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EX-32.1 - SECTION 906 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER - Affinia Group Intermediate Holdings Inc.dex321.htm
EX-31.2 - SECTION 302 CERTIFICATION OF CHIEF FINANCIAL OFFICER - Affinia Group Intermediate Holdings Inc.dex312.htm
EX-31.1 - SECTION 302 CERTIFICATION OF CHIEF EXECUTIVE OFFICER - Affinia Group Intermediate Holdings Inc.dex311.htm
EX-21.1 - LIST OF SUBSIDIARIES - Affinia Group Intermediate Holdings Inc.dex211.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-K

 

 

Annual Report Pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2009

 

 

LOGO

Affinia Group Intermediate Holdings Inc.

(Exact name of registrant as specified in its charter)

 

 

Delaware

(State or other jurisdiction of incorporation or organization)

I.R.S. Employer Identification Number: 34-2022081

1101 Technology Drive

Ann Arbor, MI 48108

(734) 827-5400

 

 

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.    Yes  x    No  ¨

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  x

(Note: As a voluntary filer not subject to the filing requirements of Section 13 or 15(d) of the Exchange Act, the registrant has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant would have been required to file such reports) as if it were subject to such filing requirements).

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

 

Large accelerated filer   ¨    Accelerated Filer   ¨
Non-accelerated filer   x    (Do not check if a smaller reporting company)    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  x

There were 1,000 shares outstanding of the registrant’s common stock as of March 16, 2010 (all of which are privately owned and not traded on a public market).

 

 

 


Table of Contents

TABLE OF CONTENTS

 

          Page
   PART I.   

Item 1.

  

Business

   1
  

The Company

   1
  

History and Ownership

   1
  

Overview

   4
  

Sales by Region

   4
  

Industry

   5
  

Products

   7
  

Sales Channels and Customers

   8
  

Customer Support

   9
  

Intellectual Property

   9
  

Raw Materials and Manufactured Components

   9
  

Seasonality

   10
  

Backlog

   10
  

Research and Development Activities

   10
  

Competition

   10
  

Employees

   10
  

Environmental Matters

   10
  

Internet Availability

   11

Item 1A.

  

Risk Factors

   11

Item 1B.

  

Unresolved Staff Comments

   16

Item 2.

  

Properties

   16

Item 3.

  

Legal Proceedings

   16

Item 4.

  

Removed and Reserved

   16
   PART II.   

Item 5.

  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Shares

   17

Item 6.

  

Selected Consolidated and Combined Financial Data

   17

Item 7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   20
  

Company Overview

   20
  

Refinancing

   20
  

Acquisition and Global Growth

   20
  

Positioning through Restructuring

   21
  

Restructuring Activities

   22
  

Disposition

   23
  

Nature of Business

   23
  

Business Environment

   24
  

Results of Operations

   25
  

Liquidity and Capital Resources

   30
  

Contractual Obligations and Commitments

   32
  

Commitments and Contingencies

   32
  

Critical Accounting Estimates

   33
  

Recent Accounting Pronouncements

   35

Item 7A.

  

Quantitative and Qualitative Disclosures About Market Risk

   35

 

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          Page

Item 8.

   Financial Statements and Supplementary Data    37

Item 9.

   Changes In and Disagreements with Accountants on Accounting and Financial Disclosure    78

Item 9A(T).

   Controls and Procedures    78

Item 9B.

   Other Information    79
   PART III.   

Item 10.

   Directors, Executive Officers and Corporate Governance    80

Item 11.

   Executive Compensation    84

Item 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters    98

Item 13.

   Certain Relationships and Related Transactions, and Director Independence    101

Item 14.

   Independent Registered Public Accounting Firm Fees    102
   PART IV.   

Item 15.

   Exhibits, Financial Statement Schedules    103

 

ii


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Cautionary Note Regarding Forward-Looking Statements

This report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-looking statements include statements concerning our plans, objectives, goals, strategies, future events, future revenue or performance, capital expenditures, financing needs, plans or intentions relating to acquisitions, business trends and other information that is not historical information. When used in this report, the words “estimates,” “expects,” “anticipates,” “projects,” “plans,” “intends,” “believes,” “forecasts,” or future or conditional verbs, such as “will,” “should,” “could” or “may,” and variations of such words or similar expressions are intended to identify forward-looking statements. All forward-looking statements, including, without limitation, management’s examination of historical operating trends and data are based upon our current expectations and various assumptions. Our expectations, beliefs and projections are expressed in good faith and we believe there is a reasonable basis for them. However, there is no assurance that these expectations, beliefs and projections will be achieved. With respect to all forward-looking statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

There are a number of risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements contained in this report. Such risks, uncertainties and other important factors include, among others: the impact of the recent turmoil in the financial markets on the availability and cost of credit; financial viability of key customers and key suppliers; our substantial leverage; limitations on flexibility in operating our business contained in our debt agreements; pricing and import pressures; the shift in demand from premium to economy products; our dependence on our largest customers; changing distribution channels; increasing costs for manufactured components, raw materials, crude oil and energy; our ability to achieve cost savings from our restructuring; increased costs in imported products from low cost sources; the consolidation of distributors; risks associated with our non-U.S. operations; product liability and customer warranty and recall claims; changes to environmental and automotive safety regulations; risk of impairment to intangibles and goodwill; non-performance by, or insolvency of, our suppliers or our customers; work stoppages or similar difficulties that could significantly disrupt our operations, and other labor disputes; challenges to our intellectual property portfolio; changes in accounting standards that impact our financial statements; difficulties in developing, maintaining or upgrading information technology systems; the adequacy of our capital resources for future acquisitions; our ability to successfully combine our operations with any businesses we have acquired or may acquire; effective tax rates and timing and amounts of tax payments; and our exposure to a recession. Additionally, there may be other factors that could cause our actual results to differ materially from the forward-looking statements.

 

iii


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PART I.

 

Item 1. Business

The Company

Affinia is a global leader in the on and off-highway replacement products and services industry, which is also referred to as the aftermarket. Our extensive aftermarket product offering, which consists principally of brake, chassis and filtration products, fits nearly every car, truck, off-highway and agricultural make and model, allowing us to serve as a full line supplier in our product categories to our customers. We believe the growth of the aftermarket, from which we derive approximately 98% of our sales, is predominantly driven by the size, age, and by the population of vehicles in operation. We believe we hold the No. 1 market position in North America in aftermarket brake and filtration products and the No. 2 market position in North America in aftermarket chassis products.

The following charts illustrate the aggregation of net sales by product grouping together with a representative brand and the concentration of On and Off-Highway replacement product sales and automotive original equipment manufacturers (“OEM”) sales. Excluded from the charts is our Commercial Distribution Europe division which is classified as a discontinued operation and was sold on February 2, 2010 (refer to Note 2 Discontinued Operation, which is included in Item 8 of this report).

LOGO

Our brands include WIX®, Raybestos®, McQuay-Norris®, Nakata®, Filtron® and Brake Pro®. Additionally, we provide private label offerings for NAPA®, CARQUEST®, ACDelco® and other customers and co-branded offerings for Federated Auto Parts (“Federated”) and Automotive Distribution Network (“ADN”). For the year ended December 31, 2009, our net sales from continuing operations were approximately $1.8 billion.

History and Ownership

Affinia Group Inc., a Delaware corporation formed on June 28, 2004 and controlled by affiliates of The Cypress Group L.L.C. (“Cypress”), entered into a stock and asset purchase agreement, as amended (the “Purchase Agreement”), with Dana Corporation (“Dana”). Affinia Group Inc. is a wholly-owned subsidiary of Affinia Group Intermediate Holdings Inc. a Delaware corporation formed on October 18, 2004. The Purchase Agreement provided for the acquisition by Affinia Group Inc. of substantially all of Dana’s aftermarket business operations (the “Acquisition”). The Acquisition was completed on November 30, 2004, for a purchase price of $1.0 billion.

All references in this report to “Affinia,” “Company,” “we,” “our,” and “us” mean, unless the context indicates otherwise, Affinia Group Intermediate Holdings Inc. and its subsidiaries on a consolidated basis.

As a result of the Acquisition, investment funds controlled by Cypress hold approximately 61% of the common stock of Affinia Group Holdings Inc. (“Affinia Group”), which directly owns 100% of our common stock, and therefore Cypress controls us. The other Affinia Group Holdings Inc. initial investors are the following: OMERS Administration Corporation (formerly known as Ontario Municipal Employees Retirement Board), California State Teachers Retirement System, The Northwestern Mutual Life Insurance Company and Stockwell Capital.

 

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On December 15, 2005, Affinia Group, our parent company, entered into stockholder and other agreements with certain officers, directors and key employees (collectively, the “Executives”) of the Company, pursuant to which those Executives purchased an aggregate of 9,520 shares (the “Shares”) of Affinia Group’s common stock for $100 per Share in cash. Affinia Group received aggregate proceeds of $952,000 as a result of the offering, which was made pursuant to the Affinia Group’s 2005 Stock Incentive Plan. Affinia Group purchased from key Executives 250 shares in 2007, 1,600 shares in 2008 and 370 shares in 2009. Therefore, as of December 31, 2009 the Executives owned 7,300 shares (excluding shares issued pursuant to our non-qualified deferred compensation plan).

On October 30, 2008, Affinia Group authorized 9.5% Class A Convertible preferred stock, with an initial issuance price of $1,000 per share, consisting of 150,000 shares. There were 51,475 shares issued on October 31, 2008 to our investors and certain Management and Directors. The proceeds from the issuance of preferred shares were contributed to Affinia Acquisition LLC and were utilized to purchase HBM Investment Limited (“HBM”), which subsequently changed its name to Affinia Hong Kong Limited.

 

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Ownership Structure

LOGO

 

(1) Affinia Group Holdings Inc. received $51 million in return for preferred stock from Cypress, Co-investors and management. Affinia Group Holdings Inc. contributed $50 million of the $51 million to Affinia Acquisition LLC to purchase 85% of the equity interests in HBM which is now known as Affinia Hong Kong Limited.
(2) On June 30, 2008, Affinia entered into a Shares Transfer Agreement with Mr. Zhang Haibo for the purchase by Affinia of 85% of the equity interests (the “Acquired Shares”) in HBM. HBM is the sole owner of Longkou Haimeng Machinery Company Limited (“Haimeng”), a drum and rotor manufacturing company located in Longkou City, China. Affinia Acquisition LLC, an affiliate, completed the purchase of the Acquired Shares on November 6, 2008, with an effective date of October 31, 2008. HBM subsequently changed its name to Affinia Hong Kong Limited. Affinia Group Holdings Inc. owned 95% of Affinia Acquisition LLC and Affinia Group Inc. owned the remaining 5% interest. Based on the criteria for consolidation of a variable interest entity (“VIE”), we determined that Affinia Group Inc. is deemed the primary beneficiary of Affinia Acquisition LLC. Therefore, the consolidated financial statements within this report include Affinia Acquisition LLC and its subsidiaries. Effective June 1, 2009, Affinia Group Inc. acquired an additional 35% ownership interest for a purchase price of $25 million, increasing its ownership to 40%.
(3) The guarantors of the outstanding senior subordinated notes guarantee our senior credit facilities on a senior secured basis.
(4) On August 13, 2009, we refinanced our former term loan facility, revolving credit facility and accounts receivable facility. The refinancing consisted of a new four-year $315 million asset-based revolving credit facility (the “ABL Revolver”) and $225 million of new 10.75% senior secured notes (“Secured Notes”), the proceeds of which were used to repay outstanding borrowings under our former term loan facility, revolving credit facility and accounts receivable facility, as well as to settle interest rate derivatives and to pay fees and expenses related to the refinancing. The ABL Revolver and the Secured Notes replaced our revolving credit facility, which would have otherwise matured on November 30, 2010, our former term loan facility, which would have otherwise matured on November 30, 2011, and our accounts receivables facility, which would have otherwise matured on November 30, 2009. The ABL Revolver was entered into by Affinia Group Inc. and Affinia Group Intermediate Holdings Inc.
(5) As of December 31, 2008, $300 million principal amount of the Issuer’s senior subordinated notes was outstanding. During the second quarter of 2009, Affinia Group Holdings Inc. purchased approximately $33 million principal amount of the senior subordinated notes in the open market and thereafter contributed such notes to Affinia Group Intermediate Holdings Inc., which contributed such notes to Affinia Group Inc. Affinia Group Inc. promptly surrendered such purchased notes for cancellation, such that as of December 31, 2009, approximately $267 million principal amount of the senior subordinated notes was outstanding. The cancellation of the notes resulted in an $8 million pre-tax gain.

 

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Overview

Our extensive product offering fits nearly every car, truck, off-highway and agricultural make and model on the road, allowing us to serve as a full line supplier to our customers for our product categories. These customers primarily comprise large aftermarket distributors and retailers selling to professional technicians or installers. Our customer base also includes original equipment service (“OES”) participants such as ACDelco. Many of our customers are leading aftermarket companies, including NAPA, CARQUEST, Aftermarket Auto Parts Alliance (“the Alliance”), Uni-Select Inc., O’Reilly Auto Parts, and Federated Auto Parts. As an active participant in the aftermarket for more than 60 years, we have many long-standing customer relationships.

We derived approximately 98% of our 2009 net sales from the on and off-highway replacement products and services industry, which is also referred to as the aftermarket. We believe that the aftermarket will continue to grow as a result of the increase in the light vehicle population and the average age of light vehicles. According to the Automotive Aftermarket Industry Association (“AAIA”), the U.S. aftermarket grew by 0.2% during 2008. In 2009, the industry was forecasted to decrease by 1.3% and rebound in 2010 with 4.5% growth.

Sales by Region

Our broad range of brake, chassis and filtration products are primarily sold in North America, Europe and South America. We are also focusing on expanding manufacturing capabilities globally to position Affinia to take advantage of global growth opportunities. With Affinia Acquisition LLC purchasing Affinia Hong Kong Limited we believe we are well positioned in Asia. In the future we plan to sell our broad product offering in China and other Asian markets. The percentage of sales by geographic region for the last three years is outlined in the chart below (For information about our segments refer to Note 18 Segment Information, which is included in Item 8 of this report). Excluded from the charts is our Commercial Distribution Europe segment which is classified as a discontinued operation and was sold on February 2, 2010 (refer to Note 2 Discontinued Operation, which is included in Item 8 of this report).

LOGO

North America

We believe we hold the #1 market position in North America in brake and filtration components and the #2 market position in chassis components in the aftermarket. We believe we have achieved our #1 and #2 market positions due to the quality and reputation of our brands and products among professional technicians, who are the primary installers of the types of components we supply to the aftermarket. These professionals prefer to order reliable, well known brands because it is industry practice to replace, free of any labor or service charge, malfunctioning parts. We believe that the quality and reputation of our brands for form, fit, and functional quality creates and maintains significant demand for our products from these technicians and throughout the aftermarket supply chain.

Over the last several years, domestic production has been diminishing due to price sensitivity in the market. To meet our customers’ needs and continue to be a leader in the aftermarket we initiated restructuring plans in 2005 to consolidate domestic production and shift a significant portion of our manufacturing base to lower cost countries. We have opened new facilities in China, Ukraine, Mexico, and India over the last couple of years. In addition, we manufacture and distribute our products in 18 countries, which include the 7 countries of the Commercial Distribution Europe segment, and we also export to many other countries covering four continents. Not only do we plan to increase our manufacturing capabilities globally, but we also intend to grow our business in those new markets. To continue to be a full product line leader in our industry we will continue to research and develop, design, and manufacture products globally.

 

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South America

We have manufacturing and distribution operations in Brazil, Argentina, Uruguay and Venezuela. We manufacture and/or distribute filters, brakes, pumps and other aftermarket components in South America. Our South American operations manufacture and distribute product mostly in their domestic markets. We believe we hold the # 3 position as a distributor of aftermarket parts in Brazil.

Europe

In Europe, we have one significant operation classified in continuing operations: Filtron, which manufactures filters in Poland and Ukraine. We believe Filtron holds the #1 position in filters in Poland. Approximately 61% of Filtron products are exported outside of Poland. As part of our strategic plan we committed to a plan to sell our Commercial Distribution Europe business unit during the fourth quarter of 2009. Our Commercial Distribution Europe business unit, also known as Quinton Hazell, is a diverse aftermarket manufacturer and distributor of automotive components throughout Europe. On February 2, 2010, we sold our Commercial Distribution Europe operations and it is classified as a discontinued operation in our consolidated financial statements.

Asia

Haimeng, which is located in China, significantly expands Affinia’s worldwide manufacturing capacity for high-quality brake components. Haimeng operates drum and rotor manufacturing facilities comprising over one million square feet. This acquisition also provides Affinia with a strategic opportunity for continued market expansion through Haimeng’s current aftermarket customer base in Asia and Europe. We also have a joint venture in India with MAT Holdings Inc., to manufacture brake friction products. The testing and manufacturing of brake friction products began during the fourth quarter of 2008, and initial shipments began in the first quarter of 2009.

Restructuring

In 2005, we announced two restructuring plans: (i) a restructuring plan that we announced at the beginning of 2005 as part of the Acquisition, referred to as the acquisition restructuring and (ii) a restructuring plan that we announced at the end of 2005, referred to as the comprehensive restructuring. During the last four years we have rationalized and consolidated many of our facilities and have shifted some production to low cost sources. We have closed 46 facilities over the last four years in connection with the restructuring plans. We completed the acquisition restructuring plan in 2005 and we anticipate finishing the comprehensive restructuring plan by the end of 2010. As of the end of 2009, we have incurred restructuring costs of $154 million in connection with the comprehensive restructuring, and forecast that we will incur another $7 million until completion, for a total of $161 million ($9 million higher than the original plan of $152 million). The major cost components of the plan are employee severance costs, asset impairment charges related to fixed assets, and other costs such as environmental remediation, site clearance and repair costs, each of which should represent approximately 45%, 19% and 36%, respectively, of the total $161 million restructuring expense.

Industry

Statements regarding industry outlook, our expectations regarding the performance of our business and other non-historical statements are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described under “Forward-Looking Statements.” Our actual results may differ materially from those contained in or implied by any forward-looking statements. You should read the following discussion together with “Forward-Looking Statements,” “Item 6. Selected Consolidated and Combined Financial Data” and “Item 8. Financial Statements and Supplementary Data.”

Aftermarket products can be classified into three primary groups: routine service parts, wear parts and components that commonly fail. We primarily compete in the routine service parts and wear parts product categories.

We believe the overall U.S. motor vehicle aftermarket, excluding tires, was approximately $247 billion in sales in 2009. We are one of the largest participants, offering a full line of quality products within our product categories. To facilitate efficient inventory management, many of our customers rely on larger suppliers like us to have full line product offerings, consistent value-added services and timely delivery. There are important advantages to having meaningful size and scale in the aftermarket, including the ability to support significant distribution operations, offer sophisticated supply chain management capabilities and provide broad product line offerings.

In general, aftermarket industry participants can be categorized into three major groups: (1) manufacturers of parts, (2) distributors of replacement parts (without manufacturing capabilities) and (3) installers, both professional and Do-It-Yourself (“DIY”). Distributors purchase products from manufacturers and sell them to wholesale or retail operations, which in turn sell them to installers.

 

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The distribution business is comprised of the (1) traditional, (2) retail and (3) OES channels. Typically, professional installers purchase their products through the traditional channel, and DIY mechanics purchase products through both traditional and retail stores. The traditional channel includes such well-known distributors as NAPA, CARQUEST, Federated, the Alliance, Uni-Select and ADN. Through a network of distribution centers, these distributors sell primarily to owned or affiliated stores, which in turn supply professional installers. The retail sector includes merchants such as O’Reilly Auto Parts, AutoZone, Advance Auto Parts and Canadian Tire. OES channels consist primarily of new vehicle manufacturers’ service departments at new vehicle dealerships.

We believe that future growth in aftermarket product sales will be driven by the following key factors:

Increase in light vehicle population. The light vehicle population in the United States has been increasing in recent years, driven principally by growth in the number of licensed drivers and an increase in the average vehicles in service per licensed driver. As of 2008, there were over 242 million light vehicles in operation in the U.S. Although this figure represents only a 0.5% increase over 2007, the U.S. light vehicle population has risen in each of the past ten years; increasing by a total of 23% from 197 million vehicles in 1998. From 1998 to 2008, the U.S. light vehicle population experienced a compound annual growth rate of 2.1%.

The vehicle population has also been increasing in South America and Europe. As of 2006, there were 37 million vehicles in operation in South America and 311 million vehicles in Europe. Those vehicle populations have increased to 42 million and 319 million in 2008, respectively; representing a growth of 13.5% in South America and 2.6% in Europe.

The vehicle population has also been increasing in China in both vehicle production and sales. As of 2008, there were 47 million vehicles in operation. According to industry sources the vehicle population is expected to grow by 18% in each of the next three years in China. We are working to establish distribution channels in China to capitalize on the growth of the vehicle population.

Increase in average age of light vehicles. As of 2008, the average light vehicle age in the United States was 10.0 years, compared to an average of 8.7 years in 1998. As the average light vehicle age continues to rise, the use of aftermarket products generally increases as well.

Increase in total miles driven. In the United States, the total miles driven rose from 2.6 trillion in 1998 to 2.9 trillion in 2008, an increase of 12%. However, the total miles driven decreased by 3.6% in 2008 relative to 2007 due to a number of factors including a 16% increase in average retail gasoline prices, the unstable economy, and the growth in unemployment. From 1998 to 2008, the annual miles driven in the U.S. has experienced a compound annual growth rate of 1.1%.

Increase in the number of light trucks and cross-over vehicles in service. The AAIA estimates that the number of light trucks and cross-over vehicles in operation in the United States has increased by 36 million, or 50% from 1998 to 2008. This group of larger and heavier vehicles which place more wear on brake systems and chassis components is expected to result in a corresponding growth in the sale of aftermarket brake and chassis components. Also, the percentage of these vehicles in operation that use disc brakes, rather than drum brakes, continues to grow. Smaller and lighter weight disc brake systems have shorter operational lives than drum brakes, and therefore require more frequent replacement. From 1998 to 2008, the U.S. light truck population experienced a compound annual growth rate of 4.1%.

The medium and heavy duty truck population has also experienced significant growth. As of 2008, there were 8.7 million medium and heavy duty trucks in operation in the U.S. versus 6.7 million in 1999; an increase of 29%. From 1999 to 2008, the U.S. medium and heavy duty truck population experienced a compound annual growth rate of 2.9%.

