for significant costs associated with a product recall or a
redesign. In addition, our business depends on the strong brand reputation we
have developed. In the event that our reputation is damaged, we may face
difficulty in maintaining our pricing positions with respect to some of our
products or have reduced demand for our products, which could negatively impact
our net sales and profitability.
We are subject to class action
lawsuits alleging conspiracy violations of Section 1 of the Sherman Act, 15
U.S.C. § 1 and state law, related to aftermarket oil, air, fuel and transmission
filters and lawsuits alleging violations of the Canadian Competition Act. If the
plaintiffs in these lawsuits against us are successful, our financial condition,
results of operations and liquidity, as well as our reputation may be materially
and adversely affected.
UCI’s
wholly-owned subsidiary, Champion Laboratories, Inc., or Champion, has been
named as one of multiple defendants in three consolidated amended complaints
alleging conspiracy violations of Section 1 of the Sherman Act, 15
U.S.C. § 1 and state law, related to aftermarket oil, air, fuel and
transmission filters. The complaints are styled as putative class actions. One
asserts claims on behalf of a putative class of direct filter purchasers, one
asserts claims on behalf of a putative class of indirect end user filter
purchases and one asserts claims on behalf of a class of operators of service
stations in California who indirectly purchased filters from defendants for
resale. All three complaints seek damages, including statutory treble damages,
an injunction against future violations, costs and attorney’s fees. Champion was
also named as one of multiple defendants in a related complaint filed by William
G. Burch in the United States District Court for the Northern District of
Oklahoma on behalf of the United States pursuant to the False Claims Act, 31
U.S.C. § 3730. The United States declined to intervene in that case. Champion
was also named as one of five defendants in a putative class action filed in
Quebec, Canada. This action alleges conspiracy violations of the Canadian
Competition Act and violations of the obligation to act in good faith (contrary
to art. 6 of the Civil Code of Quebec) related to the sale of aftermarket
filters. The plaintiff seeks compensatory damages against the five defendants in
the amount of $5 million and $1 million in punitive damages. Champion, but not
UCI, was also named as one of 14 defendants in a putative class action filed in
Ontario, Canada. This action alleges civil conspiracy, intentional interference
with economic interests, and conspiracy violations under the Canadian
Competition Act related to the sale of aftermarket filters. The plaintiff seeks
$150 million in general damages against the 14 defendants and $15 million in
punitive damages. The Offices of the Attorney Generals for the State of Florida
and the State of Washington are also investigating the allegations raised in
these suits. We are fully cooperating with the Florida and Washington Attorney
General investigations. The Florida Attorney General filed a complaint against
Champion and eight other defendants in the Northern District of
Illinois. The complaint alleges violations of Section 1 of the Sherman
Act and Florida law related to the sale of aftermarket filters. The
complaint asserts direct and indirect purchaser claims on behalf of Florida
governmental entities and Florida consumers. It seeks damages, including
statutory treble damages, penalties, fees, costs and an
injunction.
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The
Antitrust Division of the Department of Justice, or DOJ, investigated the
allegations raised in these suits, and certain current and former employees of
the defendants, including Champion, testified pursuant to subpoenas. On
January 21, 2010, DOJ sent a letter to counsel for Champion stating that
“the Antitrust Division’s investigation into possible collusion in the
replacement auto filters industry is now officially closed.”
We intend
to vigorously defend against these claims. However, the outcome of these class
actions, like other litigation proceedings, is uncertain. Also, litigation and
other steps taken to defend these lawsuits can be costly, and we may incur
substantial costs and expenses in doing so. Multidistrict litigation is
particularly complex and can extend for a protracted time, which can
substantially increase the cost of such litigation. The defense of these
lawsuits is also expected to divert the efforts and attention of some of our key
management and personnel from the normal business operations of our company. As
a result, our defense of this litigation, regardless of its eventual outcome,
will likely be costly and time consuming. If the plaintiffs in these lawsuits
against us are successful, it may result in substantial monetary damages, which
could have a material adverse effect on our business, financial condition,
results of operations, and liquidity as well as our reputation.
Entering
new markets poses commercial risks.
We have
recently made significant investments as part of our strategy to expand into new
markets. Maintaining continued expansion requires significant investment and
resources and we cannot be assured these resources will continue to be available
as needed. We also cannot guarantee that our expansion into any new market will
be successful, or whether we will be able to meet the needs of new customers or
compete favorably in any new market. Therefore, we may be unable to recover the
costs associated with such efforts.
If
we are unable to meet future capital requirements, our business may be adversely
affected.
