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EX-32 - Federal-Mogul Holdings LLCv182476_ex32.htm
EX-31.1 - Federal-Mogul Holdings LLCv182476_ex31-1.htm
EX-31.2 - Federal-Mogul Holdings LLCv182476_ex31-2.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

 x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2010

or

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

Commission File Number:  000-52986

FEDERAL-MOGUL CORPORATION
(Exact name of Registrant as specified in its charter)

Delaware
20-8350090
(State or other jurisdiction of
incorporation or organization)
(IRS employer
identification number)
 
26555 Northwestern Highway, Southfield, Michigan
48033
(Address of principal executive offices)
(Zip Code)
 
(248) 354-7700
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x   No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes ¨   No ¨

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

Large accelerated filer ¨   Accelerated filer x    Non-accelerated filer ¨   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

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.
Yes x   No ¨

As of April 27, 2010, there were 98,904,500 outstanding shares of the registrant’s $0.01 par value common stock.

 
 

 

FEDERAL-MOGUL CORPORATION

Form 10-Q

For the Quarter Ended March 31, 2010

INDEX

 
Page No.
Part I – Financial Information
  3
Item 1 – Financial Statements
  3
Consolidated Statements of Operations
3
Consolidated Balance Sheets
4
Consolidated Statements of Cash Flows
5
Notes to Consolidated Financial Statements
6
Forward-Looking Statements
25
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
25
Item 3 – Qualitative and Quantitative Disclosures about Market Risk
34
Item 4 – Controls and Procedures
34
Part II – Other Information
35 
Item 1 – Legal Proceedings
35
Item 6 – Exhibits
35
Signatures
36
Exhibits
 
 
 
2

 

PART I
FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

FEDERAL-MOGUL CORPORATION
Consolidated Statements of Operations (Unaudited)

   
Three Months Ended
March 31
 
   
2010
   
2009
 
   
(Millions of Dollars,
 
   
Except Per Share Amounts)
 
             
Net sales
  $ 1,489     $ 1,238  
Cost of products sold
    (1,235 )     (1,080 )
                 
Gross margin
    254       158  
                 
Selling, general and administrative expenses
    (184 )     (184 )
Interest expense, net
    (33 )     (34 )
Amortization expense
    (12 )     (12 )
Equity earnings of non-consolidated affiliates
    7        
Restructuring expense, net
    (1 )     (38 )
Other (expense) income, net
    (21 )     13  
                 
Income (loss) before income taxes
    10       (97 )
Income tax benefit (expense)
    7       (4 )
                 
Net income (loss)                                                                                                        
    17       (101 )
Less net income attributable to noncontrolling interests
    (2 )      
                 
Net income (loss) attributable to Federal-Mogul
  $ 15     $ (101 )
                 
Basic and diluted income (loss) per common share
  $ 0.15     $ (1.02 )

See accompanying notes to consolidated financial statements.

 
3

 

FEDERAL-MOGUL CORPORATION
Consolidated Balance Sheets

   
(Unaudited)
March 31
2010
   
December 31
2009
 
   
(Millions of Dollars)
 
ASSETS
           
Current assets:
           
Cash and equivalents
  $ 1,028     $ 1,034  
Accounts receivable, net
    1,018       950  
Inventories, net
    842       823  
Prepaid expenses and other current assets
    231       221  
Total current assets
    3,119       3,028  
                 
Property, plant and equipment, net
    1,762       1,834  
Goodwill and indefinite-lived intangible assets
    1,427       1,427  
Definite-lived intangible assets, net
    503       515  
Other noncurrent assets
    320       323  
                 
    $ 7,131     $ 7,127  
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
Current liabilities:
               
Short-term debt, including current portion of long-term debt
  $ 97     $ 97  
Accounts payable
    576       537  
Accrued liabilities
    408       410  
Current portion of postemployment benefit liability
    60       61  
Other current liabilities
    159       175  
Total current liabilities
    1,300       1,280  
                 
Long-term debt
    2,758       2,760  
Postemployment benefits
    1,284       1,298  
Long-term portion of deferred income taxes
    496       498  
Other accrued liabilities
    187       192  
                 
Shareholders’ equity:
               
Preferred stock ($.01 par value; 90,000,000 authorized shares; none issued)
           
Common stock ($.01 par value; 450,100,000 authorized shares; 100,500,000 issued shares; 98,904,500 outstanding shares as of March 31, 2010 and December 31, 2009)
    1       1  
Additional paid-in capital, including warrants
    2,150       2,123  
Accumulated deficit
    (498 )     (513 )
Accumulated other comprehensive loss
    (607 )     (571 )
Treasury stock, at cost
    (17 )     (17 )
Total Federal-Mogul shareholders’ equity
    1,029       1,023  
Noncontrolling interests
    77       76  
Total shareholders’ equity
    1,106       1,099  
                 
    $ 7,131     $ 7,127  

See accompanying notes to consolidated financial statements.