 

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Products

Our principal product areas are described below:

 

Product

   2009 Net Sales
(Dollars
in Millions)
    Percent of
2009 Net
Sales
    Representative Brands   

Product Description

Filtration products

   $ 713      40   WIX, FILTRON, NAPA and
CARQUEST
  

Oil, fuel, air, hydraulic and

other filters for light-, medium- and heavy-duty on and off-highway vehicle applications

Brake products

North America & Asia

South America

  

 

 

593

22

  

  

 

33

1

  Raybestos, NAPA, CARQUEST,

AIMCO and ACDelco

   Drums, rotors, calipers, pads and shoes and hydraulic components
                   

Total Brake products

     615      34     

Commercial Distribution South America products

     333      19   Nakata, Urba, WIX    Steering, suspension, driveline components, brakes, fuel and water pumps and other aftermarket products

Chassis products

     153      8   Raybestos Chassis, NAPA

Chassis, McQuay-Norris,

ACDelco and Nakata

   Steering, suspension and driveline components

Eliminations and other

     (17   (1 )%      
               

Net sales of continuing operations

     1,797          

Discontinued Operations

         

Commercial Distribution European products(1)

     237       

Quinton Hazell and other

  

Cooling, transmission, steering

and suspension, brake, shock absorber, electrical and filter products

               

Net sales

   $ 2,034          
               

 

(1) We committed to a plan to sell the Commercial Distribution European products business in the fourth quarter of 2009 and sold it on February 2, 2010.

Filtration Products. We are a leading designer, manufacturer, marketer and distributor of a broad range of filtration products for the aftermarket. Based on 2009 net sales, we believe we hold the #1 market position in North America. In addition, we also manufacture filtration products in Europe and South America. We are one of the few aftermarket suppliers of both heavy-duty and light-duty filters. Our filtration product lines include oil, fuel, air and other filters for automobiles, trucks and off-road equipment. We sell our filtration products into the three primary distribution channels—traditional, retail and OES.

Under our well-known WIX brand, we offer automotive, diesel, agricultural, industrial and specialty filter applications. WIX is the #1 filter for cars on the NASCAR circuit and an exclusive NASCAR Performance Product. We also provide a comprehensive private label product offering to our two largest customers, NAPA and CARQUEST. We also sell our filters under the Filtron brand in Europe.

The heavy-duty filtration market is expected to continue to grow at a stable rate. Demand for heavy-duty oil filters is expected to increase due to newer diesel engines with exhaust gas recirculation technology, which generates more soot particulates compared to older engine designs, thereby increasing engine filtration demands. In other heavy-duty filter categories, demand is expected to experience stable growth, as there are more filters per engine in newer vehicles. Proprietary filtration designs and increasingly complicated filtration systems are also expected to create additional demand.

Brake Products. We are a leading designer, manufacturer, marketer and distributor of a broad range of brake products for the aftermarket. Based on 2009 net sales, we believe we hold the #1 market position in North America for brake components. Our products include master cylinders, wheel cylinders, hardware and hydraulics, drums, shoes, linings, bonded/riveted segments, rotors, brake pads, calipers and castings. We sell our brake products into the three primary distribution channels—traditional, retail and OES.

We have an extensive offering of high quality, premium brake products. These brake products are sold under our leading premium brand name, Raybestos. In addition to our own brands, we also provide private label offerings for NAPA, CARQUEST, ACDelco and other customers and co-branded offerings for Federated Auto Parts (“Federated”) and Automotive Distribution Network (“ADN”).

 

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Aftermarket customers rely on our expertise for product design and engineering. These customers are highly focused on delivery time for their unpredictable and changing volume requirements, as they prefer to carry lower inventory levels while demanding full product coverage of different makes and models.

This product category has and is expected to continue to have one of the highest growth rates in the aftermarket due to the high level of SUVs, cross-over vehicles and other heavy vehicles in the overall fleet mix which tend to generate greater wear of brake system products.

Commercial Distribution South America Products. We manufacture and/or distribute products in Brazil and Argentina, including: pumps, universal joint kits, axle sets, shocks, steering, filtration products and suspension parts. We believe we hold the #3 position as a distributor of aftermarket parts in Brazil and the #1 position in several product lines.

Chassis Products. We are a leading designer, manufacturer, marketer and distributor of a broad range of chassis products for the aftermarket. Based on 2009 net sales, we believe we hold the #2 market position in North America for chassis products. Our chassis parts include steering, suspension and driveline products such as ball joints, tie rods, Pitman arms, idler arms, drag links, control arms, center links, stabilizers and other related parts. In addition to our own brands, including Nakata, Raybestos and McQuay-Norris, we provide private label products for NAPA and other customers. We sell our chassis products into the three primary distribution channels—traditional, retail and OES.

Chassis products by their nature wear out and need to be replaced periodically. Frequency of replacement depends on the use of the vehicle. As a result, fleet, construction and off-road vehicles typically need to have chassis parts replaced more frequently than other types of vehicles. We believe growth in the replacement of chassis products will be driven by an increase in the proliferation of replaceable chassis products and in the average age of vehicles.

Eliminations and Other. This category consists of inter company sales eliminations between product grouping.

Discontinued Operations - Commercial Distribution European Products. As noted above, on February 2, 2010, the Company sold its Commercial Distribution European division, which sells primarily under the Quinton Hazell® brand name. As a result of the sale, the Commercial Distribution Europe segment is now classified as discontinued operations in the Company’s Consolidated Financial Statements and the accompanying notes for all periods presented.

Further information relating to the Company’s reportable operating segments, for the three most recent fiscal years, appears in Note 18 of the Notes to the Consolidated Financial Statements contained in Item 8, “Financial Statements and Supplementary Data.”

Sales Channels and Customers

We distribute our products across several sales channels, including traditional, retail and OES channels. Approximately 29% and 8% of our 2009 net sales from continuing operations were derived from our two largest customers, NAPA and CARQUEST, respectively (See “Risk Factors—Our Business would be materially and adversely affected if we lost any of our larger customers”). During 2009, we derived 60% of our net sales from the United States and 40% of our net sales from other countries.

We have maintained long-standing relationships with many of our top customers. Some of our most significant customers include NAPA, CARQUEST, ADN, ACDelco, Federated, Parts Plus, Uni-Select, Les Schwab, the Alliance, and O’Reilly Auto Parts, each of which is a key player in the aftermarket.

 

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The following table provides a description of the primary sales channels to which we supply our products:

 

Primary Sales Channels

  

Description

  

Customers

Traditional

   Warehouses and distribution centers that supply local distribution outlets, which sell to professional installers.    NAPA, CARQUEST, Federated, ADN, the Alliance and Uni-Select

Retail and Mass Merchant

   Retail stores, including national chains that sell replacement parts directly to consumers (the DIY market) and to some professional installers.    O’Reilly Auto Parts

OES

   Vehicle manufacturers and service departments at vehicle dealerships.    ACDelco, Robert Bosch, TRW Automotive and Chrysler

The traditional channel is important to us because it is the primary source of products for professional installers. We believe that the quality and reputation of our brands for form, fit, and function promotes significant demand for our products from these installers and throughout the aftermarket supply chain. We have many long-standing relationships with leading distributors in the traditional channel such as NAPA and CARQUEST, for whom we have manufactured products for 42 and 20 years, respectively.

As retailers become increasingly focused on consolidating their supplier base, we believe that our broad product offering, product quality, sales and marketing support and customer service capabilities make us more valuable to these customers.

Recently, automobile dealerships have begun providing “all-makes” service whereby dealers will service a vehicle even if they do not sell the make or model being serviced. These dealerships can choose to purchase competitive components from aftermarket suppliers. We believe the volumes generated by OES customers, especially in brakes, may provide an opportunity for sales growth.

Customer Support

We believe that our emphasis on customer support has been a key factor in maintaining our leading market positions. We continuously seek to improve service, order turnaround time, product coverage and order accuracy. Our ability to replenish inventory quickly is extremely important to customers as it enables them to maximize their sales while carrying reduced inventory levels. For these reasons, we ship the majority of orders within 24 to 48 hours of receipt.

In order to maintain the competitiveness of our existing customers and maximize new sales opportunities, we have extensive product coverage. In turn, this has allowed our customers to develop a reputation for carrying the parts their customers need, especially for newer vehicles for which warranties may not have expired and aftermarket parts are not generally available.

In addition, as the aftermarket becomes more electronically integrated, customers often prefer to receive their application information electronically as well as in print form. We provide both printed and electronic catalog media. We also provide products which are problem solvers for professional installers, such as alignment products that allow installers to properly align a vehicle, even though the vehicle was not equipped with adjustment features. We provide many other support features, such as technical support hot lines and training and electronic systems which interface with customers and conform to aftermarket industry standards.

Intellectual Property

The Company strategically manages its portfolio of patents, trade secrets, copyrights, trademarks and other intellectual property.

We maintain and have pending in excess of 300 patents and patent applications on a worldwide basis. These patents expire over various periods up to the year 2028. The Company does not materially rely on any single patent, nor will the expiration of any single patent materially affect the Company’s business. The Company has proprietary trade secrets, technology, know-how, processes, and other intellectual property rights that are not registered.

Trademarks are important to the Company’s business activities. The Company has a robust worldwide program of trademark registration and enforcement to maintain and strengthen the value of the trademarks and prevent the unauthorized use of the trademarks. The RAYBESTOS and WIX trade names are highly recognizable to the public and are valuable assets. Additionally, the Company uses numerous other trademarks which are registered worldwide. We maintain more than 1,150 active trademark registrations and applications worldwide.

Raw Materials and Manufactured Components

We use a broad range of manufactured components and raw materials in our products, including steel, steel-related components, filtration media, aluminum, brass, iron, rubber, resins, plastics, paper and packaging materials. We purchase raw materials from a wide variety of domestic and international suppliers, and we have not, in recent years, experienced any significant shortages of these items and normally do not carry inventories of these items in excess of those reasonably required to meet our production and shipping schedule. Raw materials comprise the largest component of our manufactured goods cost structure.

 

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With our commitment to globalization, we are subject to increases in freight costs due to increased oil prices. During 2009 oil prices decreased in comparison to the prior year. The decrease in oil prices during 2009 had a positive affect on products such as filtration media and oil based products. Steel prices decreased in 2009 in comparison to the prior year which had a positive affect on certain products. The U.S. dollar strengthened during 2009 and it had a positive impact on the purchasing of raw materials and finished goods from our international sources. We will continue to review our purchasing and sourcing strategies for opportunities to reduce costs.

Seasonality

In a typical year, we build inventory during the first and second quarters to accommodate our peak sales during the second and third quarters. Our working capital requirements therefore tend to be highest from March through August. In periods of weak sales, inventory can increase beyond typical levels, as our product delivery lead times are less than two days while certain components we purchase from overseas require lead times of approximately 90 days.

Backlog

Substantially all of the orders on hand at December 31, 2009 are expected to be filled during 2010. The Company does not view its backlog as being insufficient, excessive or problematic, or a significant indication of 2010 sales.

Research and Development Activities

We provide information regarding our research and development activities in Note 4 to our consolidated financial statements, which is included in Item 8 of this report.

Competition

The brake aftermarket is comprised of several large manufacturers: our Company, Federal Mogul Corp. under the brand name Wagner, Honeywell International Inc. under the brand name Bendix, and Cardone Industries, Inc. under the brand name A1 Cardone. The light-duty filter aftermarket is comprised of several large U.S. manufacturers: our Company, United Components, Inc. under the brand name Champ, Honeywell International Inc. under the FRAM brand and Purolator Filters NA LLC under the Purolator brand, along with several international light-duty filter suppliers. The heavy-duty filter aftermarket is comprised of several manufacturers: our Company, Cummins, Inc. under the brand name Fleetguard, CLARCOR Inc. under the brand name Baldwin, and Donaldson Company Inc. under the brand name Donaldson. The chassis aftermarket is comprised primarily of two large U.S. manufacturers: our Company and Federal Mogul Corp. under the brand name Moog, along with some international chassis suppliers. We compete on, among other things, quality, price, service, brand reputation, delivery, technology and product offerings.

Employees

As of December 31, 2009, we had 11,572 employees (including Commercial Distribution Europe), of whom 5,682 were employed in North America, 2,331 were employed in Asia, 1,873 were employed in Europe, and 1,686 were employed in South America. The Commercial Distribution Europe segment had 793 employees. Approximately 23% of our employees are salaried and the remaining 77% of our employees are hourly. As of December 31, 2009, approximately 3% of our 3,978 U.S. employees and approximately 17% of our 342 Canadian employees were represented by unions. We consider our relations with our employees to be good.

Environmental Matters

We are subject to a variety of federal, state, local and foreign environmental laws and regulations, including those governing the discharge of pollutants into the air or water, the emission of noise and odors, the management and disposal of hazardous substances or wastes, the clean-up of contaminated sites and human health and safety. Some of our operations require environmental permits and controls to prevent or reduce air and water pollution, and these permits are subject to modification, renewal and revocation by issuing authorities. Contamination has been discovered at certain of our owned properties, which is currently being monitored and/or remediated. We are not aware of any contaminated sites which we believe will result in material liabilities; however, the discovery of additional remedial obligations at these or other sites could result in significant liabilities. Accounting Standards Codification (“ASC”) Topic 410 Asset Retirement and Environmental Obligations, requires that a liability for the fair value of an Asset Retirement Obligation (“ARO”) be recognized in the period in which it is incurred if it can be reasonably estimated, with the offsetting associated asset retirement costs capitalized as part of the carrying amount of the long-lived asset.

In addition, many of our current and former facilities are located on properties with long histories of industrial or commercial operations. Because some environmental laws can impose liability for the entire cost of clean-up upon any of the current or former owners or operators, regardless of fault, we could become liable for investigating or remediating contamination at these properties if contamination requiring such activities is discovered in the future. We have incurred environmental remediation costs associated with the comprehensive restructuring and the acquisition restructuring.

 

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We are also subject to the U.S. Occupational Safety and Health Act and similar state and foreign laws regarding worker safety. We believe that we are in substantial compliance with all applicable environmental, health and safety laws and regulations. Historically, our costs of achieving and maintaining compliance with environmental and health and safety requirements have not been material to our operations.

Internet Availability

Available free of charge through our internet website, www.affiniagroup.com, under the investor relations tab are our recent filings of forms 10-K, 10-Q, 8-K and amendments to those reports filed with the Securities and Exchange Commission. These reports can be found on our internet website as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission. The information contained on or connected to our website is not incorporated by reference into this Annual Report on Form 10-K and should not be considered part of this or any other report filed with the Securities and Exchange Commission (SEC).

 

Item 1A. Risk Factors

If any of the following events discussed in the following risks were to occur, our results of operations, financial conditions, or cash flows could be materially affected. Additional risks and uncertainties not presently known by us may also constrain our business operations.

Continued volatility and disruption to the global capital and credit markets and the economy more broadly has and may continue to adversely affect our results of operations and financial condition, as well as our ability to access credit and has and may continue to adversely affect the financial soundness of our customers and suppliers.

Recently, the global capital and credit markets have been experiencing a period of significant uncertainty, characterized by the bankruptcy, failure, collapse or sale of various financial institutions and a considerable level of intervention from the United States federal government. These conditions have adversely affected the demand for our products and services and, therefore, reduced purchases by our customers, which has negatively affected our revenue growth and caused a decrease in our profitability. In addition, interest rate fluctuations, financial market volatility or credit market disruptions may limit our access to capital, and may also negatively affect our customers’ and our suppliers’ ability to obtain credit to finance their businesses on acceptable terms. 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. If our customers’ or suppliers’ operating and financial performance deteriorates, or if they are unable to make scheduled payments or obtain credit, our customers may not be able to pay, or may delay payment of, accounts receivable owed to us, and our suppliers may restrict credit or impose different payment terms. Any inability of customers to pay us for our products and services, or any demands by suppliers for different payment terms, may adversely affect our earnings and cash flow.

As the contraction of the global capital and credit markets has spread throughout the broader economy, the United States and other major markets around the world have experienced very weak or negative economic growth. These recessionary conditions have and will continue to impact demand for our products by consumers. Although many vehicle maintenance and repair expenses are non-discretionary, difficult economic conditions may reduce miles driven and thereby increase periods between maintenance and repairs.

Our substantial leverage could harm our business by limiting our available cash and our access to additional capital and, to the extent of our variable rate indebtedness, exposing us to interest rate risk.

As a result of the Acquisition in 2004 and refinancing in 2009, we are highly leveraged. This leverage may limit our ability to obtain additional financing for working capital, capital expenditures, product development, debt service requirements, acquisitions, restructuring and general corporate or other purposes, limit our ability to adjust to changing market conditions and place us at a competitive disadvantage compared to our less leveraged competitors. Further volatility in the credit markets could adversely impact our ability to obtain favorable terms on financing in the future. In addition, a substantial portion of our cash flows from operations must be dedicated to the payment of principal and interest on our indebtedness and is not available for other purposes, including our operations, capital expenditures and future business opportunities. We may be more vulnerable than a less leveraged company to a downturn in the general economic conditions or in our business, or we may be unable to carry out capital spending that is important to our growth. We may be vulnerable to interest rate increases, as certain of our borrowings, including those under our ABL Revolver, are at variable rates. We can give no assurance that our business will generate sufficient cash flow from operations, that revenue growth or operating improvements will be realized, or that future borrowings will be available under our ABL Revolver in an amount sufficient to enable it to service its indebtedness or to fund other liquidity needs.

 

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Our business would be materially and adversely affected if we lost any of our larger customers.

For the year ended December 31, 2009, approximately 29% and 8% of our net sales from continuing operations were to NAPA and CARQUEST, respectively. To compete effectively, we must continue to satisfy these and other customers’ pricing, service, technology and increasingly stringent quality and reliability requirements. Additionally, our revenues may be affected by decreases in NAPA’s or CARQUEST’s business or market share. Consolidation among our customers may also negatively impact our business. We cannot provide any assurance as to the amount of future business with these or any other customers. While we intend to continue to focus on retaining and winning these and other customers’ business, we may not succeed in doing so. Although business with any given customer is typically split among numerous contracts, the loss of, or significant reduction in purchases by, one of those major customers could materially and adversely affect our business, results of operations and financial condition.

The shift in demand from premium to economy brands may require us to produce value products at the expense of premium products, resulting in lower prices, thereby reducing our margins and decreasing our net sales.

We estimate that a majority of our net sales are currently derived from products we consider to be premium products; however, this number has been declining. There has been, and may continue to be, a shift in demand from premium products, on which we can generally command premium pricing and generate enhanced margins, to value products. If such a trend continues, we may be forced to expand our production and/or purchases of value products at competitive prices. In addition, we could be forced to further reduce our prices to remain competitive, in which case our margins will decrease unless we make corresponding reductions in our cost structure.

Increasing costs for manufactured components, raw materials, and energy prices may adversely affect our profitability.

We use a broad range of manufactured components and raw materials in our products, including raw steel, steel-related components, filtration media, aluminum, brass, iron, rubber, resins, plastics, paper and packaging materials. Materials comprise the largest component of our manufactured goods cost structure. Further increases in the price of these items could further materially increase our operating costs and materially adversely affect our profit margins. In addition, in connection with passing through steel and other raw material price increases to our customers, there has typically been a delay of up to several months in our ability to increase prices, which has temporarily impacted profitability. In the future, it may be difficult to pass further price increases on to our customers, especially if we experience additional cost increases soon after implementing price increases. In addition, we have experienced longer than typical lead times in sourcing some of our steel-related components and certain finished products, which caused us to buy from non-preferred vendors at higher costs.

We are subject to other risks associated with our non-U.S. operations.

We have significant manufacturing operations outside the United States, including joint ventures and other alliances. In 2009, approximately 40% of our net sales originated outside the United States. Risks inherent in international operations include:

 

   

Exchange controls and currency restrictions;

 

   

Currency fluctuations and devaluations;

 

   

Changes in local economic conditions;

 

   

Changes in laws and regulations;

 

   

Exposure to possible expropriation or other government actions; and

 

   

Unsettled political conditions and possible terrorist attacks against American interests.

These and other factors may have a material adverse effect on our international operations or on our business, results of operations and financial condition. In addition, we may experience net foreign exchange losses due to currency fluctuations.

As a result of the consolidation driven by improved logistics and data management, distributors have reduced their inventory levels, which have reduced and could continue to reduce our sales.

Warehouse distributors have consolidated through acquisition and rationalized inventories, while streamlining their own distribution systems through more timely deliveries and better data management. The corresponding reduction in purchases by distributors negatively impacted our sales. Further consolidation could have a similar adverse impact on our sales.

Increases in crude oil and energy prices could reduce global demand for and use of automobiles and increase our costs, 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. An increase in the price of crude oil could reduce global demand for and use of automobiles and continue to 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. Further, as higher gasoline prices result in a reduction in discretionary spending for auto repair by the end users of our products, our results of operations have been, and could continue to be, impacted. Additionally, higher gasoline prices also have an adverse impact on our freight expenses.

 

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Our operations would be adversely affected if we are unable to purchase raw materials, manufactured components or equipment from our suppliers.

Because we purchase from suppliers various types of raw materials, finished goods, equipment and component parts, we may be materially and adversely affected by the failure of those suppliers to perform as expected. This non-performance may consist of delivery delays or failures caused by production issues or delivery of non-conforming products. The risk of non-performance may also result from the insolvency or bankruptcy of one or more of our suppliers. Our suppliers’ ability to supply products to us is also subject to a number of risks, including availability of raw materials, such as steel, destruction of their facilities or work stoppages. In addition, our failure to promptly pay, or order sufficient quantities of inventory from, our suppliers may increase the cost of products we purchase or may lead to suppliers refusing to sell products to us at all. Our efforts to protect against and to minimize these risks may not always be effective.

We are subject to costly regulation, particularly in relation to environmental, health and safety matters, which could adversely affect our business and results of operations.