We
periodically make capital investments to, among other things, maintain and
upgrade our facilities and enhance our production processes. As we grow, we may
have to incur capital expenditures. Historically, we have been able to fund
these expenditures through cash flow from operations and borrowings under UCI’s
senior credit facility. However, UCI’s senior credit facility contains
limitations that could affect our ability to fund our future capital
expenditures and other capital requirements. In addition, the revolving credit
facility of UCI’s senior credit facility terminated in June 2009. We cannot be
assured that we will have, or be able to obtain, adequate funds to make all
necessary capital expenditures when required, or that the amount of future
capital expenditures will not be materially in excess of our anticipated or
current expenditures. If we are unable to make necessary capital expenditures,
our product line may become dated, our productivity may be decreased and the
quality of our products may be adversely affected, which, in turn, could reduce
our net sales and profitability.
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We
are subject to risks associated with changing manufacturing techniques, which
could place us at a competitive disadvantage.
The
successful implementation of our business strategy requires us to continuously
evolve our existing products and introduce new products to meet customers’ needs
in the industries we serve. Our products are characterized by stringent
performance and specification requirements that mandate a high degree of
manufacturing and engineering expertise. If we fail to meet these requirements,
our business could be at risk. We believe that our customers rigorously evaluate
their suppliers on the basis of a number of factors, including:
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product
quality;
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technical
expertise and development
capability;
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new
product innovation;
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reliability
and timeliness of delivery;
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price
competitiveness;
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product
design capability;
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manufacturing
expertise;
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operational
flexibility;
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customer
service; and
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overall
management.
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Our
success will depend on our ability to continue to meet our customers’ changing
specifications with respect to these criteria. We cannot be assured that we will
be able to address technological advances or introduce new products that may be
necessary to remain competitive within our businesses. Furthermore, we cannot be
assured that we can adequately protect any of our own technological developments
to produce a sustainable competitive advantage.
We
may not be able to continue to grow through acquisitions of, or investments in,
other companies.
In the
past we have grown through acquisitions and partnership opportunities and we may
engage in similar transactions in the future. Such transactions, however,
involve significant risks including the integration of the newly acquired
business, the diversion of management’s attention from other business concerns
and effects on our business relationships with customers and suppliers. We
cannot be assured we will successfully identify suitable acquisition or
partnership opportunities in the future, and in the event we do commence with
such transactions, we cannot assure we will be successful at integrating the
newly acquired businesses or that it will perform as anticipated. Any such
failure could have a material and adverse effect on our business.
Our
intellectual property may be misappropriated or subject to claims of
infringement.
We
attempt to protect our intellectual property rights through a combination of
patent, trademark, copyright and trade secret protection, as well as licensing
agreements and third-party nondisclosure and assignment agreements. The costs
associated with the protection of our intellectual property are ongoing and in
some instances may be substantial. We cannot be assured that any of our
applications for protection of our intellectual property rights will be approved
or that others will not infringe or challenge our intellectual property rights.
We currently do, and may continue in the future to, rely on unpatented
proprietary technology. It is possible that our competitors will independently
develop the same or similar technology or otherwise obtain access to our
unpatented technology. To protect our trade secrets and other proprietary
information, we require employees, consultants and advisors to maintain the
confidentiality of our trade secrets and proprietary information. We cannot be
assured that these measures will provide meaningful protection for our trade
secrets, know-how or other proprietary information in the event of any
unauthorized use, misappropriation or disclosure. If we are unable to maintain
the proprietary nature of our technologies, our ability to sustain margins on
some or all of our products may be affected, which could reduce our sales and
profitability.
In
addition, from time to time, we pursue and are pursued in potential litigation
relating to the protection of certain intellectual property rights, including
with respect to some of our more profitable products. In some instances, we may
be found to have infringed on the intellectual property rights of others. In
such a case, we may incur significant costs or losses and may be subject to an
injunction that would prevent us from selling a product found to infringe. For
example, in December of 2009, a jury determined that Champion, our wholly-owned
subsidiary, had infringed on a competitor’s patent and the court entered a
partial judgment in this matter, awarding the plaintiff $6.5 million in damages
and a permanent injunction. The plaintiff is currently seeking treble damages
and attorneys’ fees.
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An
impairment in the carrying value of goodwill or other assets could negatively
affect our consolidated results of operations and net worth.