 
4

 

FEDERAL-MOGUL CORPORATION
Consolidated Statements of Cash Flows (Unaudited)

   
Three Months Ended
March 31
 
   
2010
   
2009
 
   
(Millions of Dollars)
 
             
Cash Provided From (Used By) Operating Activities
           
Net income (loss)
  $ 17     $ (101 )
Adjustments to reconcile net income (loss) to net cash provided from (used by) operating activities:
               
Depreciation and amortization
    81       77  
Cash received from 524(g) Trust
          40  
Payments to settle non-debt liabilities subject to compromise, net
    (14 )     (49 )
Loss on Venezuelan currency devaluation
    20        
Equity earnings of non-consolidated affiliates
    (7 )      
Cash dividends received from non-consolidated affiliates
    20        
Change in postemployment benefits, including pensions
    7       14  
Change in deferred taxes
    (27 )     (3 )
Gain on sale of property, plant and equipment
    (2 )      
Changes in operating assets and liabilities:
               
Accounts receivable
    (83 )     (66 )
Inventories
    (36 )     (22 )
Accounts payable
    56       (107 )
Other assets and liabilities
    48       57  
Net Cash Provided From (Used By) Operating Activities
    80       (160 )
                 
Cash Provided From (Used By) Investing Activities
               
Expenditures for property, plant and equipment
    (46 )     (45 )
Net proceeds from the sale of property, plant and equipment
    2        
Net Cash Used By Investing Activities
    (44 )     (45 )
                 
Cash Provided From (Used By) Financing Activities
               
Principal payments on term loans
    (7 )     (7 )
Decrease in other long-term debt
    (1 )     (1 )
Increase in short-term debt
    1       2  
Net payments from factoring arrangements
    (14 )     (9 )
Net Cash Used By Financing Activities
    (21 )     (15 )
                 
Effect of Venezuelan currency devaluation on cash
    (16 )      
Effect of foreign currency exchange rate fluctuations on cash
    (5 )     (4 )
Effect of foreign currency fluctuations on cash
    (21 )     (4 )
                 
Decrease in cash and equivalents
    (6 )     (224 )
                 
Cash and equivalents at beginning of period
    1,034       888  
                 
Cash and equivalents at end of period
  $ 1,028     $ 664  

See accompanying notes to consolidated financial statements.

 
5

 

FEDERAL-MOGUL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
March 31, 2010
 
1.
BASIS OF PRESENTATION

Interim Financial Statements: The unaudited consolidated financial statements of Federal-Mogul Corporation (the “Company”) have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) have been condensed or omitted pursuant to such rules and regulations. These statements include all adjustments (consisting of normal recurring adjustments) that management believes are necessary for a fair presentation of the results of operations, financial position and cash flows. The Company’s management believes that the disclosures are adequate to make the information presented not misleading when read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. Operating results for the three months ended March 31, 2010 are not necessarily indicative of the results that may be expected for the year ended December 31, 2010.

Principles of Consolidation: The Company consolidates into its financial statements the accounts of the Company, all wholly-owned subsidiaries, and any partially-owned subsidiary that the Company has the ability to control. Control generally equates to ownership percentage, whereby investments that are more than 50% owned are consolidated, investments in affiliates of 50% or less but greater than 20% are accounted for using the equity method, and investments in affiliates of 20% or less are accounted for using the cost method. The Company does not consolidate any entity for which it has a variable interest based solely on power to direct the activities and significant participation in the entity’s expected results that would not otherwise be consolidated based on control through voting interests. Further, the Company’s joint ventures are businesses established and maintained in connection with its operating strategy. All intercompany transactions and balances have been eliminated.

Use of Estimates: The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported therein. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may be based upon amounts that differ from these estimates.