We are subject to a substantial number of costly regulations. In particular, we are required to comply with frequently changing and increasingly stringent requirements of federal, state and local environmental and occupational safety and health laws and regulations in the United States and other countries, including those governing emissions to air, discharges to air and water, and the creation and emission of noise and odor; the generation, handling, storage, transportation, treatment and disposal of waste materials; and the cleanup of contaminated properties and occupational health and safety. We could incur substantial costs, including cleanup costs, fines and civil or criminal sanctions, third party property damage or personal injury claims, or costs to upgrade or replace existing equipment, as a result of violations of or liabilities under environmental, health and safety laws or non-compliance with environmental permits required at our facilities. In addition, many of our current and former facilities are located on properties with long histories of industrial or commercial operations. Because some environmental laws can impose joint and several liability for the entire cost of cleanup upon any of the current or former owners or operators, regardless of fault, we could become liable for investigating and/or remediating contamination at these properties if contamination requiring such activities is discovered in the future. We cannot assure that we have been, or will at all times be, in complete compliance with all environmental requirements, or that we will not incur material costs or liabilities in connection with these requirements in excess of amounts we have reserved. In addition, environmental requirements are complex, change frequently and have tended to become more stringent over time. These requirements may change in the future in a manner that could have a material adverse effect on our business, results of operations and financial condition. We have made and will continue to make expenditures to comply with environmental requirements. These requirements, responsibilities and associated expenses and expenditures, if they continue to increase, could have a material adverse effect on our business and results of operations. While our costs to defend and settle claims arising under environmental laws in the past have not been material, we cannot assure you that this will remain the case in the future. For more information about our environmental compliance and potential environmental liabilities, see “Item 1. Business—Environmental Matters” and “Item 3. Legal Proceedings.”

We may incur material losses and costs as a result of product liability and warranty and recall claims that may be brought against us.

We may be exposed to product liability and warranty claims in the event that our products actually or allegedly fail to perform as expected or the use of our products results, or is alleged to result, in bodily injury and/or property damage. Accordingly, we could experience material warranty or product liability losses in the future and incur significant costs to defend these claims.

In addition, if any of our products are, or are alleged to be, defective, we may be required to participate in a recall of that product if the defect or the alleged defect relates to automotive safety. Our costs associated with providing product warranties could be material. Product liability, warranty and recall costs may have a material adverse effect on our business, results of operations and financial condition. Our insurance may not be sufficient to cover such costs.

We are subject to increasing pricing pressure from imports, particularly from low cost sources.

Price competition from other aftermarket manufacturers particularly those based in lower cost countries have historically played a role and may play an increasing role in the aftermarket sectors in which we compete. Pricing pressures have historically been more prevalent with respect to our brake 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, many are expanding their manufacturing capabilities to produce a broad range of lower cost, higher quality products and provide an expanded product offering. The pressure from these low cost sources was partially alleviated in our drum and rotor products due to the acquisition of Haimeng. In the future, competitors in Asia or other low cost sources 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.

 

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We must successfully maintain and/or upgrade our information technology systems.

We rely on various information technology systems to manage our operations. We are currently implementing modifications and upgrades to our systems, including making changes to legacy systems, replacing legacy systems with successor systems with new functionality and acquiring new systems with new functionality. These types of activities subject us to inherent costs and risks associated with replacing and changing these systems, including impairment of our ability to fulfill customer orders, potential disruption of our internal control structure, substantial capital expenditures, additional administration and operating expenses, retention of sufficiently skilled personnel to implement and operate the new systems, demands on management time, and other risks and costs of delays or difficulties in transitioning to new systems or of integrating new systems into our current systems. Our system implementations may not result in productivity improvements at a level that outweighs the costs of implementation, or at all. In addition, the implementation of new technology systems may cause disruptions in our business operations and have an adverse effect on our business and operations, if not anticipated and appropriately mitigated.

The introduction of new and improved products and services may reduce our future sales.

Improvements in technology and product quality may extend the longevity of automotive parts and delay aftermarket sales. In particular, in our oil filter business the introduction of oil change indicators and the use of synthetic motor oils may further extend oil filter replacement cycles. The introduction of electric, fuel cell and hybrid automobiles may pose a long-term risk to our business because these vehicles may alter demand for our primary product lines. In addition, the introduction by OEMs of increased warranty and maintenance service initiatives, which are gaining popularity, have the potential to decrease the demand for our products in the traditional and retail sales channels.

Our success depends in part on our development of improved products, and our efforts may fail to meet the needs of customers on a timely or cost-effective basis.

Our continued success depends on our ability to maintain advanced technological capabilities, machinery and knowledge necessary to adapt to changing market demands as well as to develop and commercialize innovative products. We cannot assure that we will be able to develop new products as successfully as in the past or that we will be able to keep pace with technological developments by our competitors and the industry generally. In addition, we may develop specific technologies and capabilities in anticipation of customers’ demands for new innovations and technologies. If such demand does not materialize, we may be unable to recover the costs incurred in such programs. If we are unable to recover these costs or if any such programs do not progress as expected, our business, financial condition or results of operations could be adversely affected.

We may not be able to achieve the cost savings that we expect from the restructuring of our operations.

Although we expect to realize cost savings as a result of restructuring, we may not be able to achieve the level of benefits that we expect to realize or we may not be able to realize these benefits within the timeframes we currently expect. We have rationalized many domestic manufacturing operations in order to alleviate redundant capacity and reduce our cost structure. This restructuring has involved the movement of some U.S. and Canadian production to Mexico, South America and Asia. Our ability to achieve cost savings could be affected by a number of factors. Since our restructuring efforts focus on increasing our international presence, they will exacerbate the risks described above relating to our non-U.S. operations. Changes in the amount, timing and character of charges related to the restructuring, failure to complete or a substantial delay in completing the restructuring and planned divestitures or the receipt of lower proceeds from such divestitures than currently is anticipated could have a material adverse effect on us. Our cost savings is also predicated upon maintaining our sales levels.

Our intellectual property portfolio is subject to legal challenges.

We have developed and actively pursue developing a considerable amount of proprietary technology in the automotive industry and rely on intellectual property laws and a number of patents to protect such technology. In doing so, we incur ongoing costs to enforce and defend our intellectual property. We also face increasing exposure to the claims of others for infringement of intellectual property rights. We cannot assure that we will not incur material intellectual property claims in the future or that we will not incur significant costs or losses related to such claims. We also cannot assure that our proprietary rights will not be invalidated or circumvented.

Work stoppages or similar difficulties could significantly disrupt our operations.

As of December 31, 2009, 116 U.S. employees and 57 of our Canadian employees were represented by unions. It is possible that our workforce will become more unionized in the future. We may be subject to work stoppages and may be affected by other labor disputes. A work stoppage at one or more of our plants may have a material adverse effect on our business. Unionization activities could also increase our costs, which could have an adverse effect on our profitability.

Additionally, a work stoppage at one of our suppliers could adversely affect our operations if an alternative source of supply were not readily available. Stoppages by employees of our customers also could result in reduced demand for our products.

 

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Any acquisitions we make could disrupt our business and seriously harm our financial condition.

We may, from time to time, consider acquisitions of complementary companies such as Affinia Hong Kong Limited, products or technologies. Acquisitions involve numerous risks, including difficulties in the assimilation of the acquired businesses, the diversion of our management’s attention from other business concerns and potential adverse effects on existing business relationships with current customers and suppliers. In addition, any acquisitions could involve the incurrence of substantial additional indebtedness. We cannot assure that we will be able to successfully integrate any acquisitions that we pursue or that such acquisitions will perform as planned or prove to be beneficial to our operations and cash flow. Any such failure could seriously harm our business, financial condition and results of operations.

Cypress controls us and may have conflicts of interest with us or the holders of our notes in the future.

Cypress beneficially owns 61% of the outstanding shares of our common stock. As a result, Cypress has control over our decisions to enter into any corporate transaction and has the ability to prevent any transaction that requires the approval of stockholders regardless of whether or not other stockholders or note holders believe that any such transactions are in their own best interests. Additionally, Cypress is in the business of making investments in companies and may from time to time acquire and hold interests in businesses that compete directly or indirectly with us. So long as Cypress continues to own a significant amount of the outstanding shares of our common stock, even if such amount is less than 50%, it will continue to be able to strongly influence or effectively control our decisions.

We are required to evaluate our internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act. Failure to comply with the requirements of Section 404 or any adverse results from such evaluation could result in a loss of investor confidence in our financial reports and have an adverse effect on the credit ratings and trading price of our debt securities.

We are not currently an “accelerated filer” as defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended. As required by Section 404 of the Sarbanes-Oxley Act of 2002, we have provided an internal control report with this Annual Report, which includes management’s assessment of the effectiveness of our internal control over financial reporting as of the end of the year. Beginning with our Annual Report for the year ending December 31, 2010, our independent registered public accounting firm will also be required to issue a report on their evaluation of the effectiveness of our internal control over financial reporting. Our assessment requires us to make subjective judgments and our independent registered public accounting firm may not agree with our assessment. If we or our independent registered public accounting firm were unable to conclude that our internal control over financial reporting was effective as of the relevant period, investors could lose confidence in our reported financial information, which could have an adverse effect on the trading price of our debt securities, negatively affect our credit rating, and affect our ability to borrow funds on favorable terms.

We may be required to recognize impairment charges for our long-lived assets.

At December 31, 2009, the net carrying value of long-lived assets (property, plant and equipment) totaled approximately $199 million. We recorded an impairment charge in 2009 related to the discontinued operation of Commercial Distribution Europe due to a reduction in market value of its operations. In accordance with generally accepted accounting principles, we periodically assess our long-lived assets to determine if they are impaired. Significant negative industry or economic trends, disruptions to our business, unexpected significant changes or planned changes in use of the assets, divestitures and market capitalization declines may result in charges to long-lived asset impairments. Future impairment charges could significantly affect our results of operations in the periods recognized. Impairment charges would also reduce our consolidated net worth and increase our debt to total capitalization ratio, which could negatively impact our access to the public debt and equity markets.

We could be required to record a material non-cash charge to income if our recorded intangible assets or goodwill is impaired, or if we shorten intangible asset useful lives.

We have $192 million of recorded intangible assets and goodwill on our consolidated balance sheet as of December 31, 2009. These assets may become impaired with the loss of significant customers or a decline of profitability. In assessing the recoverability of goodwill, projections regarding estimated future cash flows and other factors are made to determine the fair value of the respective reporting unit. If these estimates or related projections change in the future, we may be required to record impairment charges for goodwill at that time. If our trade names carrying values exceed fair value we will be required to record an impairment charge.

While our intangibles with definite lives may not be impaired, the useful lives are subject to continual assessment, taking into account historical and expected losses of relationships that were in the base at time of acquisition. This assessment may result in a reduction of the remaining useful life of these assets, resulting in potentially significant increases to non-cash amortization expense that is charged to our consolidated statement of operations. An intangible asset or goodwill impairment charge, or a reduction of amortization lives, could have an adverse effect on our results of operations.

 

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Business disruptions could seriously affect our future sales and financial condition or increase our costs and expenses.

Our business may be impacted by disruptions including, but not limited to, threats to physical security, information technology, or public health crises. Any of these disruptions could affect our internal operations or services provided to customers, and could impact our sales, increase our expenses or adversely affect our reputation.

 

Item 1B. Unresolved Staff Comments.

None.

 

Item 2. Properties

Our principal executive offices are located in Ann Arbor, Michigan; our operations include numerous manufacturing, research and development, and warehousing facilities as well as offices. The table below summarizes the number of facilities by geographical region for our manufacturing, distribution and warehouse, and other facilities.

 

     Manufacturing
facilities
   Distribution
&
Warehouse
facilities
   Other
facilities

United States

   9    12    8

Canada

   1    2    1

Mexico

   5    1    2

Europe

   6    17    2

South America

   5    23    1

Asia

   3    —      1
              

Total

   29    55    15
              

The other facilities around the globe include 5 facilities that have been closed as part of our restructuring programs, 9 sales and administration offices and 1 non operational storage site. Approximately 55% of our principal manufacturing facilities are brake production facilities, 24% are filtration production facilities, 4% are chassis production facilities, and 17% relates to other production facilities. Of the total number of principal manufacturing facilities, approximately 72% of such facilities are owned and 28% are leased. The table above includes the Commercial Distribution Europe segment that we sold on February 2, 2010, which included 4 manufacturing facilities, 16 distribution & warehouse facilities and 1 other facility.

 

Item 3. Legal Proceedings

On March 31, 2008, a class action lawsuit was filed by S&E Quick Lube Distributors, Inc. of Utah against several auto parts manufacturers for allegedly conspiring to fix prices for replacement oil, air, fuel and transmission filters. Several auto parts companies are named as defendants, including Champion Laboratories, Inc., Purolator Filters NA LLC, Honeywell International Inc., Cummins Filtration Inc., Donaldson Company, Baldwin Filters Inc., Bosch USA., Mann + Hummel USA Inc., ArvinMeritor Inc., United Components Inc and Wix Filtration Corp LLC (“Wix”), one of our subsidiaries. The lawsuit is currently pending as a consolidated Multi-District Litigation (“MDL”) Proceeding in Chicago, IL because of multiple “tag-along” filings in several jurisdictions. Two suits have also been filed in the Canadian provinces of Ontario and Quebec. Wix, along with other named defendants, have filed various motions to dismiss Plaintiffs’ complaints, which were denied by the court in December 2009, but are currently the focus of motions to reconsider. Initial discovery has begun in the case. Significantly, the U.S. Justice Department has recently closed its investigation into this matter. Affinia believes that Wix did not have significant sales in this particular market at the relevant time periods so we currently expect any potential exposure to be immaterial.

By letter dated March 4, 2010, Butzel Long, attorneys for Delphi Corporation, requested that the United States Bankruptcy Court for the Southern District of New York issue a summons in Case No. 07-02198 to Affinia Group Inc. and certain subsidiaries seeking recovery of certain allegedly avoidable transfers in the amount of $17 million. Affinia Group Inc. has not yet been served with the requested summons and compliant. We believe the action is without merit and intend to vigorously defend ourselves in this matter.

The Company has various accruals for civil product liability and other costs. If there is a range of equally probable outcomes, we accrue the lower end of the range. The Company has $1 million accrued as of December 31, 2008 and December 31, 2009, respectively. There are no recoveries expected from third parties.

 

Item 4. Removed and Reserved

 

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PART II.

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Shares

No trading market for our common stock currently exists. As of March 16, 2010, our parent, Affinia Group Holdings Inc., was the sole holder of our common stock. The Company has never declared or paid any cash dividends on its common stock. We intend to retain all current and foreseeable future earnings to support operations. Our senior credit facilities and our senior subordinated notes indenture restrict our ability to pay cash dividends on our common stock. For information in respect of securities authorized under our equity compensation plan, see “Item 11. Executive Compensation.”

The following table provides information about Affinia Group Holdings Inc.’s shares of common stock that may be issued upon the exercise of options under its existing equity compensation plans as of December 31, 2009:

 

Plan Category

   Number of
securities
to be issued

upon exercise of
outstanding
options, warrants
and rights
   Weighted
average exercise
price of
outstanding
options, warrants
and rights
   Number of
securities
remaining
available for
future
issuance

Equity compensation plans approved by security holders

   N/A      N/A    N/A

Equity compensation plans not approved by security holders(1):

   175,638    $ 100.00    51,362
                

Total

   175,638    $ 100.00    51,362

 

(1) This plan consists of the Affinia Group Holdings Inc. 2005 Stock Incentive Plan. See “Item 11. Executive Compensation” for a description of the plan.

 

Item 6. Selected Consolidated and Combined Financial Data

Affinia Group Intermediate Holdings Inc. was formed in connection with the Acquisition. The financial statements included in this report are the consolidated financial statements of Affinia Group Intermediate Holdings Inc. The selected financial data are derived from our financial statements. The financial data as of December 31, 2008 and 2009 and for the years ended December 31, 2007, 2008, and 2009 are derived from the audited financial statements contained under “Item 8. Financial Statements and Supplementary Data.” The selected financial data as of December 31, 2005, December 31, 2006 and December 31, 2007; and for the years ended December 31, 2005 and 2006, are derived from audited financial statements of the Company.

 

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You should read the following data in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 8. Financial Statements and Supplementary Data.” (Dollars in Millions)

 

     Year Ended December 31,  
     2005     2006     2007     2008     2009  

Statement of income data:(1)

          

Net sales

   $ 1,872      $ 1,892      $ 1,857      $ 1,915      $ 1,797   

Cost of sales

     (1,613     (1,550     (1,512     (1,546     (1,429
                                        

Gross profit

     259        342        345        369        368   

Selling, general and administrative expenses

     (228     (298     (276     (276     (267

Income from settlement(2)

     —          —          15        —          —     

Loss on disposition of Beck Arnley(3)

     (21     —          —          —          —     
                                        

Operating profit

     10        44        84        93        101   

Gain on extinguishment of debt

     —          —          —          —          8   

Other income, net

     6        7        4        (3     5   

Interest expense

     (54     (58     (59     (56     (69
                                        

Income (loss) before taxes and noncontrolling interest

     (38     (7     29        34        45   

Income tax provision (benefit)

     (6     (5     6        18        22   

Equity in income, net of tax

     —          —          —          —          1   
                                        

Net income (loss) from continuing operations

     (32     (2     23        16        24   

Income (loss) from discontinued operations, net of tax

     2        (3     (17     (19     (61
                                        

Net income (loss)

     (30     (5     6        (3     (37

Less: Net income attributable to noncontrolling interest, net of tax

     —          —          —          —          (7
                                        

Net income (loss) attributable to the Company

   $ (30   $ (5   $ 6      $ (3   $ (44
                                        

Statement of cash flows data:

          

Net cash (used in) from operations:

          

Operating activities

   $ 101      $ 22      $ 1      $ 48      $ 55   

Investment activities

     (52     (21     (16     (75     (36

Financing activities

     (49     (15     —          51        (35

Other financial data:

          

Capital expenditures

   $ 35      $ 24      $ 30      $ 25      $ 31   

Depreciation and amortization(4)

     41        41        30        34        36   

Balance sheet data (end of period): (5)

          

Cash and cash equivalents

   $ 82      $ 70      $ 59      $ 77      $ 65   

Total current assets

     907        896        970        994        973   

Total assets

     1,440        1,381        1,457        1,515        1,483   

Total current liabilities

     408        389        401        467        437   

Total non-current liabilities

     657        609        622        632        609   

Shareholder’s equity(6)

     375        383        434        416        437   

 

(1) In accordance with ASC Topic 360, the Commercial Distribution Europe segment is accounted for as a discontinued operation. The consolidated statements of operations for all periods presented have been adjusted to reflect this segment as a discontinued operation.
(2) Affinia received a general unsecured nonpriority claim against Dana relating to a settlement in 2007. The claim was monetized for $15 million and was recorded as income from the settlement (Refer to Note 4 Settlement, which is included in Item 8 of this report).
(3) On March 31, 2005, the Company completed the legal sale of its subsidiary, Beck Arnley Worldparts Corporation (“Beck Arnley”) to Heritage Equity Group, pursuant to a stock purchase agreement. In connection with the transaction, Affinia recognized a pre-tax loss on the sale of $21 million. The transaction did not qualify as a sale under accounting rules and could not be presented as a discontinued operation.

 

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(4) The depreciation and amortization expense excludes the Commercial Distribution Europe segment. The consolidated cash flow statement, which is included in Item 8 of this report, includes the Commercial Distribution Europe segment.
(5) For presentation purposes, the various balance sheet line items as of December 31, 2005 within the table have not been modified to reflect the 2005 disposition of Candados Universales de Mexico, S.A. de C.V. (“Cumsa”) as such a presentation would not be materially different. Additionally, the various balance sheet line items as of December 31, 2005, 2006, 2007 and 2008 have not been modified to reflect the discontinued operation of the Commercial Distribution Europe segment.
(6) Effective January 1, 2009, the Company changed the accounting for and reporting of minority interest (now called noncontrolling interest) in our consolidated financial statements as required under ASC Topic 810, Consolidation. Upon adoption, applicable prior period amounts have been retrospectively changed to conform. The noncontrolling interest was reclassified to the equity section of the balance sheet.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Statements in the discussion and analysis regarding industry outlook, our expectations regarding the performance of our business and other non-historical statements in the discussion and analysis are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described under “Forward-Looking Statements.” Our actual results may differ materially from those contained in or implied by any forward-looking statements. You should read the following discussion together with “Forward-Looking Statements,” “Item 6. Selected Consolidated and Combined Financial Data” and “Item 8. Financial Statements and Supplementary Data.”

Company Overview

We are a global leader in the on and off-highway replacement products and services industry. Our extensive aftermarket product offering fits nearly every car, truck, off-highway and agricultural make and model, allowing us to serve as a full line supplier to our customers. We derive approximately 98% of our sales from this industry and, as a result, are not directly affected by the market cyclicality of the automotive original equipment manufacturers. Our broad range of brake, filtration, chassis products and other products are sold globally.

We believe our key global advantages as a leading on and off-highway replacement products and services company are our broad product offering, quality products, brand recognition (e.g., Wix and Raybestos), value-added services, and distribution and global sourcing capabilities. Due to these key advantages, we believe we hold the #1 market position in North America in filtration products and in brake product sales and the #2 market position in North America in chassis product sales. Additionally, we hold a significant presence in South America and Europe, which we believe is demonstrated by our number three position as a distributor of aftermarket products in Brazil, our number one position in filtration products in Poland and our leading position in other products in various other countries.

Among the value-added services we bring to our customers are our customer focused sales force, professional tech support, and e-cataloguing services. The value we bring to our customers has been recognized with numerous awards over the last several years. We believe that these key advantages strategically position us for growth globally.

Refinancing

On August 13, 2009 we refinanced our former term loan facility, revolving credit facility and the accounts receivable facility. The refinancing consisted of a new four-year $315 million asset-based revolving credit facility (the “ABL Revolver”) and $225 million of new 10.75% senior secured notes (“Secured Notes”), the proceeds of which were used to repay outstanding borrowings under our former term loan facility, revolving credit facility and accounts receivable facility, as well as to settle interest rate derivatives and to pay fees and expenses related to the refinancing. The ABL Revolver and the Secured Notes replaced our former revolving credit facility, which would have otherwise matured on November 30, 2010, our former term loan facility, which would have otherwise matured on November 30, 2011, and our accounts receivables facility, which would have otherwise matured on November 30, 2009. The refinancing provides the company with additional liquidity and the ability to expand our global manufacturing footprint.

Acquisition and Global Growth

To successfully compete in today’s global market-driven economy, Affinia is focused on becoming a world class global manufacturer and distributor of on and off-highway replacement products and services. During the fourth quarter of 2008 Affinia’s affiliate, Affinia Acquisition LLC, purchased an 85% ownership in Haimeng, which is one of the world’s largest drum and rotor manufacturing companies. Haimeng, which is the subsidiary of Affinia Hong Kong Limited, significantly expands Affinia’s worldwide manufacturing capacity for high-quality brake components. The acquisition also provides Affinia with a strategic opportunity for continued market expansion through Haimeng’s current aftermarket customer base in Asia and Europe. This new business venture clearly reinforces our commitment to excelling as a major global manufacturer of aftermarket products. We have purchased products from Haimeng for a number of years and can attest to the quality of its manufacturing assets and the talent of its staff and management team. The combination of Affinia and Haimeng gives us world-class manufacturing in China, while enhancing our market access for growth around the world.