Pursuant
to accounting principles generally accepted in the United States, we are
required to annually assess our goodwill, intangibles and other long-lived
assets to determine if they are impaired. In addition, interim reviews must be
performed whenever events or changes in circumstances indicate that impairment
may have occurred. If the testing performed indicates that impairment has
occurred, we are required to record a non-cash impairment charge for the
difference between the carrying value of the goodwill or other intangible assets
and the implied fair value of the goodwill or other intangible assets in the
period the determination is made. Disruptions to our business, end market
conditions, protracted economic weakness and unexpected significant declines in
operating results may result in charges for goodwill and other asset
impairments. We assess the potential impairment of goodwill on an annual basis,
as well as when interim events or changes in circumstances indicate that the
carrying value may not be recoverable. We assess definite lived intangible
assets when events or changes in circumstances indicate that the carrying value
may not be recoverable. Our annual goodwill impairment test resulted in no
goodwill impairment. Although our analysis regarding the fair value of goodwill
indicates that it exceeds its carrying value, materially different assumptions
regarding the future performance of our businesses could result in goodwill
impairment losses.
Our
pension obligations could adversely impact our business.
We
sponsor defined benefit plans that were underfunded by $61.1 million at
December 31, 2009. If the performance of the assets in the pension plans
does not meet our expectations or actuarial assumptions, our required
contributions may be significantly greater than we currently expect. In such an
event, our cash flows may be insufficient to make such a payment or otherwise be
negatively impacted.
Our
substantial indebtedness could adversely affect our financial
health.
As of
June 30, 2010, we and our subsidiaries had total indebtedness of $742.6
million (not including intercompany indebtedness).
Our
substantial indebtedness could have important consequences to you. For example,
it could:
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require
us to dedicate a substantial portion of our cash flow from operations to
payments on our indebtedness, thereby reducing the availability of our
cash flow to fund acquisitions, working capital, capital expenditures,
research and development efforts and other general corporate
purposes;
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increase
our vulnerability to and limit our flexibility in planning for, or
reacting to, changes in our business and the industry in which we
operate;
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expose
us to the risk of increased interest rates as borrowings under UCI’s
senior credit facility are subject to variable rates of
interest;
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place
us at a competitive disadvantage compared to our competitors that have
less debt;
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limit
our ability to borrow additional funds;
and
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could
make us more vulnerable to a general economic downturn than a company that
is less leveraged.
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In
addition, the indentures governing our UCI International Notes due 2013 and
UCI’s senior subordinated notes, as well as the agreement governing UCI’s senior
credit facility, contain financial and other restrictive covenants that limit
our ability to engage in activities that may be in our long-term best interests.
Our failure to comply with those covenants could result in an event of default
which, if not cured or waived, could result in the acceleration of all of our
debts.
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To
service our indebtedness, we will require a significant amount of cash. Our
ability to generate cash depends on many factors beyond our
control.
Our cash
interest expense for fiscal year 2009 was $28.7 million. Our ability to make
payments on and to refinance our indebtedness, and to fund planned capital
expenditures will depend on our ability to generate cash in the future. This, to
a certain extent, is subject to general economic, financial, competitive,
legislative, regulatory and other factors that are beyond our
control.
We cannot
be assured that our business will generate sufficient cash flow from operations
or that future borrowings will be available to us in an amount sufficient to
enable us to pay our indebtedness, including our UCI International Notes, UCI’s
senior credit facility and UCI’s senior subordinated notes, or to fund our other
liquidity needs. In such circumstances, we may need to refinance all or a
portion of our indebtedness on or before maturity, and we cannot be assured that
we will be able to refinance any of our indebtedness including our UCI
International Notes, the senior credit facility and the senior subordinated
notes, on commercially reasonable terms or at all. If we cannot service our
indebtedness, we may have to take actions such as selling assets, seeking
additional equity or reducing or delaying capital expenditures, strategic
acquisitions, investments and alliances. We cannot be assured that any such
actions, if necessary, could be effected on commercially reasonable terms or at
all. Even in the event these actions are taken, we cannot be assured that we
will generate sufficient cash flow to enable us to pay our indebtedness. In
addition, the indentures governing our UCI International Notes and UCI’s senior
subordinated notes and the agreement governing UCI’s senior credit facility
limit our ability to sell assets and will also restrict the use of proceeds from
any such sale. Furthermore, UCI’s senior credit facility is secured by
substantially all of the assets of UCI. Therefore, we may not be able to sell
assets quickly enough or for sufficient amounts to enable us to meet our debt
service obligations. If we fail to make scheduled payments on our debt, such a
failure to pay would be an event of default and would likely result in a cross
default under other debt instruments enabling our lenders to declare all
outstanding principal and interest due and payable. Further, if we are unable to
repay debt, lenders having secured obligations could proceed against the
collateral securing that debt. As a result of such a default or action against
the collateral, we may be forced into bankruptcy or liquidation, which may
result in a partial or total loss of your investment.
Despite
current indebtedness levels, we and our subsidiaries may still be able to incur
substantially more debt. This could further exacerbate the risks associated with
our substantial financial leverage.