Controlling Ownership: Mr. Carl C. Icahn indirectly controls approximately 76% of the voting power of the Company’s capital stock and, by virtue of such stock ownership, is able to control or exert substantial influence over the Company, including the election of directors, business strategy and policies, mergers or other business combinations, acquisition or disposition of assets, future issuances of common stock or other securities, incurrence of debt or obtaining other sources of financing, and the payment of dividends on the Company’s common stock. The existence of a controlling stockholder may have the effect of making it difficult for, or may discourage or delay, a third party from seeking to acquire a majority of the Company’s outstanding common stock, which may adversely affect the market price of the stock.

Mr. Icahn’s interests may not always be consistent with the Company’s interests or with the interests of the Company’s other stockholders. Mr. Carl C. Icahn and entities controlled by him may also pursue acquisitions or business opportunities that may or may not be complementary to the Company’s business. To the extent that conflicts of interest may arise between the Company and Mr. Icahn and his affiliates, those conflicts may be resolved in a manner adverse to the Company or its other shareholders.

Trade Accounts Receivable: Federal-Mogul subsidiaries in Brazil, France, Germany, Italy, Japan and Spain are party to accounts receivable factoring arrangements. Gross accounts receivable factored under these facilities were $225 million and $217 million as of March 31, 2010 and December 31, 2009, respectively. Of those gross amounts, $195 million and $190 million, respectively, were factored without recourse and treated as sales. The remaining $30 million and $27 million, respectively, were factored with recourse, pledged as collateral, accounted for as secured borrowings and recorded in the consolidated balance sheets within “Accounts receivable, net” and “Short-term debt, including current portion of long-term debt.” Under terms of these factoring arrangements, the Company is not obligated to draw cash immediately upon the factoring of accounts receivable. Thus, as of March 31, 2010 and December 31, 2009, the Company had outstanding factored amounts of $3 million and $4 million, respectively, for which cash had not yet been drawn. For each of the three months ended March 31, 2010 and 2009, expenses associated with receivables factored of $1 million were recorded in the consolidated statements of operations within “Other (expense) income, net.” The Company receives a fee to service and monitor these factored receivables. The fees associated with the servicing of factored receivables are sufficient to offset the cost and as such, a servicing asset or liability is not incurred as a result of these factoring arrangements.

 
6

 

Equity and Comprehensive Loss:  The following table presents a rollforward of the changes in equity for the three months ended March 31, 2010, including changes in the components of comprehensive loss (also contained in Note 14). In accordance with FASB ASC Topic 810, Consolidation, amounts attributable to the Company’s shareholders and to the noncontrolling interests are as follows:

   
Total
   
Federal-Mogul
Shareholders’
Equity
   
Non-
Controlling
Interests
 
   
(Millions of Dollars)
 
                   
Equity balance as of December 31, 2009
  $ 1,099     $ 1,023     $ 76  
Comprehensive loss:
                       
Net income
    17       15       2  
Foreign currency translation adjustments and other
    (34 )     (33 )     (1 )
Hedge instruments, net of tax
    (10 )     (10 )      
Postemployment benefits, net of tax
    7       7        
      (20 )     (21 )     1  
Stock-based compensation (see Note 16)
    27       27        
Equity balance as of March 31, 2010
  $ 1,106     $ 1,029     $ 77  

Adoption of New Accounting Pronouncements:  In June 2009, the FASB issued accounting guidance on accounting for transfers of financial assets. This guidance amends previous guidance by including: the elimination of the qualifying special-purpose entity (“QSPE”) concept; a new participating interest definition that must be met for transfers of portions of financial assets to be eligible for sale accounting; clarifications and changes to the derecognition criteria for a transfer to be accounted for as a sale; and a change to the amount of recognized gain or loss on a transfer of financial assets accounted for as a sale when beneficial interests are received by the transferor. Additionally, the guidance requires extensive new disclosures regarding an entity’s involvement in a transfer of financial assets. Finally, existing QSPEs (prior to the effective date of this guidance) must be evaluated for consolidation by reporting entities in accordance with the applicable consolidation guidance upon the elimination of this concept. The adoption of this new guidance effective January 1, 2010 had no impact on the Company’s consolidated financial position, results of operations or cash flows.

In June 2009, the FASB issued accounting guidance on the consolidation of variable interest entities (“VIE”). This new guidance revises previous guidance by eliminating the exemption for qualifying special purposes entities, by establishing a new approach for determining who should consolidate a VIE. The adoption of this new guidance effective January 1, 2010 had no impact on the Company’s consolidated financial position, results of operations or cash flows.
 