We are focusing on expanding our manufacturing capabilities globally to position us to take advantage of global growth opportunities. Currently, we have manufacturing and distribution operations in North America, South America, Asia and Europe. We have recently completed or are in the process of completing the following transformation projects:

 

   

As discussed above effective October 31, 2008, Affinia Acquisition LLC purchased a controlling interest in HBM Investment Limited, a Hong Kong company, now known as Affinia Hong Kong Limited (“Affinia Hong Kong”). Affinia Hong Kong owns Haimeng, one of the world’s largest drum and rotor manufacturing companies, which is located in China. Haimeng has over 1 million square feet of modern manufacturing and machining capacity.

 

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During the fourth quarter of 2008, we started production of brake products at a new facility in northern Mexico. We are in the process of ramping up to full capacity at this new facility.

 

   

We recently completed our 50% owned manufacturing site in India. The testing and manufacturing of brake friction products began during the fourth quarter of 2008, and initial shipments began in the first quarter of 2009. As of the end of 2009, we are still in the process of ramping up to full capacity at this facility.

 

   

We opened a new filter manufacturing plant in Ukraine on April 1, 2007 to help meet increased demand for filtration products in Eastern Europe. The plant was fully operational in 2009.

 

   

Our first filter manufacturing operation in Mexico opened in the third quarter of 2007. During 2008, the manufacturing operation was brought up to its full capabilities. This operation serves markets in North America. We are currently expanding our distribution capabilities at this operation to increase our sales in the Mexican market.

These new business ventures reinforce our commitment to expanding our position as a global manufacturer. The chart below illustrates our global position based on manufacturing square feet as of December 31, 2009.

LOGO

As the chart shows, our manufacturing capabilities are spread throughout North America, Asia, Europe and South America. In the last four years the diversification of our manufacturing locations has transformed us from a domestic manufacturer to a global manufacturer with a significant portion of our manufacturing base in low cost countries. We are also focusing on growing our business in emerging markets as we continue to diversify our global manufacturing and distribution capabilities. We will continue to expand our global capabilities as we pursue our objective of becoming a world class on and off-highway replacement products and services company. We categorize our customers into three channels (1) traditional distributors, (2) retailers and (3) OES. OES consists primarily of vehicle manufacturers’ service departments at vehicle dealerships. As the majority of our sales are to traditional distributors and retailers rather than to OES, the closure of a large number of automotive dealerships in connection with the bankruptcies of General Motors and Chrysler may benefit our business if vehicle owners who previously relied on dealership service centers turn to traditional aftermarket distributors and retailers.

Positioning through Restructuring

To successfully compete in today’s global market-driven economy, Affinia is focused on being a world class global manufacturer and distributor of on and off-highway replacement products and services. The focus in our first four years has been on positioning ourselves through our restructuring programs. We believe these efforts are necessary in order to remain a leader in the on and off-highway global replacement products and services industry.

 

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Restructuring Activities

We announced at the end of 2005 a restructuring plan that is referred to herein as the comprehensive restructuring. We are in the process of completing the comprehensive restructuring program. Near the end of 2009 we approved the closure of another facility, which is referred to herein as other restructuring.

Comprehensive Restructuring

In connection with the comprehensive restructuring, we have recorded $154 million in restructuring costs to date. We recorded $23 million in 2005, $40 million in 2006, $38 million in 2007, $40 million in 2008, and $13 million in 2009. We forecast that the comprehensive restructuring program will result in approximately $161 million in restructuring costs, which exceeds preliminary expectations of $152 million. We anticipate that we will incur approximately $7 million more in restructuring costs during 2010 to complete the closure of the previously announced facilities. The restructuring activities and the disposition of the Commercial Distribution Europe segment have had favorable impacts on our gross margin over the last four years as shown in the chart below:

LOGO

We have closed 46 facilities over the last four years in connection with our two restructuring plans. The acquisition restructuring plan commenced in 2005 and was mainly completed during that year. The comprehensive restructuring plan was announced in December 2005 and will be completed by the end of 2010. We have closed many plants over the last few years and we have two more plants that have been announced for closure that are still in the process of being closed (Milton Ontario and Litchfield Illinois). Once these two plants close in 2010 we will have completed the comprehensive restructuring plan.

 

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In connection with the comprehensive restructuring, we recorded $154 million in restructuring costs to date. The restructuring costs are recorded in selling, general and administrative expense, cost of sales, and as part of discontinued operations and are disclosed by year in the chart below (Dollars in Millions).

 

     Discontinued
Operations
   Selling, General
and Administrative

Expenses
   Cost of Sales    Total

2005

   $ —      $ 2    $ 21    $ 23

2006

     1      38      1      40

2007

     12      23      3      38

2008

     12      27      1      40

2009*

     2      10      1      13
                           

Total

   $ 27    $ 100    $ 27    $ 154
                           

 

* The total restructuring costs for 2009 were $14 million. The comprehensive restructuring plan accounted for $13 million and $1 million was for the Mississauga restructuring plan.

In connection with the comprehensive restructuring, we have modified our hydraulic product offering from a premium line and a value line to one distinct product offering that most resembles the value line in cost but the premium line in product attributes. Secondly, for our drum and rotor product offering, we have retained the premium line but have expanded the coverage in our value line product offering. Lastly, for our friction product offerings we reduced the product offerings from multiple lines to three product offerings. Even with the reduction in offerings we still retain one of our key advantages over our competitors, which is a broad product offering.

With the comprehensive restructuring plan nearing completion we have accomplished a major transformation. We anticipate from time to time further refinements through continued restructuring.

Other Restructuring

At the end of 2009 we approved the closure of our distribution operations located in Mississauga, Ontario, Canada. The operations are expected to close by the end of the first quarter of 2010. The closure of this operation is part of the Company’s continuing effort to improve its distribution system and serve the replacement parts market effectively and efficiently. This closure is expected to result in the Company incurring pre-tax charges of approximately $5 million. The charges are comprised of employee severance costs of $1 million, lease termination costs of $2 million and other trailing liabilities of $2 million. We incurred approximately $1 million in severance costs in the fourth quarter of 2009 related to the closure of this facility.

Disposition

As part of our strategic plan we committed to a plan to sell our Commercial Distribution Europe business unit during the fourth quarter of 2009. Subsequently, on February 2, 2010, we sold this business unit for approximately $12 million subject to post closing adjustments. Our Commercial Distribution Europe business unit, also known as Quinton Hazell, is a diverse aftermarket manufacturer and distributor of automotive components throughout Europe. Quinton Hazell’s financial performance did not meet our strategic financial metrics, as evidenced by a 2009 pre-tax loss of $84 million, of which $75 million related to an impairment of assets.

Nature of Business

We typically conduct business with our customers pursuant to short-term contracts and purchase orders. However, our business is not characterized by frequent customer turnover due to the critical nature of long-term relationships in our industry. The expectation of quick turnaround times for car repairs and the broad proliferation of available part numbers require a large investment in inventory and strong fulfillment capabilities in order to deliver high fill rates and quick cycle times. Large aftermarket distributors typically source their product lines at a particular price point and product category with one “full-line” supplier, such as our Company, which covers substantially all of their product requirements. Switching to a new supplier typically requires that a distributor or supplier make a substantial investment to purchase, or “changeover” to, the new supplier’s products.

In addition, the end user of our products, who is most frequently a professional installer, requires consistently high quality products because it is industry practice to replace, free of any labor or service charge, malfunctioning parts. Despite these factors, our business is becoming more competitive as “value line” and offshore suppliers have tried to penetrate our customer base by targeting the highest volume part numbers in the value category, without offering full product line coverage or many value added services. In many cases, the presence of these lower priced parts has caused full-line suppliers either to reduce prices in their premium categories or introduce new, intermediate-priced product offerings. In many instances, full-line suppliers have also been required to move more of their sourcing and production of value products to offshore, lower cost locations to offset this trend. We estimate that a majority of our brake product net sales are currently derived from products we consider to be premium products but this has been shifting to a more diverse mix of products.

 

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Business Environment

Our Markets. According to Automotive Aftermarket Industry Association, the U.S. aftermarket was forecasted to slow down by 1.3% during 2009 and grow by 4.5% in 2010. We believe that the aftermarket will grow as a result of continuing increases in (1) the light vehicle population, (2) the average age of vehicles, (3) the total number of miles driven (despite recent declines) and (4) the prevalence of SUVs and lighter trucks in the fleet mix, since larger vehicles place greater wear on components such as brake systems and chassis components. SUVs and the lighter truck sales have decreased recently due to higher energy costs; however, overall the fleet mix contains more SUVs and light trucks than in any previous 10 year period. Growth in sales in the aftermarket does not always have a direct correlation to sales growth for aftermarket suppliers like us. For example, as automotive parts distributors have consolidated during the past several years, they have reduced purchases from manufacturers as they focused on reducing their combined inventories. The automotive distributors are also focused on reducing inventories due to the recent decline in miles driven.

Raw Materials and Manufactured Components. Our variable costs are proportional to sales volume and mix and are comprised primarily of raw materials and labor and certain overhead costs. Our fixed costs are not significantly influenced by volume in the short-term and consist principally of selling, general and administrative expenses, depreciation and other facility-related costs.

We use a broad range of manufactured components and raw materials in our products, including raw steel, steel-related components, filtration media, aluminum, brass, iron, rubber, resins, plastics, paper and packaging materials. We purchase raw materials from a wide variety of domestic and international suppliers, and we have not, in recent years, experienced any significant shortages of these items and normally do not carry inventories of these items in excess of those reasonably required to meet our production and shipping schedules.

Seasonality. Our working capital requirements are significantly impacted by the seasonality of the aftermarket. In a typical year, we build inventory during the first and second quarters to accommodate our peak sales during the second and third quarters. Our working capital requirements therefore tend to be highest from March through August. In periods of weak sales, inventory can increase beyond typical seasonal levels, as our product delivery lead times are less than two days while certain components we purchase from overseas require lead times of approximately 90 days.

Global Developments. The aftermarket has also experienced increased price competition from manufacturers based in China and other lower cost countries. We responded to this challenge by our affiliate acquiring one of the largest drum and rotor manufacturers in the world, Haimeng located in China, and by expanding with new plants in India, Mexico and Ukraine. Additionally, we are meeting this challenge through restructuring and outsourcing initiatives, as well as through ongoing cost reduction programs.

 

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Results of Operations

Year Ended December 31, 2009 compared to the Year Ended December 31, 2008

In accordance with ASC Topic 360, the Commercial Distribution Europe segment qualified as a discontinued operation. Previously reported consolidated statements of operations for all periods presented have been adjusted to reflect this segment as a discontinued operation. Consolidated sales decreased by $118 million in 2009 in comparison to 2008 due mainly to unfavorable foreign currency translation effects of $96 million. The following table summarizes the consolidated net sales results for the years ended December 31, 2008 and December 31, 2009 (Dollars in Millions):

 

     Consolidated
Year Ended
December 31,
2008
    Consolidated
Year Ended
December 31,
2009
    Dollar
Change
    Percent
Change
    Currency
Effect
 

Net sales

          

Filtration products

   $ 727      $ 713      $ (14   -2   $ (47

Brake North America and Asia products

     658        593        (65   -10     (14

Commercial Distribution South America products

     368        333        (35   -10     (35

Chassis products

     155        153        (2   -1     (2
                                      

On and Off-highway segment

     1,908        1,792        (116   -6     (98

Brake South America segment

     26        22        (4   -15     —     

Eliminations and other

     (19     (17     2      11     2   
                                      

Total net sales

   $ 1,915      $ 1,797      $ (118 )    -6 %    $ (96 ) 

On and Off-highway segment product sales decreased due to the following:

Filtration products sales decreased in 2009 in comparison to 2008 due to unfavorable foreign currency translation effects of $47 million, which were related to the weakening of the Polish Zloty, the Canadian Dollar, the Ukraine Hryvnia and the Mexican Peso against the U.S. Dollar. Offsetting the translation effects were increased sales in our Polish and Venezuelan operations.

Brake North America and Asia products sales decreased in 2009 in comparison to 2008 partially due to $14 million in unfavorable foreign currency translation effects. The decrease is also attributable to a decline in volume, which is related to the general softness in the aftermarket business relating to our branded products. Additionally, one of our customers ceased orders of certain of our brake products and as a result our sales decreased by $21 million. The same customer has increased its filtration orders so we anticipate only a marginal effect on consolidated sales. OES channels, which consist primarily of new vehicle manufacturers’ service departments at new vehicle dealerships, have also decreased orders due to recessionary pressures. We began to discontinue in 2006 OEM and co-manufacturing contracts, which were not profitable. The sales relating to these contracts have decreased since 2006 by approximately $100 million. The decrease relating to these contracts in 2009 in comparison 2008 was $9 million.

Commercial Distribution South America products sales decreased in 2009 in comparison to 2008 due to unfavorable foreign currency translation effects of $35 million. The general softness of the South American economies led to a decline in sales in most of our South American operations. However, our Brazilian distribution company offset the decline in sales as it continued to grow its market share even in unfavorable market conditions.

Chassis products sales decreased in 2009 in comparison to 2008 due to unfavorable foreign currency translation effects of $2 million, which were related to the weakening of the Canadian Dollar against the U.S. Dollar.

Brake South America segment sales for 2009 decreased in comparison to 2008 due to the closure of a facility in Argentina in 2008. The closed facility had approximately $7 million in sales in 2008. The closed facility mainly manufactured product for our Brake North America operations and Commercial Distribution South America operations. On a consolidated basis the closure did not result in a significant loss of sales.

 

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In accordance with ASC Topic 360, the Commercial Distribution Europe segment qualified as a discontinued operation. Previously reported consolidated statements of operations for all periods presented have been adjusted to reflect this segment as a discontinued operation. The following table summarizes the consolidated results for the years ended December 31, 2008 and December 31, 2009 (Dollars in Millions):

 

     Consolidated
Year Ended
December 31,
2008
    Consolidated
Year Ended
December 31,
2009
    Dollar
Change
    Percent
Change
 

Net sales

   $ 1,915      $ 1,797      $ (118   –6

Cost of sales(1)

     (1,546     (1,429     117      –8
                          

Gross profit

     369        368        (1 )   —  

Gross margin

     19     20    

Selling, general and administrative expenses(2)

     (276     (267     9      –3

Selling, general and administrative expenses as a percent of sales

     14     15    
                          

Operating profit (loss)

        

On and Off-highway segment

     141        153        12      9

Brake South America segment

     (11     (3     8      73

Corporate and other

     (37     (49     (12   –32
                          

Operating profit

     93        101        8      9

Operating margin

     5     6    

Gain on extinguishment of debt

     —          8        8      NM   

Other income (loss), net

     (3     5        8      267

Interest expense

     (56     (69     (13   23
                          

Income from continuing operations before income tax provision, equity in income and noncontrolling interest

     34        45        11      32

Income tax provision

     (18     (22     (4   22

Equity in income, net of tax

     —          1        1      NM   
                          

Net income from continuing operations, net of tax

     16        24        8      50

Loss from discontinued operations, net of taxes(3)

     (19     (61     (42   NM   
                          

Net income (loss)

     (3     (37     (34   NM   

Less: Net income attributable to noncontrolling interest, net of tax

     —          (7     (7   NM   
                          

Net income (loss) attributable to the Company

   $ (3   $ (44   $ (41   NM   
                          

 

(1) We recorded $1 million in restructuring charges in cost of sales in 2008 and 2009.
(2) We recorded $27 million and $11 million of restructuring costs in selling, general and administrative expenses for 2008 and 2009, respectively.
(3) We recorded in our discontinued operations $12 million and $2 million in restructuring costs in 2008 and 2009, respectively.

NM (Not Meaningful)

Cost of sales/Gross margin. The gross margin improved to 20% in 2009 in comparison to 19% in 2008. In 2005 we embarked on a comprehensive restructuring program to transform our brake operations from a domestic manufacturer to a global manufacturer and distributor. We have completed the majority of the restructuring plan and as a result our gross margin improved due to cost savings realized in 2009.

Selling, general and administrative expenses. Our selling, general and administrative expenses for 2009 decreased from 2008 due mainly to a reduction in restructuring costs of $16 million. The higher restructuring expenses in 2008 were related to announcing the closure of six facilities in 2008 and, in contrast, we approved the closure of one facility in 2009. Offsetting the decrease in expense was a $3 million management fee charged by Cypress for services related to the refinancing and other advisory services. Cypress is the majority owner of and controls our parent, Affinia Group Holdings Inc.

 

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Operating profit. The operating profit increased in 2009 in comparison to 2008 due to the increase in gross margin and the reduction in selling, general and administrative expenses. The On and Off-Highway segment operating profit increased in 2009 in comparison to 2008 despite a 6% decrease in sales. The operating profit increased due to an increase in gross margin percentage and a reduction in our selling, general and administrative costs. The Brake South America segment operating loss decreased in 2009 due to the reduction in operating costs from the closure of an Argentina facility in the middle of 2008.

Gain on extinguishment of debt. In June of 2009, Affinia Group Holdings Inc. purchased in the open market approximately $33 million in principal amount of the Subordinated Notes due 2014 and thereafter contributed such notes to Affinia Group Intermediate Holdings Inc., who contributed such notes to Affinia Group Inc. Affinia Group Inc. promptly surrendered such purchased notes for cancellation, which resulted in a pre-tax gain on the extinguishment of debt of $8 million in the second quarter of 2009.

Interest expense. Interest expense increased by $13 million during 2009 in comparison to 2008. On August 13, 2009 we refinanced our former term loan facility, revolving credit facility and accounts receivable facility. The refinancing consisted of the ABL Revolver and the Secured Notes, the proceeds of which were used to repay outstanding borrowings under our former term loan facility, revolving credit facility and accounts receivable facility, as well as to settle interest rate derivatives and to pay fees and expenses related to the refinancing. We recorded a write-off of $5 million to interest expense for unamortized debt issue costs associated with the former term loan facility, revolving credit facility and the accounts receivable facility. We also recorded $4.4 million in settlement costs and $0.2 million of accrued interest related to the termination of our interest rate swap agreements. The remaining increase in interest expense related to higher borrowing levels and rates.

Income tax provision. The income tax provision increased $4 million for 2009 in comparison to 2008 due mainly to a higher level of income from continuing operations. The effective tax rates were comparable for both periods.

Net income attributable to noncontrolling interest, net of tax. The noncontrolling interest mainly relates to Affinia Acquisition LLC, which is further described in Note 3 Variable Interest Entity, which is included in Item 8 of this report. We started consolidating Affinia Acquisition LLC, a VIE, during the fourth quarter of 2008. Affinia increased its ownership from 5% to 40% effective on June 1, 2009. Therefore our noncontrolling interest related to Affinia Acquisition LLC, net of tax, eliminates 95% of the VIE’s consolidated income for January through May and 60% starting June 1, 2009, resulting in net income attributable to noncontrolling interest of $7 million in 2009.

Loss from discontinued operations, net of taxes. As part of our strategic plan we committed to a plan to sell our Commercial Distribution Europe business unit during the fourth quarter of 2009. Subsequently, on February 2, 2010, we sold the business unit for approximately $12 million subject to post closing adjustments. Commercial Distribution Europe incurred a loss of $61 million in 2009 of which $10 million relates to loss on operations, $75 million relates to an impairment charge to reduce the carrying value of the business to expected realizable value, and offsetting these amounts is $24 million which relates to a tax benefit to Affinia resulting from this transaction.

Net income (loss) attributable to the Company. The net income from continuing operations increased in 2009 in comparison to 2008. However, the net loss attributable to the company increased due to the increased loss in our discontinued operation.

 

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Results of Operations

Year Ended December 31, 2008 compared to the Year Ended December 31, 2007

In accordance with ASC Topic 360, the Commercial Distribution Europe segment qualified as a discontinued operation. Previously reported consolidated statements of operations for all periods presented have been adjusted to reflect this segment as a discontinued operation. The consolidated sales increased by $58 million in 2008 in comparison to 2007. The increase in net sales was primarily a result of currency translation gains of $46 million, largely attributable to a stronger Brazilian Real and Polish Zloty. The U.S. dollar weakened during the first three quarters of 2008 and subsequently strengthened during the fourth quarter of 2008. The following table summarizes the consolidated net sales results for the years ended December 31, 2007 and December 31, 2008 (Dollars in Millions):

 

     Consolidated
Year Ended
December 31,
2007
    Consolidated
Year Ended
December 31,
2008
    Dollar
Change
    Percent
Change
    Currency
Effect
 

Net sales

          

Filtration products

   $ 728      $ 727      $ (1   —     $ 17   

Brake North America and Asia products

     674        658        (16   –2     1   

Commercial Distribution South America products

     301        368        67      22     29   

Chassis products

     150        155        5      3     —     
                                  

On and Off-highway segment

     1,853        1,908        55      3     47   

Brake South America segment

     30        26        (4   –13     —     

Eliminations and other

     (26     (19     7      27     (1
                                  

Total net sales

     1,857        1,915        58      3 %    $ 46   

On and Off-highway segment product sales decreased due to the following:

On and Off-Highway segment sales increased in 2008 in comparison to 2007 due principally to the increase in our Commercial Distribution South America products sales. The Commercial Distribution South America product operations are mainly comprised of our Brazilian operations. Our Brazilian operations sales increased $65 million in 2008 compared to 2007 due to favorable market conditions, gains in market share and currency translation gains of $29 million.

Filtration products sales decreased slightly in 2008 in comparison to 2007. Filtration sales decreased due to recessionary pressures in the North America market. Offsetting the decrease in North American sales were an increase in Filtration product sales from our Polish operation, which was due to the strengthening of the Polish Zloty against the U.S. Dollar during the first three quarters of 2008.

Brake North America and Asia products sales decreased in 2008 in comparison to 2007. As planned, we have not renewed certain unprofitable OEM contracts thus reducing sales by $27 million. Partially offsetting the decrease were increased sales with two of our larger customers.

Chassis products sales increased by 3% in 2008 in comparison to 2007 due to an increase in sales with a few of our larger customers.