We and
our subsidiaries may be able to incur substantial additional indebtedness in the
future because the terms of the indentures governing our UCI International Notes
and UCI’s senior subordinated notes and the agreement governing UCI’s senior
credit facility do not fully prohibit us or our subsidiaries from doing so. If
new debt is added to our and our subsidiaries’ current debt levels, the related
risks that we and they now face could intensify.
Restrictive
covenants in the indenture governing our debt may restrict our ability to pursue
our business strategies.
The
indentures governing our UCI International Notes and UCI’s senior subordinated
notes and the agreement governing UCI’s senior credit facility limit our ability
and the ability of our restricted subsidiaries, among other things,
to:
|
•
|
pay
dividends and make distributions, investments or other restricted
payments;
|
|
•
|
incur
additional indebtedness;
|
|
•
|
sell
assets, including capital stock of restricted
subsidiaries;
|
|
•
|
agree
to payment restrictions affecting our restricted
subsidiaries;
|
|
•
|
consolidate,
merge, sell or otherwise dispose of all or substantially all of our
assets;
|
53
|
•
|
enter
into transactions with our
affiliates;
|
|
•
|
incur
liens; and
|
|
•
|
designate
any of our subsidiaries as unrestricted
subsidiaries.
|
In
addition, as of the end of any given quarter, UCI’s senior credit facility
require us to maintain a maximum consolidated leverage ratio and a minimum
consolidated interest coverage ratio, covering the previous four quarters,
through the term of the senior credit facility. At June 30, 2010, UCI was
required to maintain a maximum consolidated leverage ratio and a minimum
consolidated interest coverage ratio of 3.75 to 1 and 3.0 to 1, respectively.
These ratio requirements change quarterly under the terms of UCI’s senior credit
facility. Our ability to comply with these ratios may be affected by events
beyond our control.
The
restrictions contained in the indentures governing our UCI International Notes
and UCI’s senior subordinated notes and the agreement governing UCI’s senior
credit facility could limit our ability to plan for or react to market
conditions, meet capital needs or make acquisitions or otherwise restrict our
activities or business plans.
The
breach of any of these covenants or restrictions could result in a default under
the indentures governing our Notes or UCI’s senior subordinated notes and the
agreement governing UCI’s senior credit facility. An event of default under
either or both of these indentures or UCI’s senior credit facility would permit
some of our lenders to declare all amounts borrowed from them to be due and
payable, and there is no assurance that we would have sufficient assets to repay
our indebtedness. An event of default under either of these indentures or UCI’s
senior credit facility would likely result in a cross default under either or
both of the other instruments. If we are unable to repay debt, lenders having
secured obligations could proceed against the collateral securing that debt. As
a result of such a default or action against collateral, we may be forced into
bankruptcy or liquidation, which may result in a partial or total loss of your
investment.
We
are controlled by Carlyle, whose interests in our business may be different than
yours.
As of
June 30, 2010, Carlyle Partners III, L.P. and CP III Coinvestment, L.P.,
both of which are affiliates of The Carlyle Group, owned 90.8% of our equity and
are able to control our affairs in all cases. Our entire board has been
designated by the affiliates of Carlyle and a majority of the board is
associated with Carlyle. In addition, the affiliates of Carlyle control the
appointment of our management, the entering into of mergers, sales of
substantially all of our assets and other extraordinary transactions. The
interests of Carlyle and its affiliates could conflict with
yours.
Item 2. Unregistered Sales of Equity
Securities and Use of Proceeds
None.
Item 3. Default Upon Senior
Securities
None.
Item 4. Reserved
None.
Item 5. Other
Information
None.
54
Item
6. Exhibits
Exhibit
31.1
|
Certification
of Periodic Report by the Chief Executive Officer pursuant to Rule
13a-14(a) of the Securities Exchange Act of 1934.
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Exhibit
31.2
|
Certification
of Periodic Report by the Chief Financial Officer pursuant to Rule
13a-14(a) of the Securities Exchange Act of 1934.
|
Exhibit
32
|
Certification
of Periodic Report by the Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. 1350, as created by Section 906 of the
Sarbanes-Oxley Act of
2002.*
|
*
|
This
certificate is being furnished solely to accompany the report pursuant to
18 U.S.C. 1350 and is not being filed for purposes of Section 18 of the
Securities Exchange Act of 1934, as amended, and is not to be incorporated
by reference into any filing of UCI International, whether made before or
after the date hereof, regardless of any general incorporation language in
such filing.
|
55
SIGNATURES
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.
UCI
INTERNATIONAL, INC.
|
||
Date:
August 11, 2010
|
By:
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/s/ MARK P. BLAUFUSS
|
Name:
Mark P. Blaufuss
|
||
Title:
Chief Financial Officer and Authorized
Representative
|
56