2.
RESTRUCTURING

The costs contained within “Restructuring expense, net” in the Company’s consolidated statements of operations are comprised of two types: employee costs (principally termination benefits) and facility closure costs. Termination benefits are accounted for in accordance with FASB ASC Topic 712, Compensation – Nonretirement Postemployment Benefits, and are recorded when it is probable that employees will be entitled to benefits and the amounts can be reasonably estimated. Estimates of termination benefits are based on the frequency of past termination benefits, the similarity of benefits under the current plan and prior plans, and the existence of statutory required minimum benefits. Facility closure and other costs are accounted for in accordance with FASB ASC Topic 420, Exit or Disposal Cost Obligations, and are recorded when the liability is incurred.

 
7

 

Estimates of restructuring charges are based on information available at the time such charges are recorded. In certain countries where the Company operates, statutory requirements include involuntary termination benefits that extend several years into the future. Accordingly, severance payments continue well past the date of termination at many international locations. Thus, these programs appear to be ongoing when, in fact, terminations and other activities under these programs have been substantially completed. Management expects that future savings resulting from execution of its restructuring programs will generally result in full pay back within 36 months.

Due to the inherent uncertainty involved in estimating restructuring expenses, actual amounts paid for such activities may differ from amounts initially estimated. Accordingly, previously recorded liabilities of $1 million and $5 million were reversed for the three months ended March 31, 2010 and 2009, respectively. Such reversals result from: changes in estimated amounts to accomplish previously planned activities; changes in expected (based on historical practice) outcome of negotiations with labor unions, which reduced the level of originally committed actions; newly implemented government employment programs, which lowered the expected cost; and changes in approach to accomplish restructuring activities.

Management expects to finance these restructuring programs over the next several years through cash generated from its ongoing operations or through cash available under its existing credit facility, subject to the terms of applicable covenants. Management does not expect that the execution of these programs will have an adverse impact on its liquidity position.

The Company’s restructuring activities are undertaken as necessary to execute management’s strategy and streamline operations, consolidate and take advantage of available capacity and resources, and ultimately achieve net cost reductions. Restructuring activities include efforts to integrate and rationalize the Company’s businesses and to relocate manufacturing operations to best cost markets. These activities generally fall into one of the following categories:

1.
Closure of facilities and relocation of production – in connection with the Company’s strategy, certain operations have been closed and related production relocated to best cost countries or to other locations with available capacity.

2.
Consolidation of administrative functions and standardization of manufacturing processes – as part of its productivity strategy, the Company has acted to consolidate its administrative functions to reduce selling, general and administrative costs and change its manufacturing processes to improve operating efficiencies through standardization of processes.

During the three months ended March 31, 2010, the Company recorded $1 million in net restructuring expenses, all of which were facility closure costs. During the three months ended March 31, 2009, the Company recorded $38 million in net restructuring expenses, all of which were employee costs. The facility closure costs were paid within the quarter of incurrence and there were no reversals. The following table provides a summary of the Company’s consolidated restructuring liabilities and related activity as of and for the three months ended March 31, 2010 by reporting segment. “PTE,” “PTSB,” “VSP,” and “GA” represent the Powertrain Energy, Powertrain Sealing and Bearings, Vehicle Safety and Protection, and Global Aftermarket reporting segments, respectively.

   
PTE
   
PTSB
   
VSP
   
GA
   
Corporate
   
Total
 
   
(Millions of Dollars)
 
                                     
Balance at December 31, 2009
  $ 19     $ 24     $ 5     $ 4     $ 3     $ 55  
Provisions
          1             1             2  
Reversals
    (1 )                             (1 )
Payments
    (3 )     (5 )     (3 )     (1 )           (12 )
Foreign currency
    (1 )     (1 )                       (2 )
Balance at March 31, 2010
  $ 14     $ 19     $ 2     $ 4     $ 3     $ 42  
 
 
8

 

Activities under Global “Restructuring 2009” Program

An unprecedented downturn in the global automotive industry and global financial markets led the Company to announce, in September and December 2008, certain restructuring actions, herein referred to as “Restructuring 2009,” designed to improve operating performance and respond to increasingly challenging conditions in the global automotive market. It was anticipated that this plan would reduce the Company’s global workforce by approximately 8,600 positions when compared with the workforce as of September 30, 2008. The Company expects to incur additional restructuring expenses up to $5 million through 2010, of which $2 million are expected to be employee costs and $3 million are expected to be facility closure costs. As the majority of the costs expected to be incurred in relation to Restructuring 2009 are related to severance, such activities are expected to yield future annual savings at least equal to the incurred costs.