Brake South America segment sales decreased in 2008 in comparison to 2007 due to the closure of a facility in Argentina in the middle of the year. The closed facility mainly manufactured product for our Brake North America operations and Commercial Distribution South America segment. On a consolidated basis the closure did not result in a significant loss of sales.

 

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In accordance with ASC Topic 360, the Commercial Distribution Europe segment qualified as a separate component of the Company’s business and as a consequence, the operating results of this segment are accounted for as a discontinued operation. Previously reported consolidated statements of operations for all periods presented have been adjusted to reflect this segment as a discontinued operation. The following table summarizes the consolidated results for the years ended December 31, 2007 and December 31, 2008 (Dollars in Millions):

 

     Consolidated
Year Ended
December 31,
2007
    Consolidated
Year Ended
December 31,
2008
    Dollar
Change
    Percent
Change
 

Net sales

   $ 1,857      $ 1,915      $ 58      3

Cost of sales(1)

     (1,512 )      (1,546 )      (34 )    2 % 
                          

Gross profit

     345        369        24      7

Gross margin

     19 %      19 %     

Selling, general and administrative expenses(2)

     (276     (276     —        NM   

Selling, general and administrative expenses as a percent of sales

     15 %      14 %     

Income from settlement

     15        —          (15   NM   
                          

Operating profit (loss)

        

On and Off-highway segment

     109        141        32      29

Brake South America segment

     (6     (11     (5   83

Corporate and other

     (19     (37     (18   95
                          

Operating profit

     84        93        9      11

Operating margin

     5     5    

Other income (loss), net

     4        (3     (7   NM   

Interest expense

     (59     (56     3      -5
                          

Income from continuing operations before income tax provision, equity in income and noncontrolling interest

     29        34        5      17 % 

Income tax provision

     (6     (18     (12   200
                          
        

Net income from continuing operations, net of tax

     23        16        (7   -30

Loss from discontinued operations, net of taxes

     (17     (19     (2   12
                          

Net income (loss)

     6        (3     (9   NM   

Less: Net income attributable to noncontrolling interest, net of tax

     —          —          —        NM   
                          

Net income (loss) attributable to the Company

   $ 6      $ (3 )    $ (9 )    NM   
                          

 

(1) We recorded $3 million and $1 million in restructuring charges in cost of sales in 2007 and 2008, respectively.
(2) We recorded $23 million and $27 million of restructuring costs in selling, general and administrative expenses for 2007 and 2008, respectively.
(3) We recorded in our discontinued operations $12 million in restructuring costs in 2007 and 2008.
NM (Not Meaningful)

Cost of sales/Gross margin. The gross margin was 19% for 2008 and 2007. The comprehensive restructuring program has led to improved gross margins. However, offsetting these improvements were higher costs related to freight, steel, and oil-based products.

Selling, general and administrative expenses. Our selling, general and administrative expenses were flat for 2008 and 2007. During 2008, restructuring and legal costs increased but were offset by cost cutting measures. Legal fees increased in 2008 due mainly to the settlement costs related to a lawsuit filed against us.

Income from settlement. In December 2007, we received a general unsecured nonpriority claim against Dana in the amount of $22 million U.S. Dollars in connection with the settlement of claims against Dana as a result of their Chapter 11 filing and the termination of the Purchase Agreement and we monetized the claim for $15 million. The settlement proceeds were recorded as a component of operating expenses (Refer to Note 22 Settlement, which is included in Item 8 of this report). There were no settlement proceeds received during 2008.

 

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Operating profit. Our operating profit increased in 2008 in comparison to 2007. On and Off-Highway segment operating profit increased in 2008 in comparison to 2007. The increase was mainly due to improved operating profit in our Commercial Distribution South America products, which was due to the increase in sales. The Brake South America segment operating profit decreased in 2008 in comparison to 2007 due to the restructuring costs related to the closure of the Argentina facility. Corporate and other operating loss increased in 2008 by $18 million in comparison to 2007 due mainly to the income from settlement. The income from settlement reduced the corporate and other operating loss in 2007 by $15 million.

Interest expense. Interest expense in 2008 decreased in comparison to the same period in 2007. Interest expense was slightly lower due to lower variable short term interest rates.

Income tax provision. The income tax provision for 2008 increased by $12 million in comparison to 2007 primarily due to a $21 million non taxable dividend received in 2007 from a foreign subsidiary, which did not occur in 2008.

Loss from discontinued operations, net of taxes. The discontinued operations net loss increased to $19 million in 2008 from $17 million in 2007. The increase in the net loss is due to the increase in restructuring costs related to the closure of the Barcelona facility.

Net income (loss). Net income decreased by $9 million in 2008 in comparison to 2007 due mainly to the increase in taxes.

Liquidity and Capital Resources

The Company’s primary source of liquidity is cash flow from operations and available borrowings from our ABL Revolver. On August 13, 2009 we refinanced our former term loan facility, revolving credit facility and accounts receivable facility. The refinancing consisted of the ABL Revolver and the Secured Notes, the proceeds of which were used to repay outstanding borrowings under our former term loan facility, revolving credit facility and accounts receivable facility, as well as to settle interest rate derivatives and to pay fees and expenses related to the refinancing. Our primary liquidity requirements are expected to be for debt servicing, working capital, restructuring obligations and capital spending. Our liquidity requirements are significant, primarily due to debt service requirements, restructuring and expected capital expenditures.

We are significantly leveraged as a result of the Acquisition in 2004 and refinancing that occurred in 2009. Affinia Group Inc. issued senior subordinated notes, the Secured Notes, and entered into an ABL Revolver. As of December 31, 2009, the Company had $601 million in aggregate indebtedness. As of December 31, 2009, we had an additional $178 million of borrowing capacity available under our ABL Revolver after giving effect to $18 million in outstanding letters of credit, none of which was drawn against, and $3 million for borrowing base reserves. In addition, we had cash and cash equivalents of $77 million and $65 million as of December 31, 2008 and December 31, 2009, respectively.

We spent $25 and $31 million on capital expenditures during 2008 and 2009, respectively. Based on the current level of operations, the Company believes that cash flow from operations and available cash, together with available borrowings under its ABL Revolver, will be adequate to meet liquidity needs.

ABL Revolver. Our ABL Revolver consists of a revolving credit facility. Our ABL Revolver provides for loans in a total principal amount of up to $315 million of which $90 million was outstanding at December 31, 2009, and it matures in 2013.

Subordinated Notes and Senior Secured Notes Indenture. The indentures governing the notes limit our (and most or all of our subsidiaries’) ability to incur additional indebtedness, pay dividends on or make other distributions or repurchase our capital stock, make certain investments, enter into certain types of transactions with affiliates, use assets as security in other transactions and sell certain assets or merge with or into other companies. Subject to certain exceptions and limitations, Affinia and its restricted subsidiaries are permitted to incur additional indebtedness, including secured indebtedness, under the terms of the notes.

 

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Net cash provided by operating activities

In 2009, the cash flow from operating activities was a $55 million source of cash in comparison to a $48 million source of cash in 2008 and a $1 million source of cash during 2007. There were significant changes in the following operating activities:

 

    Year Ended
December 31,

2007
    Year Ended
December 31,

2008
    Year Ended
December 31,

2009
 

Summary of significant changes in operating activities:

     

Net (loss) income

  $ 6      $ (3   $ (37

Gain on extinguishment of debt

    —          —          (8

Write off of unamortized deferred financing costs

    —          —          5   

Change in trade accounts receivable

    (10     31        3   

Change in inventories

    (76     (39     42   

Impairment of assets

    3        2        75   

Change in other operating liabilities

    12        57        (42
                       

Subtotal

    (65     48        38   

Other changes in operating activities

    66        —          17   
                       

Net cash provided by or operating activities from cash flow statement

  $ 1      $ 48      $ 55   

Gain on extinguishment of debt – The retirement of $33 million of notes during the second quarter of 2009 resulted in a pre-tax gain on the extinguishment of debt of $8 million.

Write-off of debt issuance costs – We recorded a write-off of $5 million to interest expense for unamortized deferred financing costs associated with the retirement of the term loan facility, revolving credit facility and the accounts receivable facility.

Change in trade accounts receivable – Our accounts receivable decreased in 2008 mainly due to the timing of payments in the United States.

Change in inventories – The change in inventories was a $42 million source of cash in 2009 and a $39 million use of cash in 2008. The reduction in inventory in 2009 was due to a concerted effort to reduce inventories due to the economic downturn. In 2008, our inventory increased mainly due to increases in Brazil and other international locations. Our Brazilian operations were experiencing record sales in 2008 and, as a result, built up inventory to keep up with demand.

Net (loss) income and Impairment of assets – Absent asset impairments, net income in 2009 would have been a record for Affinia due to the improved gross margin relating to our comprehensive restructuring program. However, we had a $75 million impairment related to our Commercial Distribution Europe segment, which was sold on February 2, 2010.

Net cash used in investing activities

The following table summarizes investing activities (Dollars in Millions):

 

    Year Ended
December 31,

2007
    Year Ended
December 31,

2008
    Year Ended
December 31,

2009
 

Investing activities

     

Proceeds from sales of assets

  $ 14      $ 1      $ —     

Investments in companies, net of cash acquired

    —          (50     —     

Proceeds from sales of affiliates

    —          6        —     

Investment in affiliate

    —          (6     —     

Change in restricted cash

    —          (1     (5

Additions to property, plant and equipment

    (30     (25     (31
                       

Net cash used in investing activities

  $ (16   $ (75   $ (36

Net cash used in investing activities is summarized in the table above for the years ended 2007, 2008 and 2009. The changes in investing activities are mainly comprised of the following:

(1) Proceeds from sales of assets and affiliates were a source of cash of $14 million in 2007, $7 million in 2008 and nil in 2009. The higher proceeds in 2007 mainly related to the sale of assets as part of the comprehensive restructuring program. During 2007, we sold some significant facilities in connection with the comprehensive restructuring program. We also received $6 million in 2008 related to the sale of two subsidiaries;

 

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(2) The increase in the use of cash in 2008 was mainly due to the $50 million acquisition of Affinia Hong Kong Limited;

(3) An additional use of cash was a change in restricted cash of $5 million during 2009. The change in restricted cash related to Haimeng, which we commenced consolidating during the fourth quarter of 2008.

Net cash provided by financing activities

Net cash provided by financing activities for 2009 was a $35 million use of cash compared to a $51 million source of cash in 2008, respectively. In the third quarter of 2009, we refinanced a portion of our then-existing debt. We settled the former term loan facility by paying $287 million. The refinancing included sources of cash of $222 million from the Secured Notes. We also had $90 million of net borrowings on the new ABL Revolver and $22 million of fees and other associated financing costs. Effective June 1, 2009, Affinia Group Inc. acquired an additional 35% ownership interest in Affinia Acquisition LLC for a purchase price of $25 million, which increased its ownership to 40%. The $25 million reduced our non controlling interest balance in 2009.

Contractual Obligations and Commitments

Cash obligations. Under various agreements, we are obligated to make future cash payments in fixed amounts. These include payments under debt obligations at maturity, under operating lease agreements, and under purchase commitments for property, plant, and equipment. The following table summarizes our fixed cash obligations over various future periods as of December 31, 2009:

 

     Payments Due By Period

Contractual Cash Obligations*

   Total    Less
than
1 year
   1 – 3
Years
   4 – 5
years
   After
5 Years
     (Dollars in Millions)

Debt obligations

   $ 601    $ 12    $ 10      357    $ 222

Interest on senior subordinated notes

     118      24      48      46      —  

Interest on senior secured notes

     160      24      48      49      39

Interest on ABL Revolver**

     21      8      8      5      —  

Operating leases***

     168      27      51      44      46

Post employment obligations

     21      1      18      1      1

Purchase commitments for property, plant, and equipment

     2      2      —        —        —  
                                  

Total contractual obligations

   $ 1,091    $ 98    $ 183    $ 502    $ 308
                                  

 

* Excludes the $2 million reserve for income taxes under ASC Topic 740 as we are unable to reasonably predict the ultimate timing of settlement of our reserves for income taxes.
** The ABL Revolver consists of a 4% fixed margin and 1.5% floor on LIBOR borrowings. The fixed margin can vary based on availability on the ABL Revolver.
*** The operating leases include a contractual obligation of $73 million for a logistics service agreement and $27 million for operating leases for our Commercial Distribution Europe segment, which was sold on February 2, 2010. The obligations have been assumed by the buyer of this segment.

Commitments and Contingencies

The Company is party to various pending judicial and administrative proceedings arising in the ordinary course of business. These include, among others, proceedings based on product liability claims and alleged violations of environmental laws.

The Company has various accruals for contingent liability costs associated with pending judicial and administrative proceedings (excluding environmental liabilities). The Company had $1 million accrued at December 31, 2008 and 2009. There are no recoveries expected from third parties. If there is a range of equally probable outcomes, we accrue the lower end of the range.

The fair value of an ARO is required to be recognized in the period in which it is incurred if it can be reasonably estimated, with the offsetting associated asset retirement costs capitalized as part of the carrying amount of the long-lived asset. The ARO is subsequently allocated to expense using a systematic and rational method over its useful life. Changes in the ARO liability resulting from the passage of time are recognized as an increase in the carrying amount of the liability and an accretion to expense. Changes resulting from revisions to the timing or amount of the original estimate of cash flows are recognized as an increase or a decrease in both the asset and liability. Our ARO liability recorded at December 31, 2008 and December 31, 2009 was $2 million and the accretion for 2008 and 2009 was less than $1 million.

 

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Critical Accounting Estimates

The critical accounting estimates that affect our financial statements and that use judgments and assumptions are listed below. These estimates are subject to a range of amounts because of inherent imprecision that may result from applying judgment to the estimation process. The expenses and accrued liabilities or allowances related to certain of these policies are initially based on our best estimate at the time of original entry in our accounting records. Adjustments are recorded when actual results differ from the expected forecasts underlying the estimates. These adjustments could be material if our results were to change significantly in a short period of time. We make frequent comparisons of actual results and expected forecasts in order to mitigate the likelihood of material adjustments.

Asset impairment.

We perform impairment analyses, which are based on the guidance found in ASC Topic 350, Intangibles-Goodwill and Other and ASC Topic 360, Property, Plant, and Equipment. Management also evaluates the carrying amount of our inventories on a recurring basis for impairment due to lower of cost or market issues, and for excess or obsolete quantities. Goodwill and intangibles with indefinite lives are tested for impairment as of December 31 of each year or more frequently as necessary. The factors that would cause a more frequent test for impairment include, among other things, a significant negative change in the estimated future cash flows of the reporting unit that has goodwill or other intangibles because of an event or a combination of events. If the carrying amount of the asset is determined not to be recoverable, a write-down to fair value is recorded. Fair values are determined based on quoted market values, discounted cash flows, or external appraisals, as applicable. We review long-lived assets for impairment at the individual asset or the asset group level for which the lowest level of independent cash flows can be identified.

Goodwill. The impairment test involves a two-step process. First, a comparison of the fair value of the applicable reporting unit with the aggregate carrying values, including goodwill, is performed. If the carrying amount of a reporting unit exceeds the reporting unit’s fair value, we perform the second step of the goodwill impairment test to determine the amount of impairment loss. The second step includes comparing the implied fair value of the affected reporting unit’s goodwill with the carrying value of that goodwill.

We primarily determine the fair value of our reporting units using a discounted cash flow model (“DCF model”), and supplement this with observable valuation multiples for comparable companies, as applicable. The completion of the DCF model requires that we make a number of significant assumptions to produce an estimate of future cash flows. These assumptions include projections of future revenue, costs and working capital changes. In addition, we make assumptions about the estimated cost of capital and other relevant variables, as required, in estimating the fair value of our reporting units. The projections that we use in our DCF model are updated annually and will change over time based on the historical performance and changing business conditions for each of our reporting units. The determination of whether goodwill is impaired involves a significant level of judgment in these assumptions, and changes in our business strategy, or economic or market conditions could significantly impact these judgments. We will continue to monitor market conditions and other factors to determine if interim impairment tests are necessary in future periods. If impairment indicators are present in future periods, the resulting impairment charges could have a material impact on our results of operations.

Trade names. The fair value for each trade name is estimated based upon management’s estimates using a royalty savings approach, which is based on the principle that, if the business did not own the asset, it would have to license it in order to earn the returns that it was earning. The fair value is calculated based on the present value of the royalty stream that the business was saving by owning the asset. The projections that we use in our model are updated annually and will change over time based on the historical performance and changing business conditions for each of our reporting units. The determination of whether trade names are impaired involves a significant level of judgment in these assumptions, and changes in our business strategy, or economic or market conditions could significantly impact these judgments.

Other intangibles. Finite-lived intangibles are amortized over their estimated useful lives. Impairment tests for these intangible assets are only performed when a triggering event occurs that indicates that the carrying value of the intangible may not be recoverable based on the undiscounted future cash flows of the intangible. If the carrying amount of the intangible is determined not to be recoverable, a write-down to fair value is recorded. Fair values are determined based on a DCF model.

Inventories. Inventories are valued at the lower of cost or market. Cost is determined on the FIFO basis for all inventories or average cost basis for non-U.S. inventories. Where appropriate, standard cost systems are utilized for purposes of determining cost; the standards are adjusted as necessary to ensure they approximate actual costs. Estimates of inventory value are determined on a product line basis. These estimates are based upon current economic conditions, historical sales quantities and patterns and, in some cases, the specific risk of loss on specifically identified inventories.

 

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We also evaluate inventories on a regular basis to identify inventory on hand that may be obsolete or in excess of current and future projected market demand principally based on historical market demand. For inventory deemed to be obsolete, we provide a reserve on the full value of the inventory. Inventory that is in excess of current and projected use, which is generally defined as inventory quantities in excess of 24 months of historical sales, is adjusted for certain allowances such as new part number introductions and product repacking opportunities.

Revenue recognition. Sales are recognized when products are shipped or received depending on terms and whether risk of loss has transferred to the customer. The Company estimates and records provisions for warranty costs, sales returns and other allowances based on experience when sales are recognized. The Company assesses the adequacy of its recorded warranty and sales returns and allowances liabilities on a regular basis and adjusts the recorded amounts as necessary. While management believes that these estimates are reasonable, actual returns and allowances and warranty costs may differ from estimates. Inter-company sales have been eliminated.

Sales returns and rebates. The amount of sales returns accrued at the time of sale is estimated on the basis of the history of the customer and the history of products returned. Other factors considered in establishing the accrual include consideration of current economic conditions and changes in trends in returns, as well as adjusting for the impact of extraordinary returns that may result from individual negotiations with a customer in an unusual situation. The level of sales returns are recorded as a reduction of gross sales in our financial statements at the time of sale. In addition, we periodically perform studies to determine a scrap factor to be applied to the returns on a product-by-product basis, since a portion of the goods historically returned by customers have not been in saleable condition. Estimates of returned goods that are not in saleable condition are included in cost of sales.

We customize rebate programs with individual customers. Under certain rebate programs, a customer may earn a rebate that will increase as a percentage of the sale amount based on the achievement of specified sales levels. In order to estimate the amount of a rebate under this type of arrangement, we project the amount of sales that the customer will make over the specified rebate period in order to calculate an overall rebate to be accrued at the time that each sale is made. Gross sales are reduced at the time of sale. These estimates may need to be adjusted based on actual customer purchases compared to the projected purchases. Adjustments to the accrual are made as new information becomes available. In other cases a customer may earn a specific rebate for a specific period of time, based upon the sales of certain product types within the specified timeframe. Rebates are recorded as a reduction of gross sales.

Warranty. Estimated costs related to product warranty are accrued at the time of sale and included in cost of sales. Estimated costs are based upon past warranty claims and sales history. In certain situations the estimated cost of the warranty includes a salvage factor where a portion of the inventory returned proves to be saleable. These costs are then adjusted, as required, to reflect subsequent experience.

Pension and post-retirement benefits other than pensions. We have defined benefit plans related to Canadian employees with fair value of assets of approximately $20 million and liabilities of approximately $22 million as of December 31, 2009.

Under the defined benefit plans, annual net periodic expense and benefit liabilities are determined on an actuarial basis. Each year, actual experience is compared to the more significant assumptions used and, if warranted, we make adjustments to the assumptions. Discount rates are based upon an expected benefit payments duration analysis and the equivalent average yield rate for high-quality fixed-income investments. Pension benefits are funded through deposits with trustees and the expected long-term rates of return on fund assets are based upon actual historical returns modified for known changes in the market and any expected changes in investment policy.

Income taxes. We account for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to be in effect for the year in which those temporary differences are expected to be recovered or settled. Deferred tax assets are recognized for temporary differences that will result in deductible amounts in future years and for carryforwards. A valuation allowance is recognized if, based on the weight of available evidence, it is more likely than not that some portion or all of a deferred tax asset will not be realized. All available evidence, both positive and negative, is considered when determining the need for a valuation allowance. Judgment is used in considering the relative impact of negative and positive evidence. The weight given to the potential effect of negative and positive evidence is commensurate with the extent to which it can be objectively verified. Accounting for income taxes involves matters that require estimates and the application of judgment. Our income tax estimates are adjusted in light of changing circumstances, such as the progress of tax audits and our evaluation of the realizability of our tax assets.

Contingency reserves. We have historically been subject to a number of loss exposures, such as environmental claims, product liability and litigation. Establishing loss reserves for these matters requires the use of estimates and judgment with regard to risk exposure and ultimate liability. We expect to estimate losses relating to such contingent liabilities using consistent and appropriate methods. Changes to assumptions we use could materially affect the recorded liabilities.

 

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Restructuring. The company defines restructuring charges to include costs related to business operation consolidation and exit and disposal activities. In 2005, we announced two restructuring plans: (i) a restructuring plan that we announced at the beginning of 2005 as part of the Acquisition, also referred to as the acquisition restructuring and (ii) a restructuring plan that we announced at the end of 2005, also referred to as the comprehensive restructuring. We have completed the acquisition restructuring and we are continuing the comprehensive restructuring plan. The comprehensive restructuring plan should be completed by the end of 2010. We currently estimate that we will incur in the aggregate approximately $161 million of cash and non cash restructuring costs for the comprehensive restructuring. With the comprehensive restructuring plan coming to a close we anticipate from time to time further refinement to the Company through continued restructuring. We approved the closure of our distribution operations located in Mississauga, Ontario, Canada at the end of 2009. We anticipate this new restructuring activity will result in $5 million of cash and non cash restructuring costs. Establishing a reserve requires the estimate and judgment of management with respect to employee termination benefits, environmental costs and other exit costs. We had an $11 million and $7 million reserve recorded as of December 31, 2008 and 2009, respectively.

Recent Accounting Pronouncements

Effective January 1, 2009, we adopted a general accounting principle relating to the accounting for and reporting of minority interest (now called noncontrolling interest) in our consolidated financial statements. Upon adoption, certain prior period amounts have been retrospectively changed to conform to the current period financial statement presentation.

In June 2009, the FASB issued authoritative guidance that requires additional information regarding transfers of financial assets, including securitization transactions, and where companies have continuing exposure to the risks related to transferred financial assets. The concept of a “qualifying special-purpose entity” changes the requirements for derecognizing financial assets and requires additional disclosures. The new guidance is effective for fiscal years beginning after November 15, 2009 and is effective for us on January 1, 2010. We are currently evaluating the impact that the adoption of the new guidance may have on our financial condition, results of operations, and disclosures.

In June 2009, the FASB issued authoritative guidance that modifies how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The guidance clarifies that the determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. The guidance requires an ongoing reassessment of whether a company is the primary beneficiary of a variable interest entity. The guidance also requires additional disclosures about a company’s involvement in variable interest entities and any significant changes in risk exposure due to that involvement. The guidance is effective for fiscal years beginning after November 15, 2009 and is effective for us on January 1, 2010. We are currently evaluating the impact that the adoption may have on our financial condition, results of operations, and disclosures.

In June 2009, the FASB approved the “FASB Accounting Standards Codification“ (“Codification”) as the single source of authoritative nongovernmental U.S. GAAP to be launched on July 1, 2009. The Codification does not change current U.S. GAAP, but is intended to simplify user access to all authoritative U.S. GAAP by providing all the authoritative literature related to a particular topic in one place. All existing accounting standard documents is superseded and all other accounting literature not included in the Codification is considered nonauthoritative. The Codification is effective for interim and annual periods ending after September 15, 2009. The Codification is effective for us and did not have an impact on our financial condition or results of operations, but did result in a revision to our references to generally accepted accounting principles.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to various market risks, such as currency exchange and interest rate fluctuation. Where necessary to minimize such risks we may enter into financial derivative transactions, however we do not enter into derivatives or other financial instruments for trading or speculative purposes.

Currency risk

We conduct business throughout the world. Although we manage our businesses in such a way as to reduce a portion of the risks associated with operating internationally, changes in currency exchange rates may adversely impact our results of operations and financial position.

 

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The results of operations and financial position of each of our operations are measured in their respective local (functional) currency. Business transactions denominated in currencies other than an operation’s functional currency produce foreign exchange gains and losses, as a result of the re-measurement process, as described in ASC Topic 830, Foreign Currency Matters. To the extent that our business activities create monetary assets or liabilities denominated in a non-local currency, changes in an entity’s functional currency exchange rate versus each currency in which an entity transacts business have a varying impact on an entity’s results of operations and financial position, as reported in functional currency terms. Therefore, for entities that transact business in multiple currencies, we seek to minimize the net amount of cash flows and balances denominated in non-local currencies. However, in the normal course of conducting international business, some amount of non-local currency exposure will exist. Therefore, management monitors these exposures and may engage in business activities or execute financial hedge transactions intended to mitigate the potential financial impact due to changes in the respective exchange rates.

The Company’s consolidated results of operations and financial position, as reported in U.S. dollars, are also affected by changes in currency exchange rates. The results of operations of non-U.S. dollar functional entities are translated into U.S. dollars for consolidated reporting purposes each period at the average currency exchange rate experienced during the period. To the extent that the U.S. dollar may appreciate or depreciate over time, the contribution of non-U.S. dollar denominated results of operations to the Company’s U.S. dollar reported consolidated earnings will vary accordingly. Therefore, changes in the various local currency exchange rates, as applied to the revenue and expenses of our non-U.S. dollar operations may have a significant impact on the Company’s sales and, to a lesser extent, consolidated net income trends. In addition, a significant portion of the Company’s consolidated financial position is maintained at foreign locations and is denominated in functional currencies other than the U.S. dollar. The non-U.S. dollar denominated monetary assets and liabilities are translated into U.S. dollars at each respective currency’s exchange rate then in effect at the end of each reporting period. The financial impact of the translation process is reflected within the other comprehensive income component of shareholder’s equity. Accordingly, the amounts shown in our consolidated shareholder’s equity account will fluctuate depending upon the cumulative appreciation or depreciation of the U.S. dollar versus each of the respective functional currencies in which the Company conducts business. Management seeks to mitigate the potential financial impact upon the Company’s consolidated results of operations due to exchange rate changes by engaging in business activities or may execute financial derivative transactions intended to mitigate specific transactional underlying currency exposures. We do not engage in activities solely intended to counteract the impact that changes in currency exchange rates may have upon the Company’s U.S. dollar reported statement of financial condition.

Our foreign currency exchange rate risk management efforts primarily focus upon operationally managing the net amount of non-functional currency denominated monetary assets and liabilities. In addition, we routinely execute short-term currency exchange rate forward contracts intended to mitigate the earnings impact related to the re-measurement process. At December 31, 2009, we had currency exchange rate derivatives with an aggregate notional value of $133 million and having fair values of assets and liabilities of less than $1 million each.

Interest rate risk

The Company is exposed to the risk of rising interest rates to the extent that it funds its operations with short-term or variable-rate borrowings. At December 31, 2009, the Company’s $601 million of aggregate debt outstanding consisted of $100 million of floating-rate debt and $501 million of fixed-rate debt. Based on the amount of floating-rate debt outstanding at December 31, a 1% rise in interest rates would result in insignificant incremental interest expense. The majority of our floating-rate debt relates to our ABL of $90 million. The ABL facility is primarily based on LIBOR based rates which are subject to a 1.5% floor. If the LIBOR rates stay below 0.5% then there would be no impact on our ABL facility. We did not have any interest rate derivatives outstanding at December 31, 2009.

Commodity Price Risk Management

The Company is exposed to adverse price movements or surcharges related to commodities that are used in the normal course of business operations. Management actively seeks to negotiate contractual terms with our customers and suppliers to limit the potential financial impact related to these exposures.

 

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Item 8. Financial Statements and Supplementary Data

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholder of

Affinia Group Intermediate Holdings Inc.

Ann Arbor, Michigan

We have audited the accompanying consolidated balance sheets of Affinia Group Intermediate Holdings Inc. and subsidiaries (the “Company”) as of December 31, 2009 and 2008, and the related consolidated statements of operations, shareholder’s equity, and cash flows for each of the three years in the period ended December 31, 2009. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Affinia Group Intermediate Holdings Inc. and subsidiaries as of December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

Due to the adoption of new accounting pronouncements, the Company changed its method of accounting for noncontrolling interest as of January 1, 2009, its method of accounting for the funded status of its defined benefit postretirement plans as of December 31, 2007, and its method of accounting for uncertainty in income taxes as of January 1, 2007, as discussed in Notes 23, 11, and 12, respectively.

 

/s/ DELOITTE & TOUCHE LLP

Detroit, Michigan
March 16, 2010

 

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Affinia Group Intermediate Holdings Inc.

Consolidated Statements of Operations

(Dollars in Millions)

 

     Year Ended
December 31,
2007
    Year Ended
December 31,
2008
    Year Ended
December 31,
2009
 

Net sales

   $ 1,857      $ 1,915      $ 1,797   

Cost of sales

     (1,512     (1,546     (1,429
                        

Gross profit

     345        369        368   

Selling, general and administrative expenses

     (276     (276     (267

Income from settlement

     15        —          —     
                        

Operating profit

     84        93        101   

Gain on extinguishment of debt

     —          —          8   

Other income (loss), net

     4        (3     5   

Interest expense

     (59     (56     (69
                        

Income from continuing operations before income tax provision, equity in income and noncontrolling interest

     29        34        45   

Income tax provision

     (6     (18     (22

Equity in income, net of tax

     —          —          1   
                        

Net income from continuing operations

     23        16        24   

(Loss) from discontinued operations, net of tax

     (17     (19     (61
                        

Net income (loss)

     6        (3     (37

Less: net income attributable to noncontrolling interest, net of tax

     —          —          (7
                        

Net income (loss) attributable to the Company

   $ 6      $ (3   $ (44
                        

The accompanying notes are an integral part of the consolidated financial statements.

 

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Affinia Group Intermediate Holdings Inc.

Consolidated Balance Sheets

(Dollars in Millions)

 

     December 31,
2008
    December 31,
2009
 

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 77      $ 65   

Restricted cash

     4        9   

Trade accounts receivable, less allowances of $4 million for 2008 and $3 million for 2009

     312        293   

Inventories, net

     512        430   

Current deferred taxes

     41        50   

Prepaid taxes

     42        50   

Other current assets

     6        21   

Current assets of discontinued operations

     —          55   
                

Total current assets

     994        973   

Property, plant, and equipment, net

     208        199   

Goodwill

     58        43   

Other intangible assets, net

     163        149   

Deferred financing costs

     11        24   

Deferred income taxes

     59        68   

Investments and other assets

     22        27   
                

Total assets

   $ 1,515      $ 1,483   
                

Liabilities and shareholder’s equity

    

Current liabilities:

    

Accounts payable

   $ 274      $ 201   

Notes payable

     14        12   

Other accrued expenses

     148        154   

Accrued payroll and employee benefits

     31        27   

Current liabilities of discontinued operations

     —          43   
                

Total current liabilities

     467        437   

Long-term debt

     608        589   

Deferred employee benefits and other noncurrent liabilities

     24        20   
                

Total liabilities

     1,099        1,046   
                

Contingencies and commitments

    

Common stock, $.01 par value, 1,000 shares authorized, issued and outstanding

     —          —     

Additional paid-in capital

     411        434   

Accumulated deficit

     (37     (81

Accumulated other comprehensive income (loss)

     (18     38   
                

Total shareholder’s equity of the Company

     356        391   

Noncontrolling interest in consolidated subsidiaries

     60        46   
                

Total shareholder’s equity

     416        437   
                

Total liabilities and shareholder’s equity

   $ 1,515      $ 1,483   
                

The accompanying notes are an integral part of the consolidated financial statements.

 

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Affinia Group Intermediate Holdings Inc.

Consolidated Statements of Shareholder’s Equity

(Dollars in Millions)

 

(Dollars in millions)

   Common
stock
   Additional
paid-in
capital
    Accumu-
lated
deficit
    Minimum
pension
liability
adjustment
    Foreign
currency
translation
adjustment
    Interest
rate
swap
    Accum-
ulated other
Comprehen-
sive income
(loss)
    Total
share-
holder’s
equity of
the
company
    Noncon-
trolling
Interest
    Total
equity
 

Balance at

December 31, 2006

   $ —      $ 407      $ (39   $ (1   $ 14      $ —          $ 381      $ 2      $ 383   

Adoption of ASC 740 (formerly FIN 48)

     —        —          (1     —          —          —            (1     —          (1

Adjusted balance, January 1, 2007

   $ —      $ 407      $ (40   $ (1   $ 14        —          $ 380      $ 2      $ 382   

Stock-based compensation

     —        1        —          —          —          —            1        —          1   

Adoption of ASC 715 (formerly SFAS 158) – net of tax of $1 million

     —        —          —          (2     —          —            (2     —          (2

Net income

     —        —          6        —          —          —        6        6        —          6   

Other comprehensive income (loss):

                     

Interest rate swap – net of tax of $1 million

     —        —          —          —          —          (2   (2     (2     —          (2

Currency translation – net of tax of $15 million

     —        —          —          —          49        —        49        49        —          49   
                         

Comprehensive income

     —        —          —          —          —          —        53         
                         

Balance at December 31, 2007

   $ —      $ 408      $ (34   $ (3   $ 63      $ (2     $ 432      $ 2        434   

Stock-based compensation

     —        —          —          —          —          —            —          —          —     

Capital contribution

        3                  3        —          3   

Noncontrolling interest related to acquisition of Haimeng

     —        —          —          —          —          —              58        58   

Net loss

     —        —          (3     —          —          —        (3     (3     —          (3

Other comprehensive income (loss):

                     

Interest rate swap – net of tax of $1 million

     —        —          —          —          —          (2   (2     (2     —          (2

Minimum pension liability adjustment

     —        —          —          (1     —          —        (1     (1     —          (1

Currency translation – net of tax of $1 million

     —        —          —          —          (73     —        (73     (73     —          (73
                         

Comprehensive loss

     —        —          —          —          —          —        (79      
                         

Balance at December 31, 2008

   $ —      $ 411      $ (37   $ (4   $ (10   $ (4     $ 356        60        416   

Stock-based compensation

     —        1        —          —          —          —        —          1        —          1   

Capital contribution

        25                  25        —          25   

Noncontrolling interest decrease due to acquisition of additional ownership

     —        (3     —          —          —          —            (3     (21     (24

Net (loss) income

     —        —          (44     —          —          —        (44     (44     7        (37

Other comprehensive income (loss):

                     

Interest rate swap – net of tax of $2

     —        —          —          —          —          4      4        4        —          4   

Minimum pension liability adjustment

     —        —          —          —          —          —            —          —          —     

Currency translation – net of tax of $2 million

     —        —          —          —          52        —        52        52        —          52   
                         

Comprehensive income

     —        —          —          —          —          —        12         
                         

Balance at December 31, 2009

   $ —      $ 434      $ (81   $ (4   $ 42      $ —          $ 391        46        437   

The accompanying notes are an integral part of the consolidated financial statements.

 

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Affinia Group Intermediate Holdings Inc.

Consolidated Statements of Cash Flows

(Dollars in Millions)

 

     Year Ended
December 31,
2007
    Year Ended
December 31,
2008
    Year Ended
December 31,
2009
 

Operating activities

      

Net income (loss)

   $ 6      $ (3   $ (37

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

      

Depreciation and amortization

     33        36        38   

Impairment of assets

     3        2        75   

Stock-based compensation

     1        1        1   

Loss on disposition of affiliate

     —          1        —     

Gain on extinguishment of debt

     —          —          (8

Write-off of unamortized deferred financing costs

     —          —          5   

Provision for deferred income taxes

     (28     14        (9

Change in trade accounts receivable

     (10     31        3   

Change in inventories

     (76     (39     42   

Change in other current operating assets

     1        (49     (33

Change in other current operating liabilities

     12        57        (42

Change in other

     59        (3     20   
                        

Net cash provided by operating activities

     1        48        55   

Investing activities

      

Proceeds from sales of assets

     14        1        —     

Investments in companies, net of cash acquired

     —          (50     —     

Proceeds from sale of affiliates

     —          6        —     

Investments in affiliates

     —          (6     —     

Change in restricted cash

     —          (1     (5

Additions to property, plant, and equipment

     (30     (25     (31
                        

Net cash used in investing activities

     (16     (75     (36

Financing activities

      

Payments on senior term loan facility

     —          —          (297

Proceeds from senior term loan facility

     —          1        —     

Capital contribution

     —          50        —     

Net decrease in debt of noncontrolling interest

     —          —          (3

Payment of deferred financing costs

     —          —          (22

Proceeds from Secured Notes

     —          —          222   

Net proceeds from ABL Revolver

     —          —          90   

Purchase of noncontrolling interest

     —          —          (25
                        

Net cash (used in) provided by financing activities

     —          51        (35

Effect of exchange rates on cash

     4        (6     4   

Increase (decrease) in cash and cash equivalents

     (11     18        (12

Cash and cash equivalents at beginning of the period

     70        59        77   
                        

Cash and cash equivalents at end of the period

   $ 59      $ 77      $ 65   
                        

Supplemental cash flows information

      

Cash paid during the period for:

      

Interest

   $ 55      $ 52      $ 53   

Income taxes

   $ 17      $ 22      $ 14   

The accompanying notes are an integral part of the consolidated financial statements.

 

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Note 1. Organization and Description of Business

Affinia Group Intermediate Holdings Inc. (“Affinia” or the “Company”) is a global leader in the on and off-highway replacement products and services industry. We derive approximately 98% of our sales from this industry and, as a result, are not directly affected by the market cyclicality of the automotive original equipment manufacturers. Our broad range of brake, filtration, chassis and other products are sold in North America, Europe, South America, Asia and Africa. Our brands include WIX®, Raybestos®, McQuay-Norris®, Nakata®, Quinton Hazell®, Filtron® and Brake Pro®. Additionally, we provide private label offerings for NAPA, CARQUEST and ACDelco and other customers and co-branded offerings for Federated and ADN. Affinia Group Inc. is wholly-owned by Affinia Group Intermediate Holdings Inc., which, in turn, is wholly-owned by Affinia Group Holdings Inc., a company controlled by affiliates of The Cypress Group L.L.C.

Note 2. Discontinued Operation

In the fourth quarter of 2009 the Company committed to a plan to sell the Commercial Distribution Europe segment. In accordance with ASC Topic 360, the Commercial Distribution Europe segment qualified as a discontinued operation. The consolidated statements of operations for all periods presented have been adjusted to reflect this segment as a discontinued operation. The consolidated balance sheet as of December 31, 2008 and consolidated statements of cash flows for all periods presented were not adjusted to reflect this segment as a discontinued operation. The table below summarizes the Commercial Distribution Europe segment’s net sales, the pre-tax operating (loss), tax provision and loss from discontinued operations, net of tax (Dollars in Millions).

 

     2007     2008     2009  

Net sales

   $ 281      $ 263      $ 237   

Loss before income tax provision

     (16     (17     (84

Income tax provision

     (1     (2     23   
                        

Loss from discontinued operations, net of tax

   $ (17   $ (19   $ (61
                        

The Company entered into a Sale and Purchase Agreement with Klarius Group Limited (“KGL”) and Auto Holding Paris S.A.S. (“AHP”) (collectively, the “Purchaser”) on February 2, 2010 (the “Agreement”), pursuant to which KGL purchased the shares of Quinton Hazell Automotive Limited and Quinton Hazell Italia SpA and AHP purchased the shares of Quinton Hazell Deutschland GmbH and Affinia Holding S.A.S. (collectively, the “Group Companies”) for $12 million, subject to certain closing and post-closing purchase price adjustments (the “Transaction”). The Agreement also called for the Purchaser to assume debt of $2.6 million. We also retained the cash in the operations. Operations of the Group Companies and their subsidiaries consist of manufacturing and distribution facilities in eight countries in Europe.

In accordance with ASC Topic 360 intangibles and other long-lived assets are assessed for recoverability whenever events or changes in circumstances indicate that their carrying value may not be recoverable through the estimated undiscounted future cash flows resulting from the use of the assets. The Company determined that the net carrying value of the Commercial Distribution Europe segment may not be recoverable through the sales process. As a result, an impairment charge of $75 million was recorded within discontinued operations in 2009 to reduce the carrying value of the business to expected realizable value. A tax benefit to Affinia of $24 million was recorded resulting from this transaction.

The following table shows an analysis of assets and liabilities held for sale as of December 31, 2009 (Dollars in Millions):

 

     At December 31,
2009
 

Accounts receivable

   $ 34   

Inventory

     67   

Other current assets

     6   

Property, plant and equipment

     18   

Long-term assets

     5   

Impairment of assets

     (75
        

Total assets of discontinued operations

     55   
        

Current liabilities

     41   

Long-term liabilities

     2   
        

Total liabilities of discontinued operations

   $ 43   
        

 

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Note 3. Variable Interest Entity

Effective October 31, 2008, Affinia Acquisition LLC completed the purchase of 85% of the equity interests (the “Acquired Shares”) in HBM Investment Limited (“HBM”). HBM is the sole owner of Longkou Haimeng Machinery Company Limited (“Haimeng”), a drum and rotor manufacturing company located in Longkou City, China. The purchase price was $50 million and included $25 million in current and long term debt on Haimeng’s books. Affinia Group Holdings Inc. received $51 million in return for preferred stock from Cypress, Co-investors and management. Affinia Group Holdings Inc. contributed $50 million to Affinia Acquisition LLC to purchase 85% of the equity interests in HBM.

HBM subsequently changed its name to Affinia Hong Kong Limited. Affinia Group Holdings Inc. owned 95% of Affinia Acquisition LLC and Affinia Group Inc. owned the remaining 5% interest. Effective June 1, 2009, Affinia Group Inc. acquired an additional 35% ownership interest in Affinia Acquisition LLC for a purchase price of $25 million, which increased its ownership to 40%. ASC Topic 810 requires the “primary beneficiary” of a variable interest entities (“VIE”) to include the VIE’s assets, liabilities and operating results in its consolidated financial statements. Based on the criteria for consolidation of VIEs, we determined that Affinia Group Inc. is deemed the primary beneficiary of Affinia Acquisition LLC. Therefore, the consolidated financial statements of the Company include Affinia Acquisition LLC and its subsidiaries. The net income attributable to the noncontrolling interest owned in Affinia Acquisition LLC was less than $1 million in 2008 and $7 million for 2009, respectively.

The aforementioned acquisition has been accounted for under the purchase method of accounting, in accordance with Statement of Financial Accounting Standards No. 141, Business Combinations. The Company engaged independent appraisers to assist in determining the fair values of property, plant and equipment and intangible assets acquired; including trade names, trademarks, developed technology and customer relationships. Purchase price allocations are subject to adjustment until all pertinent information regarding the acquisition is obtained and fully evaluated. Based on our preliminary valuations and purchase accounting adjustments, we recorded $30 million as goodwill at the end of 2008. In 2009 goodwill was reduced by $7 million related to certain purchase accounting adjustments.

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of the Acquisition (Dollars in Millions):

 

     Preliminary
Allocation
   Adjustments     Final
Allocation

Current assets

   $ 36    $ —        $ 36

Property, plant and equipment

     38      1        39

Customer relationships

     7      —          7

Non-competition agreement

     2      —          2

Goodwill

     30      (7     23
                     

Total acquired assets

   $ 113    $ (6   $ 107
                     

Current liabilities

     42      (8     34

Other liabilities

     12      2        14
                     

Total liabilities assumed

     54      (6     48
                     

Net assets acquired

   $ 59    $ —        $ 59
                     

Cash and cash equivalents, trade accounts receivable, other current assets, accounts payable, accrued expenses and other current liabilities were recorded at historical carrying values, given the short-term nature of these assets and liabilities. Inventory, other non-current assets, long-term debt, and other non-current liabilities outstanding as of the effective date of the acquisition have been allocated based on management’s estimate of fair market value which approximates book value. Customer relationships with estimated useful lives ranging from 10 to 15 years have been valued using an income approach, which utilized a discounted cash flow method. The non-competition agreement with an estimated useful life of 6 years was valued utilizing a form of the discounted cash flow method to determine the value of lost income.

Affinia Hong Kong Limited is reporting its financial results on a one-month reporting lag. There are no arrangements between the primary beneficiary, Affinia Group Inc., and the VIE, Affinia Acquisition LLC, that would require financial support be provided to the VIE. Additionally, the primary beneficiary has not imposed any restrictions on the VIE and there are no recourse provisions in the acquisition agreement. Affinia Acquisition LLC received a contribution of $50 million for the purchase of Affinia Hong Kong Limited in the fourth quarter of 2008. Noncontrolling interest decreased to $46 million as of December 31, 2009 from $60 million as of December 31, 2008. The noncontrolling interest decreased $21 million due to acquiring an additional 35% ownership interest in Affinia Acquisition LLC offset by a $7 million increase related to the net income attributable to noncontrolling interest.

 

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Note 4. Summary of Significant Accounting Policies

Principles of Consolidation

The consolidated financial statements include the accounts of Affinia and its wholly owned subsidiaries, majority-owned subsidiaries and VIEs for which Affinia (or one of its subsidiaries) is the primary beneficiary (“the Company”). All significant intercompany transactions have been eliminated. Equity investments in which we exercise significant influence but do not control are accounted for using the equity method. Investments in which we are not able to exercise significant influence over the investee are accounted for under the cost method.

Use of Estimates

The preparation of these consolidated financial statements requires estimates and assumptions that affect the amounts reported in these consolidated financial statements and accompanying notes. Some of the more significant estimates include valuation of deferred tax assets and inventories; workers compensation; sales return, rebate and warranty accruals; restructuring, environmental and product liability accruals; valuation of postemployment and postretirement benefits, and allowances for doubtful accounts. Actual results may differ from these estimates and assumptions.

Concentration of Credit Risk

The primary type of financial instruments that potentially subject the Company to concentrations of credit risk are trade accounts receivable. The Company limits its credit risk by performing ongoing credit evaluations of its customers and, when deemed necessary, requires letters of credit, guarantees or collateral. The majority of the Company’s accounts receivable is due from replacement parts wholesalers and retailers serving the aftermarket.

The Company’s net sales to its two largest customers as a percentage of total net sales from continuing operations for the year ended December 31, 2009, were 29%, and 8%; for the year ended December 31, 2008, were 27% and 8%; and for the year ended December 31, 2007, were 29% and 8%. Net sales represent the amounts invoiced to customers after adjustments related to rebates, returns and discounts. The Company provides reserves for rebates, returns and discounts at the time of sale which are subsequently applied to the account of specific customers based upon actual activity including the attainment of targeted volumes. The Company’s two largest customers’ accounts receivable as of December 31, 2009 represented approximately 39% and 12%, and as of December 31, 2008 represented 34% and 4% of the total accounts receivable. The increase in concentration is due to the removal of Commercial Distribution Europe accounts receivables which are classified in current assets of discontinued operations on the December 31, 2009 consolidated balance sheet.

Foreign Currency Translation

Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Revenue and expenses are translated at average rates of exchange prevailing during the year. Translation adjustments resulting from this process are charged or credited to Other Comprehensive Income.

Included in net income (loss) are the gains and losses arising from foreign currency transactions. The impact on income (loss) from continuing operations before income tax provision, equity in income and noncontrolling interest of foreign currency transactions including the results of our foreign currency hedging activities amounted to a loss of $1 million, a loss of $10 million and a loss of $2 million in 2009, 2008 and 2007, respectively.

Cash and Cash Equivalents

Cash and cash equivalents include all cash balances and highly liquid investments with original maturities of three months or less.

Restricted Cash

Restricted cash relates to deposits requested by banks for notes payables issued to Haimeng’s suppliers in relation to its purchases.

Inventories

Inventories are valued at the lower of cost or market. Cost is determined on the FIFO basis for all domestic inventories or average cost basis for non-U.S. inventories.

 

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Goodwill

Goodwill is not amortized, but instead the Company evaluates goodwill for impairment, as of December 31 of each year, unless conditions arise that would require a more frequent evaluation. In assessing the recoverability of goodwill, projections regarding estimated future cash flows and other factors are made to determine the fair value of the respective reporting unit. If these estimates or related projections change in the future, we may be required to record impairment charges for goodwill at that time.

Intangibles

We have trade names with indefinite lives and other intangibles with definite lives. In lieu of amortization, we test trade names for impairment on an annual basis as of December 31 of each year, unless conditions arise that would require a more frequent evaluation. Trade names are tested for impairment by comparing the fair value to their carrying values.

Our intangibles with definite lives consist of customer relationships, patents and developed technology. These assets are amortized on a straight-line basis over estimated useful lives ranging from 6 to 20 years. Certain conditions may arise that could result in a change in useful lives or require us to perform a valuation to determine if the definite lived intangibles are impaired.

Deferred Financing Costs

Deferred financing costs are incurred to obtain long-term financing and are amortized using the effective interest method over the term of the related debt. The amortization of deferred financing costs is classified in interest expense in the statement of operations.

Properties and Depreciation

Fixed assets are being depreciated over their estimated remaining lives using primarily the straight-line method for financial reporting purposes and accelerated depreciation methods for federal income tax purposes. Major additions and improvements are capitalized and depreciated over their estimated useful lives, and repairs and maintenance are charged to expense in the period incurred. We review long-lived assets for impairment and general accounting principles require recognition of an impairment loss only if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows. If the long-lived asset is not recoverable, we measure an impairment loss as the difference between the carrying amount and fair value of the asset.

Useful lives for buildings and building improvements, machinery and equipment, tooling and office equipment, furniture and fixtures principally range from 20 to 30 years, five to ten years, three to five years and three to ten years, respectively. Upon retirement or other disposal of fixed assets, the cost and related accumulated depreciation are eliminated from the asset and accumulated depreciation accounts, respectively. The difference, if any, between the net asset value and the proceeds is recorded as a gain or loss on disposition.

Revenue Recognition

Sales are recognized when products are shipped or received, depending on the contractual terms, and risk of loss has transferred to the customer. The Company estimates and records provisions for warranty costs, sales returns, rebates and other allowances based on experience and other relevant factors, when sales are recognized. The Company assesses the adequacy of its recorded warranty, sales returns, rebates and allowances liabilities on a regular basis and adjusts the recorded amounts as necessary. While management believes that these estimates are reasonable, warranty costs, actual returns, rebates and allowances may differ from estimates. Shipping and handling fees billed to customers are included in sales and the costs of shipping and handling are included in cost of sales. Inter-company sales have been eliminated.

Income Taxes

Income taxes are recognized during the period in which transactions enter into the determination of financial statement income, with deferred income taxes being provided for the tax effect of temporary differences between the carrying amount of assets and liabilities and their tax basis. Deferred income taxes are provided on the undistributed earnings of foreign subsidiaries and affiliated companies except to the extent such earnings are considered to be permanently reinvested in the subsidiary or affiliate. In cases where foreign tax credits will not offset U.S. income taxes, appropriate provisions are included in the combined or consolidated statement of operations.

The Company accounts for uncertain tax positions in accordance with ASC Topic 740, Income Taxes. The Company adopted the provisions of general accounting principles relating to uncertain tax positions (referred to as FIN 48) on January 1, 2007. Accordingly, the Company reports a liability for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax expense.

 

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Financial Instruments

The reported fair values of financial instruments, consisting of cash and cash equivalents, trade accounts receivable and long-term debt, are based on a variety of factors. Where available, fair values represent quoted market prices for identical or comparable instruments. Where quoted market prices are not available, fair values are estimated based on assumptions concerning the amount and timing of estimated future cash flows and assumed discount rates reflecting varying degrees of credit risk. Fair values may not represent actual values of the financial instruments that could be realized as of the balance sheet date or that will be realized in the future. As of December 31, 2008 and 2009, the book value of some of our financial instruments, consisting of cash and cash equivalents and trade accounts receivable, approximated their fair values. The fair value of long-term debt is disclosed in “Note 8. Debt”.

Environmental Compliance and Remediation

Environmental expenditures that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to existing conditions caused by past operations which do not contribute to current or future revenue generation are expensed. Liabilities are recorded when environmental assessments and/or remedial efforts are probable and the costs can be reasonably estimated. Estimated costs are based upon current laws and regulations, existing technology and the most probable method of remediation. The costs are not discounted and exclude the effects of inflation. If the cost estimates result in a range of equally probable amounts, the lower end of the range is accrued.

Pension Plans

The Company maintains six defined benefit pension plans associated with its Canadian operations. The annual net periodic pension costs are determined on an actuarial basis.

Advertising Costs

Advertising expenses included in continuing operations were $26, $26, and $25 million for the years 2007, 2008, and 2009, respectively. The advertising expenses included in discontinued operations, were $3, $2 and $1 million for the years 2007, 2008, and 2009, respectively. Advertising costs are recognized as selling expenses at the time advertising is incurred.

Promotional Programs

Cooperative advertising programs conducted with customers that promote the Company’s products are accrued as a rebate based on anticipated total amounts to be rebated to customers over the period of the agreement with the customer. Aftermarket distributors typically source their product lines at a particular price point and product category with one “full-line” supplier, such as our company, which covers substantially all of their product requirements. Switching to a new supplier typically requires that a distributor or supplier make a substantial investment to purchase, or “changeover” to, the new supplier’s products. Changeover costs incurred in connection with obtaining new business are recognized as selling expense in the period in which the changeover from a competitor’s product to the Company’s product occurs.

Insurance

We use a combination of insurance and self-insurance for a number of risks, including workers’ compensation, general liability, vehicle liability and the company-funded portion of employee-related health care benefits. Liabilities associated with these risks are estimated in part by considering historical claims experience, demographic factors, severity factors and other actuarial assumptions.

Research and Development Costs

Research and development expenses are charged to operations as incurred. The Company incurred $4 million, $3 million and $4 million for the years ended 2007, 2008 and 2009, respectively.

Derivatives

The Company is subject to various financial risks during the normal course of business operations, including but not limited to, adverse changes to interest rates, currency exchange rates, counterparty creditworthiness, and commodity prices. Pursuant to prudent risk management principles, the Company may utilize appropriate financial derivative instruments in order to mitigate the potential impact of these factors. The Company’s policies strictly prohibit the use of derivatives for speculative purposes.

In 2009, the Company’s derivative instrument usage was limited to standard currency forward transactions intended to offset the earnings impact related to the periodic revaluation of specific non-functional currency denominated monetary working capital accounts and intercompany financing arrangements and pay-fixed interest rate swaps intended to manage interest expense variability.

 

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The Company does not seek hedge accounting treatment for its currency derivative transactions because the earnings impact from both the underlying exposures and the hedge transactions are recognized in each accounting period. During the portion of the year that interest rate swaps were in effect, the transactions were designated as cash flow hedges for accounting purposes. Hedge effectiveness was measured using the “hypothetical derivative” method. There was no ineffectiveness recognized in earnings related to our interest rate swap transactions during 2009.

Stock-Based Compensation

We account for the stock incentive plan employee stock options under the fair value method of accounting using a Black-Scholes model to measure stock-based compensation expense at the date of grant. The compensation expense for the year was less than $1 million for 2007 and 2008 and slightly above $1 million in 2009.

On July 20, 2005, we adopted the Affinia Group Holdings Inc. 2005 Stock Incentive Plan, which we refer to as our stock incentive plan. The stock incentive plan permits the grant of non-qualified stock options, incentive stock options, stock appreciation rights, restricted stock and other stock-based awards to employees, directors or consultants of Affinia Group Holdings Inc. and its affiliates. A maximum of 227,000 shares of common stock may be subject to awards under the stock incentive plan. The number of shares issued or reserved pursuant to the stock incentive plan (or pursuant to outstanding awards) is subject to adjustment on account of mergers, consolidations, reorganizations, stock splits, stock dividends and other dilutive changes in the common stock. Shares of common stock covered by awards that terminate or lapse and shares delivered by a participant or withheld to pay the minimum statutory withholding rate, in each case, will again be available for grant under the stock incentive plan. Refer to Note 10 Stock Option Plan for further information on and discussion of our stock incentive plan.

Deferred Compensation Plan

The Company started a deferred compensation plan in 2008 that permits executives to defer receipt of all or a portion of the amounts payable under our non-equity incentive compensation plan. All amounts deferred will be treated solely for purposes of the Plan to have been notionally invested in the common stock of Affinia Group Holdings Inc. As such, the accounts under the Plan will reflect investment gains and losses associated with an investment in the Company’s common stock. The Company matches 25% of the deferral with additional restricted stock units, which are subject to vesting as provided in the plan.

New Accounting Pronouncements

Effective January 1, 2009, we adopted a general accounting principle relating to accounting for and reporting of minority interest (now called noncontrolling interest) in our consolidated financial statements. Upon adoption, certain prior period amounts have been retrospectively changed to conform to the current period financial statement presentation.

In June 2009, the FASB issued authoritative guidance that requires additional information regarding transfers of financial assets, including securitization transactions, and where companies have continuing exposure to the risks related to transferred financial assets. The concept of a “qualifying special-purpose entity” changes the requirements for derecognizing financial assets and requires additional disclosures. The new guidance is effective for fiscal years beginning after November 15, 2009 and is effective for us on January 1, 2010. We are currently evaluating the impact that the adoption of the new guidance may have on our financial condition, results of operations, and disclosures.

In June 2009, the FASB issued authoritative guidance that modifies how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The guidance clarifies that the determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. The guidance requires an ongoing reassessment of whether a company is the primary beneficiary of a variable interest entity. The guidance also requires additional disclosures about a company’s involvement in variable interest entities and any significant changes in risk exposure due to that involvement. The guidance is effective for fiscal years beginning after November 15, 2009 and is effective for us on January 1, 2010. We are currently evaluating the impact that the adoption may have on our financial condition, results of operations, and disclosures.

In June 2009, the FASB approved the “FASB Accounting Standards Codification“ (“Codification”) as the single source of authoritative nongovernmental U.S. GAAP to be launched on July 1, 2009. The Codification does not change current U.S. GAAP, but is intended to simplify user access to all authoritative U.S. GAAP by providing all the authoritative literature related to a particular topic in one place. All existing accounting standard documents is superseded and all other accounting literature not included in the Codification is considered nonauthoritative. The Codification is effective for interim and annual periods ending after September 15, 2009. The Codification is effective for us and did not have an impact on our financial condition or results of operations, but did result in a revision to our references to generally accepted accounting principles.

 

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Note 5. Inventories, net

Inventories are valued at the lower of cost or market. Cost is determined on the FIFO basis for all domestic inventories or average cost basis for non-U.S. inventories. Inventories are reduced by an allowance for slow-moving and obsolete inventories based on management’s review of on-hand inventories compared to historical and estimated future sales and usage. A summary of inventories, net is provided in the table below (Dollars in Millions):

 

     At December 31,
2008
   At December 31,
2009 (1)

Raw materials

   $ 115    $ 103

Work-in-process

     42      26

Finished goods

     355      301
             
   $ 512    $ 430
             

 

(1) The inventory as of December 31, 2009 excludes $67 million of inventory in our Commercial Distribution Europe segment, which is classified in current assets of discontinued operations.

During 2009, we had a change in estimate that adjusted the carrying amount of finished goods inventory. The change results from new information as defined in ASC Topic 250-10 (originally issued as SFAS No. 154 “Accounting Changes and Error Corrections a replacement of APB Opinion No. 20 and FASB Statement No. 3“). Due to the recent addition of new processes related to certain remanufactured inventory components, we were able to determine the cost of these components. The financial impact of this change in estimate increased inventory and decreased cost of sales by $3 million in 2009.

Note 6. Goodwill

Goodwill is not amortized, but instead the Company evaluates goodwill for impairment, as of December 31 of each year, unless conditions arise that would require a more frequent evaluation. In assessing the recoverability of goodwill, projections regarding estimated future cash flows and other factors are made to determine the fair value of the respective reporting unit. We have tested goodwill for impairment as of the end of the year, and concluded no impairment existed.

In conjunction with the acquisition of Affinia Hong Kong Limited, we determined the fair value of intangibles, property, plant and equipment, other assets and liabilities. Based on our valuations and purchase accounting adjustments, we recorded $30 million as goodwill at the end of 2008 and we have decreased goodwill by $7 million in 2009 for purchase accounting adjustments (Refer to Note 3. Variable Interest Entities).

The goodwill also relates to the initial acquisition in 2004 and a minor acquisition in the second quarter of 2008. For the 2004 acquisition, the tax benefit for the excess of tax-deductible goodwill over the reported amount of goodwill is applied to first reduce the goodwill related to the Acquisition. The tax benefit for the excess of tax deductible goodwill reduced reported goodwill by approximately $9 million and $8 million during 2008 and 2009, respectively. The amount of goodwill remaining at the end of December 31, 2009 relating to the initial 2004 acquisition is $18 million. Once the reported amount of goodwill for the 2004 acquisition is reduced to zero, the remaining tax benefit reduces the basis of intangible assets purchased in the 2004 acquisition. Any remaining tax benefit reduces the income tax provision.

During the second quarter of 2008, we purchased the remaining 40% interest in Wix Helsa Company. The purchase price exceeded the fair value of the assets and the liabilities acquired by approximately $2 million, which was recorded to goodwill.

 

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The following table summarizes our goodwill activity, which is related to the On and Off-highway segment, during 2008 and 2009 (Dollars in Millions):

 

Balance at December 31, 2007

   $  30   

Tax benefit reductions

     (9

Adjustment to pre-acquisition tax matters

     5   

Goodwill related to acquisition of Affinia Hong Kong Limited

     30   

Acquisition of affiliate

     2   
        

Balance at December 31, 2008

   $ 58   

Tax benefit reductions

     (8

Affinia Hong Kong Limited acquisition adjustments

     (7
        

Balance at December 31, 2009

   $ 43   
        

Note 7. Other Intangible Assets

As of December 31, 2008 and December 31, 2009, the Company’s other intangible assets consisted of trade names, customer relationships, and developed technology. The Company recorded approximately $8 million, $8 million and $9 million of amortization on customer relationships and developed technology for periods ending December 31, 2007, December 31, 2008 and December 31, 2009, respectively. We anticipate $9 million in amortization in each year for the next five years. Amortization expense is calculated on a straight line basis over 6 to 20 years. We determine on a periodic basis whether the lives and the method for amortization are accurate.

Trade names and other indefinite lived intangibles are tested for impairment annually as of December 31 of each year by comparing their fair value to their carrying values. The fair value for each trade name was established based upon a royalty savings approach. We determined that there were impairments of other intangible assets of $3 million, $2 million and $4 million in 2007, 2008 and 2009, respectively.

Prior to October of 2007, we used the Raybestos brand name under a licensing agreement. During October 2007, we purchased the Raybestos brand name from Raybestos Products Company. We made a strategic decision near the end of 2007 to utilize the Raybestos name in place of the Spicer, Raymold and, on certain products, the AIMCO brand name. As a result, these indefinite lived trade names were impaired by $3 million in 2007. The impairment was recorded in cost of sales.

Due to the downturn in the credit markets and intensified competition in the United Kingdom and other Western European countries, the Commercial Distribution Europe segment trade name was impaired $2 million in 2008. In 2009, the Commercial Distribution Europe segment was impaired $4 million due to the decrease in carrying value of the intangibles which will not be recoverable through the sales process. The impairments in 2008 and 2009 are recorded in discontinued operations. A rollforward of the other intangibles and trade names for 2008 and 2009 is shown below (Dollars in Millions):

 

     12/31/2007    Amortization     Impairment     Other    12/31/08    Amortization     Impairment     Other     12/31/09

Trade names

   $ 50    $ —        $ (2   $ —      $ 48    $ —        $ —        $ —        $ 48

Customer relationships

     99      (6     —          7      100      (7     (3     —          90

Developed technology/Other

     15      (2     —          2      15      (2     (1     (1     11
                                                                   

Total

   $ 164    $ (8   $ (2   $ 9    $ 163    $ (9   $ (4   $ (1   $ 149
                                                                   

Accumulated amortization for the intangibles was $34 million and $43 million as of the periods ending December 31, 2008 and December 31, 2009, respectively. The weighted average amortization period by class of intangible was the following: 19 years for customer relationships and 12 years for developed technology and other intangibles.

 

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Note 8. Debt

On August 13, 2009 we refinanced our former term loan facility, revolving credit facility and accounts receivable facility. The refinancing consisted of the ABL Revolver and the Secured Notes, the proceeds of which were used to repay outstanding borrowings under our former term loan facility, revolving credit facility and accounts receivable facility, as well as to settle interest rate derivatives and to pay fees and expenses related to the refinancing. The ABL Revolver and the Secured Notes replaced our revolving credit facility, which would have otherwise matured on November 30, 2010, our former term loan facility, which would have otherwise matured on November 30, 2011, and our accounts receivables facility, which would have otherwise matured on November 30, 2009.

Debt consists of the following (Dollars in Millions):

 

     At December 31,  
     2008     2009  

Term loan, due November 2011

   $ 297      $ —     

9% Senior subordinated notes, due November 2014

     300        267   

10.75% Senior secured notes, due August 2016

     —          222   

ABL revolver, due August 2013

     —          90   

Haimeng debt with rates of 1.6% to 5.4%

     25        22   
                   
     622        601   

Less: Current portion

     (14     (12
                   
   $ 608      $ 589   
                   

Scheduled maturities of long-term debt for each of the next five years and thereafter are as follows (Dollars in Millions):

 

Year

   Amount

2010

   $ 12

2011

     —  

2012

     10

2013

     90

2014

     267

2015 and thereafter

     222
      

Total long term debt

   $ 601
      

The fair value of debt is as follows (Dollars in Millions):

Fair Value of Debt at December 31, 2008

 

     Book Value
of Debt
   Fair
Value

Factor
    Fair
Value

of Debt

Term loan, due November 2011

   $ 297    50   $ 149

Senior subordinated notes, due November 2014

     300    50     150

Haimeng debt

     25    100     25
           

Total fair value of debt at December 31, 2008

        $ 324
           

 

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Fair Value of Debt at December 31, 2009

 

     Book Value
of Debt
   Fair
Value
Factor
    Fair
Value
of Debt

Senior secured notes, due August 2016

   $ 222    107.63   $ 239

Senior subordinated notes, due November 2014

     267    98.75     264

ABL revolver, due August 2013

     90    100     90

Haimeng debt

     22    100     22
           

Total fair value of debt at December 31, 2009

        $ 615
           

Asset based credit facilities. Affinia and certain of its subsidiaries entered into a new four-year $315 million ABL Revolver that includes (i) a revolving credit facility (the “U.S. Facility”) of up to $295 million for borrowings solely to the U.S. domestic borrowers, including (a) a $40 million sub-limit for letters of credit and (b) a $30 million swingline facility, and (ii) a revolving credit facility (the “Canadian Facility”) of up to $20 million for Canadian Dollar denominated revolving loans solely to a Canadian borrower. Availability under the ABL Revolver is based upon monthly (or more frequent under certain circumstances) borrowing base valuations of the Affinia’s eligible inventory and accounts receivable and is reduced by certain reserves in effect from time to time. The ABL Collateral consists of all accounts receivable, inventory, cash (other than certain cash proceeds of Notes Collateral (as defined in the indenture governing the Secured Notes)) and proceeds of the foregoing and certain assets related thereto, in each case held by the Company, Affinia, and certain of its subsidiaries. At December 31, 2009, we had $90 million outstanding under the ABL Revolver with interest rates ranging from 5.50% to 6.25%. We had additional $178 million of availability after giving effect to $18 million in outstanding letters of credit and $3 million for borrowing base reserves as of December 31, 2009.

Mandatory Prepayments. If at any time Affinia’s outstanding borrowings under the ABL Revolver (including outstanding letters of credit and swingline loans) exceed the lesser of (i) the borrowing base as in effect at such time and (ii) the aggregate revolving commitments as in effect at such time, Affinia will be required to prepay an amount equal to such excess and/or cash collateralize outstanding letters of credit.

Voluntary Prepayments. Subject to certain conditions, the ABL Revolver allows Affinia to voluntarily reduce the amount of the revolving commitments and to prepay the loans without premium or penalty other than customary breakage costs for LIBOR rate contracts.

Covenants. The ABL Revolver contains affirmative and negative covenants that, among other things, limit or restrict Affinia’s and Affinia’s subsidiaries’ ability to create liens and encumbrances; incur debt; merge, dissolve, liquidate or consolidate; make acquisitions and investments; dispose of or transfer assets; pay dividends or make other payments in respect of Affinia’s capital stock; amend certain material documents; change the nature of Affinia’s business; make certain payments of debt; engage in certain transactions with affiliates; change Affinia’s fiscal periods; and enter into certain restrictive agreements, in each case, subject to certain qualifications and exceptions.

In addition, if availability under the ABL Revolver is less than the greater of 15% of the total revolving loan commitments and $47.25 million, Affinia will be required to maintain a fixed charge coverage ratio, which is defined in the ABL Revolver, of at least 1.10x measured for the last twelve-month period.

Interest Rates and Fees. Outstanding borrowings under the U.S. Facility will accrue interest at an annual rate of interest equal to (i) a base rate plus the applicable spread or (ii) a LIBOR rate plus the applicable spread. Swingline loans will bear interest at a base rate plus the applicable spread. Outstanding borrowings under the Canadian Facility will accrue interest at an annual rate of interest equal to (i) the Canadian prime rate plus the applicable spread or (ii) the BA rate (the average discount rate of bankers’ acceptances as quoted on the Reuters Screen CDOR page) plus the applicable spread. The LIBOR rate is subject to a floor of 1.50%. We will pay a commission on letters of credit issued under the U.S. Facility at a rate equal to the applicable spread for loans based upon the LIBOR rate.

Affinia will pay certain fees with respect to the ABL Revolver, including (i) an unused commitment fee of 1.00% per annum on the undrawn portion of the credit facility (subject to a step-down to 0.75% in the event more than 50% of the commitments (excluding swingline loans) under the credit facility are utilized) and (ii) customary annual administration fees and fronting fees in respect of letters of credit equal to 0.125% per annum on the stated amount of each letter of credit outstanding during each month. During an event of default, the fee payable under clause (i) shall be increased by 2% per annum.

 

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Secured Notes. On August 13, 2009, Affinia issued $225 million of Secured Notes as part of the refinancing. The notes were offered at a price of 98.799% of their face value, resulting in approximately $222 million of net proceeds. The approximately $3 million discount will be amortized based on the effective interest rate method and included in interest expense until the notes mature. Subject to our compliance with the covenants described in the indenture securing the Secured Notes we are permitted to issue more Notes from time to time under the Indenture. The Notes and the Additional Notes, if any, will be treated as a single class for all purposes of the Indenture, including waivers, amendments, redemptions and offers to purchase. The Secured Notes will mature in 2016 and will accrue interest at rate of 10.75% per annum and will be payable semiannually. The Secured Notes are senior obligations of Affinia.

Indenture. The indenture governing the Subordinated Notes limits Affinia’s (and most or all of our subsidiaries’) ability to incur additional indebtedness, pay dividends on or make other distributions or repurchase our capital stock, make certain investments, enter into certain types of transactions with affiliates, use assets as security in other transactions and sell certain assets or merge with or into other companies. Subject to certain exceptions, Affinia and its restricted subsidiaries are permitted to incur additional indebtedness, including secured indebtedness, under the terms of the Subordinated Notes.

Pursuant to the indenture, Affinia issued and sold to the initial purchasers $300 million aggregate principal amount at maturity of the Notes. The outstanding balance for December 31, 2009 was $267 million. The terms of the indenture provide that, among other things, the Notes will rank equally in right of payment to all of Affinia’s existing and future senior debt and senior in right of payment to all of Affinia’s existing and future subordinated debt. The guarantees will rank equally in right of payment with all of the Guarantors’ (as defined in the indenture) existing and future senior debt and senior in right of payment to all of the Guarantors’ existing and future subordinated debt. In June of 2009, Affinia Group Holdings Inc. purchased in the open market approximately $33 million in principal amount of the 9% senior subordinated notes (“Subordinated Notes”) due 2014 and thereafter contributed such notes to Affinia Group Intermediate Holdings Inc., who contributed such notes to Affinia Group Inc. Affinia Group Inc. promptly surrendered such purchased notes for cancellation, which resulted in a pre-tax gain on the extinguishment of debt of $8 million in the second quarter of 2009. The retirement of the debt and the gain on extinguishment were non cash transactions.

During the year we recorded a write-off of $5 million to interest expense for unamortized deferred financing costs associated with the term loan facility, revolving credit facility and the accounts receivable facility. Additionally, we recorded $22 million in total deferred financing costs related to the new ABL Revolver and the issuance of the Secured Notes. The unamortized deferred financing will be charged to interest expense over the next four years for the ABL Revolver and seven years for the Secured Notes. The following table summarizes the deferred financing activity from December 31, 2007 to December 31, 2009 (Dollars in Millions).

 

As of December 31, 2007

   $  15   

Amortization

     (4
        

As of December 31, 2008

     11   

Amortization

     (4

Write-off of unamortized deferred financing costs

     (5

Deferred financing costs

     22   
        

Balance at December 31, 2009

   $ 24   
        

Note 9. Securitization of Accounts Receivable

On November 30, 2004, Affinia established a receivables facility that provided up to $100 million in funding, based on availability of eligible receivables and satisfaction of other customary conditions. Under the receivables facility, receivables are sold by certain subsidiaries of Affinia to a wholly owned bankruptcy-remote finance subsidiary of Affinia, which transfers an undivided interest in the purchased receivables to a commercial paper conduit or bank sponsor in exchange for cash.

Affinia, as the receivables collection agent, services, administered and collected the receivables under the receivables purchase agreement for which it received a monthly servicing fee at a rate of 1.00% per annum of the average daily outstanding balance of receivables. The fees in respect of the receivables facility included a usage fee paid by the finance subsidiaries that varies based upon the Company’s leverage ratio as calculated under the senior credit facilities. Funded amounts under the receivables facility bear interest at a rate equal to the conduit’s pooled commercial paper rate plus the usage fee.

At December 31, 2008, the usage fee margin for the receivables facility was 1.75% per annum of the amount funded. In addition, the finance subsidiary was required to pay a fee on the unused portion of the receivables facility that varies based upon the same ratio. At December 31, 2008, the unused fee was 0.8% per annum of the unused portion of the receivables facility.

Availability of funding under the receivables facility depended primarily upon the outstanding trade accounts receivable balance from time to time. Aggregate availability is determined by using a formula that reduces the gross receivables balance by factors that take into account historical default and dilution rates, obligor concentrations and average days outstanding and the costs of the facility. As of December 31, 2008, approximately $37 million was available for funding. At December 31, 2008, no interest in the purchased receivables had been transferred under this facility.

 

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On August 13, 2009 we refinanced our accounts receivable facility. The refinancing consisted of a new four-year $315 million ABL Revolver and $225 million Secured Notes, the proceeds of which were used to repay outstanding borrowings under our former term loan facility, revolving credit facility and accounts receivable facility, as well as to settle interest rate derivatives and to pay fees and expenses related to the refinancing. The ABL Revolver and the Secured Notes replaced our accounts receivables facility, which would have otherwise matured on November 30, 2009.

Note 10. Stock Option Plan

On July 20, 2005, we adopted the Affinia Group Holdings Inc. 2005 Stock Incentive Plan, which we refer to as our stock incentive plan. The stock incentive plan permits the grant of non-qualified stock options, incentive stock options, stock appreciation rights, restricted stock and other stock-based awards to employees, directors or consultants of Affinia Group Holdings Inc. and its affiliates. A maximum of 227,000 shares of common stock may be subject to awards under the stock incentive plan. The number of shares issued or reserved pursuant to the stock incentive plan (or pursuant to outstanding awards) is subject to adjustment on account of mergers, consolidations, reorganizations, stock splits, stock dividends and other dilutive changes in the common stock. Shares of common stock covered by awards that terminate or lapse and shares delivered by a participant or withheld to pay the minimum statutory withholding rate, in each case, will again be available for grant under the stock incentive plan.

Administration. The stock incentive plan is administered by the compensation committee of our Board of Directors. The committee has full power and authority to make, and establish the terms and conditions of any award, and to waive any such terms and conditions at any time (including, without limitation, accelerating or waiving any vesting conditions or payment dates). The committee is authorized to interpret the plan, to establish, amend and rescind any rules and regulations relating to the plan and to make any other determinations that it, in good faith, deems necessary or desirable for the administration of the plan and may delegate such authority as it deems appropriate. The committee may correct any defect or supply an omission or reconcile any inconsistency in the plan in the manner and to the extent the committee deems necessary or desirable and any decision of the committee in the interpretation and administration of the plan shall lie within its sole and absolute good faith discretion and shall be final, conclusive and binding on all parties concerned.

Options. The committee determines the option price for each option; however, the stock options must have an exercise price that is at least equal to the fair market value of the common stock on the date the option is granted. An option holder may exercise an option by written notice and payment of the option price (i) in cash or its equivalent, (ii) by the surrender of a number of shares of common stock already owned by the option holder for at least six months (or such other period established by the committee) with a fair market value equal to the exercise price, (iii) if there is a public market for the shares, subject to rules established by the committee, through the delivery of irrevocable instructions to a broker to sell shares obtained upon the exercise of the option and to deliver to Affinia Group Holdings Inc. an amount out of the proceeds of the sale equal to the aggregate option price for the shares being purchased or (iv) by another method approved by the committee.

Stock Appreciation Rights. The committee may grant stock appreciation rights independent of or in connection with an option. The exercise price per share of a stock appreciation right shall be an amount determined by the committee. Generally, each stock appreciation right shall entitle a participant upon exercise to an amount equal to (i) the excess of (1) the fair market value on the exercise date of one share of common stock over (2) the exercise price, multiplied by (ii) the number of shares of common stock covered by the stock appreciation right. Payment shall be made in common stock or in cash, or partly in common stock and partly in cash, all as shall be determined by the committee.

Other Stock-Based Awards. The committee may grant awards of restricted stock units, rights to purchase stock, restricted stock and other awards that are valued in whole or in part by reference to, or are otherwise based on the fair market value of, shares of common stock. The other stock-based awards will be subject to the terms and conditions established by the committee.

Transferability. Unless otherwise determined by the committee, awards granted under the stock incentive plan are not transferable other than by will or by the laws of descent and distribution.

Change of Control. In the event of a change of control (as defined in the stock incentive plan), the committee may provide for (i) the termination of an award upon the consummation of the change of control, but only if the award has vested and been paid out or the participant has been permitted to exercise an option in full for a period of not less than 30 days prior to the change of control, (ii) the acceleration of all or any portion of an award, (iii) payment in exchange for the cancellation of an award and/or (iv) the issuance of substitute awards that would substantially preserve the terms of any awards.

Amendment and Termination. Our Board of Directors may amend, alter or discontinue the stock incentive plan in any respect at any time, but no amendment may diminish any of the rights of a participant under any awards previously granted, without his or her consent.

Management Stockholders Agreement. All shares issued under the plan will be subject to a management stockholders agreement or a director stockholders agreement, as applicable.

 

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Restrictive Covenant Agreement. Unless otherwise determined by our Board of Directors, all award recipients will be obligated to sign the standard Confidentiality, Non-Competition and Proprietary Information Agreement which includes restrictive covenants regarding confidentiality, proprietary information and a one year period restricting competition and solicitation of our clients, customers or employees. In the event a participant breaches these restrictive covenants, any exercise of, or payment or delivery pursuant to, an award may be rescinded by the committee in its discretion in which event the participant may be required to pay to us the amount of any gain realized in connection with, or as a result of, the rescinded exercise, payment or delivery.

Amendment. On November 14, 2006, the Compensation Committee of Affinia Group Holdings Inc. revised the vesting terms applicable to options previously awarded by the Committee to its named executive officers, as well as all other employees, under the Plan. One-half of these options vest in equal portions at the end of each year beginning with the year of the grant and ending December 31, 2009 (the “Vesting Period”), 40% are eligible for vesting in equal portions upon the Company’s achievement of certain specified annual EBITDA performance targets over the Vesting Period and 10% are eligible for vesting in equal portions upon the Company’s achievement of certain net working capital performance targets over the Vesting Period. The Committee has not modified the time-vesting options or the working capital performance options. The Committee elected to modify the vesting terms for the EBITDA performance options so that these options were eligible for vesting in equal portions at the end of each of the years 2007, 2008, and 2009. The Committee also modified the performance targets for those years. The fair value of the modified award was slightly higher than the grant date fair value.

Method of Accounting and Our Assumptions

On July 20, 2005, we adopted the stock incentive plan with a maximum of 227,000 shares of common stock subject to awards. As of December 31, 2009 there were 103,917 vested shares and 71,721 unvested shares. Additionally, at year-end 51,362 shares were available for future stock option grants. Each option expires on August 1, 2015. One-half of the options vest based on the performance of the Company and the remaining portion vested at the end of each year ratably over the period from the year of the grant until December 31, 2009. The exercise price is $100 per option.

We account for our employee stock options under the fair value method of accounting using a Black-Scholes model to measure stock-based compensation expense at the date of grant. Dividend yields were not a factor because there were no cash dividends declared during 2007, 2008, and 2009. Our weighted-average Black-Scholes fair value assumptions include:

 

     2007     2008     2009  

Weighted-average effective term

     5.5 years        5.2 years        5.2 years   

Weighted-average risk free interest rate

     4.39     4.35     4.33

Weighted-average expected volatility

     39.6     40.1     40.8

Weighted-average fair value of options

      

(Dollars in Millions)

   $ 6      $ 7      $ 7   

The fair value of the stock option grants is amortized to expense over the vesting period. The Company reduces the overall compensation expense by a turnover rate consistent with historical trends. Stock-based compensation expense, which was recorded in selling, general and administrative expenses, and tax related income tax benefits were less than $1 million for 2007 and 2008 and were $1 million for 2009.

 

     Options  

Outstanding at January 1, 2007

   149,260   

Granted

   82,050   

Forfeited/expired

   (13,800
      

Outstanding at December 31, 2007

   217,510   

Granted

   9,500   

Forfeited/expired

   (45,225
      

Outstanding at December 31, 2008

   181,785   

Granted

   1,500   

Forfeited/expired

   (7,647
      

Outstanding at December 31, 2009

   175,638   
      

 

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A summary of the status of the Company’s nonvested shares as of December 31, 2009, and changes during the year ended December 31, 2009 is presented below:

 

     Options  

Outstanding at December 31, 2008

   103,767   

Granted

   1,500   

Vested

   (25,898

Forfeited/expired

   (7,648
      

Outstanding at December 31, 2009

   71,721   
      

Note 11. Pension and Other Postretirement Benefits

The Company provides defined contribution and defined benefit, qualified and nonqualified, pension plans for certain employees.

Under the terms of the defined contribution retirement plans, employee and employer contributions may be directed into a number of diverse investments. Expenses related to these defined contribution plans were $9 million for the year ended December 31, 2007, $8 million for the year ended December 31, 2008, and $1 million for the year ended December 31, 2009.

The Company has Canadian defined benefit pension plans (the assets of which are referred to as the “Fund”). These plans are managed in accordance with applicable legal requirements relating to the investment of registered pension plans. The responsibility for the investment of the Fund lies with the Investment Committee of ITT Industries of Canada Ltd. (the “Committee”). The Committee is composed of representatives of ITT and of the participating companies, which includes our Company. The investments objectives of the plans are to maximize long-term total investment returns while assuming a prudent level of risk deemed appropriate by the Committee. The Fund may not engage in certain investments that are not permitted for a pension plan pursuant to applicable provincial pension benefits legislation and the Income Tax Act of Canada. Additionally, the Fund may not invest more than 10% of the assets in any single public issue of securities except where the security is issued by or guaranteed by the government of Canada or a Canadian province. This investment policy permits plan assets to be invested in a number of diverse investment categories such as demand or term deposits, short term notes, treasury bills, bankers acceptances, commercial paper, investment certificates issued by banks, insurance companies or trust companies, bonds and non-convertible debentures, mortgages and other asset-backed securities, convertible debentures, real estate, preferred and common stocks that are traded publicly, including both Canadian and foreign stocks, resource properties, venture capital, insured contracts, pooled funds, segregated funds, trusts, closed-end investment companies, limited partnerships and other structured vehicles invested directly or indirectly in, or in interests.

The Company adopted a general accounting principle relating to the funded status of our defined benefit postretirement plans and provided the required disclosures as of December 31, 2007. The initial recognition of the funded status of the Company’s defined benefit postretirement plans resulted in a decrease in Shareholder’s Equity of $2 million, which was net of a tax benefit of $1 million, and was recorded as of December 31, 2007.

The following tables provide a reconciliation of the changes in the Company’s defined benefit pension plans’ and other postretirement plans’ benefit obligations and the fair value of assets for the years ended December 31, 2008 and December 31, 2009, as well as the statements of the funded status and schedules of the net amounts recognized in the balance sheet at December 31, 2008 and 2009. The measurement date for the amounts in these tables was December 31 of each year presented (Dollars in Millions):

 

     Pension Benefits  
     Year Ended
December 31,
2008
    Year Ended
December 31,
2009
 

Reconciliation of benefit obligation

    

Obligation at beginning of period

   $ 35      $ 18   

Service cost

     —          —     

Interest cost

     1        1   

Plan amendment

     —          —     

Actuarial (gain) loss

     (1     1   

Benefit payments

     (10     (1

Settlement

     (1     —     

Translation adjustments

     (6     3   
                

Obligation at end of period

   $ 18      $ 22   
                

Accumulated benefit obligation

   $ 18      $ 22   
                

 

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     Pension Benefits  
     Year Ended
December 31,
2008
    Year Ended
December 31,
2009
 

Reconciliation of fair value of plan assets

    

Fair value, beginning of period

   $ 32      $ 13   

Actual return on plan assets

     (4     3   

Employer contributions

     2        3   

Benefit payments

     (10     (1

Settlement

     (1     —     

Translation adjustments

     (6     2   
                

Fair value, end of period

   $ 13      $ 20   
                

 

     Pension Benefits  
     Year Ended
December 31,
2008
    Year Ended
December 31,
2009
 

Funded Status

   $ (5   $ (2

Unrecognized net actuarial loss

     6        4   
                

Accrued benefit cost

   $ 1      $ 2   
                

The weighted average asset allocations of the pension plans at December 31, 2008 and December 31, 2009 were as follows:

 

     December 31,
2008
    December 31,
2009
 

Asset Category

    

Equity securities

   58   61

Controlled-risk debt securities

   41   38

Cash and short-term obligations

   1   1
            

Total

   100   100
            

The target asset allocations of the pension plans for equity securities, controlled-risk debt securities, absolute return strategies investments and cash and other assets at December 31, 2008 and December 31, 2009 were 70%, 30%, 0% and 0%.

 

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The following table presents the funded status of the Company’s pension plans and the amounts recognized in the balance sheet as of December 31, 2008 and 2009 (Dollars in Millions):

 

     December 31,
2008
    December 31,
2009
 

Accumulated benefit obligation at beginning of period

   $ 35      $ 18   

Projected benefit obligation

     18        22   

Fair value of assets

     13        20   
                

Accrued cost

   $ (5   $ (2
                

Amounts recognized in balance sheet:

    

Accrued benefit liability

   $ (5   $ (2

Intangible asset

     —          —     

Accumulated other comprehensive income

     6        4   
                

Net amount recognized

   $ 1      $ 2   
                

The Company’s projected benefit payments by the pension plans subsequent to December 31, 2009 are expected to be $1 million in 2010, $18 million in 2011 and less than $1 million for each of the next eight years.

Projected contributions to be made to the Company’s defined benefit pension plans are expected to be in aggregate $3 million over the next ten years.

Components of net periodic benefit costs for the Company’s defined benefit plans for the years ended December 31, 2007, December 31, 2008, and December 31, 2009 are as follows (Dollars in Millions):

 

     Pension Benefits  
     Year Ended
December 31,

2007
    Year Ended
December 31,

2008
    Year Ended
December 31,

2009
 

Service cost

   $ —        $ —        $ —     

Interest cost

     2        1        1   

Expected return on plan assets

     (2     (1     (1

Amortization of transition obligation

     —          —          —     

Amortization of prior service cost

     1        —          —     

Recognized net actuarial loss

     —          2        2   
                        

Net periodic benefit cost

   $ 1      $ 2      $ 2   
                        

 

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     December 31,
2007
    December 31,
2008
    December 31,
2009
 

Discount rate

   5.0   5.3   5.1

Expected return on plan assets

   5.7   6.1   6.1

The discount rate and expected return on plan assets for the Company’s plans presented in the tables above are used to determine pension expense for the succeeding year.

Fair Value Measurements. The following table presents our plan assets using the fair value hierarchy as of December 31, 2009. The fair value hierarc