The following table provides a summary of the Company’s Restructuring 2009 liabilities and related activity as of and for the three months ended March 31, 2010 by reporting segment:

   
PTE
   
PTSB
   
VSP
   
GA
   
Corporate
   
Total
 
   
(Millions of Dollars)
 
                                     
Balance at December 31, 2009
  $ 19     $ 23     $ 5     $ 4     $ 1     $ 52  
Provisions
          1                         1  
Reversals
    (1 )                             (1 )
Payments
    (3 )     (5 )     (3 )     (1 )           (12 )
Foreign currency
    (1 )     (1 )                       (2 )
Balance at March 31, 2010
  $ 14     $ 18     $ 2     $ 3     $ 1     $ 38  

Net charges related to Restructuring 2009 are as follows:

   
Total
Expected
Costs
   
Incurred
During
2008
   
Incurred
During
2009
   
First
Quarter
2010
   
Estimated
Additional
Charges
 
   
(Millions of Dollars)
 
                               
Powertrain Energy
  $ 50     $ 39     $ 11     $ (1 )   $ 1  
Powertrain Sealing and Bearings
    60       46       10       1       3  
Vehicle Safety and Protection
    35       31       3             1  
Global Aftermarket
    12       7       5              
Corporate
    6       4       2              
    $ 163     $ 127     $ 31     $     $ 5  
 
 
9

 

3.
OTHER (EXPENSE) INCOME, NET

The specific components of “Other (expense) income, net” are as follows:

   
Three Months Ended
 
   
March 31
 
   
2010
   
2009
 
   
(Millions of Dollars)
 
             
Foreign currency exchange
  $ (24 )   $  
Environmental claims settlements
          12  
Adjustment of assets to fair value
    (4 )     1  
Unrealized loss on hedge instruments
          (2 )
Other
    7       3  
    $ (21 )   $ 14  

The Company has operated an aftermarket distribution center in Venezuela for several years, supplying imported replacement automotive parts to the local independent aftermarket. Since 2005, two exchange rates have existed in Venezuela: the official rate, which has been frozen since 2005 at 2.15 bolivars per U.S. dollar; and the parallel rate, which floats at a rate much higher than the official rate. Given the existence of the two rates in Venezuela, the Company deemed the official rate was appropriate for the purpose of conversion into U.S. dollars at December 31, 2009 based on no positive intent to repatriate cash at the parallel rate and demonstrated ability to repatriate cash at the official rate.

Near the end of 2009, the three year cumulative inflation rate for Venezuela was above 100%, which requires the Venezuelan operation to report its results as though the U.S. dollar is its functional currency in accordance with FASB ASC Topic 830, Foreign Currency Matters, commencing January 1, 2010 (“inflationary accounting”). The impact of this transition to a U.S. dollar functional currency is that any change in the U.S. dollar value of bolivar denominated monetary assets and liabilities must be recognized directly in earnings.

On January 8, 2010, the official exchange rate was set by the Venezuelan government at 4.3 bolivars per U.S. dollar, except for certain “strategic industries” that are permitted to repatriate U.S. dollars at the rate of 2.6 bolivars per U.S. dollar. During the three months ended March 31, 2010, the Company recorded $20 million in foreign currency exchange expense due to this change in the exchange rate. Based upon recent 2010 repatriations of cash, the Company believes that all amounts currently submitted to the Venezuelan government for repatriation will be paid out at the “strategic” rate, with the remaining monetary assets being converted at the official rate of 4.3.

The Company recorded $4 million in impairment charges during the three months ended March 31, 2010 related to the identification of equipment at a Vehicle Safety and Protection facility where the Company’s assessment of future undiscounted cash flows, when compared to the current carrying value of the equipment, indicated the assets were not recoverable. The Company determined the fair value of the assets by applying a probability weighted, expected present value technique to the estimated future cash flows using assumptions a market participant would utilize. The discount rate used is consistent with other long-lived asset fair value measurements. The carrying value of the assets exceeded the resulting fair value by $4 million and an impairment charge was recorded for that amount.

The Company was a party to two lawsuits in Ohio and Michigan relating to indemnification for costs arising from environmental releases from industrial operations of the Predecessor Company prior to 1986. During the first quarter of 2009, the Company reached settlements with certain parties, which resulted in net recoveries to the Company of $12 million.

 
10

 

4.
FINANCIAL INSTRUMENTS

Interest Rate Risk

The Company, during 2008, entered into a series of five-year interest rate swap agreements with a total notional value of $1,190 million to hedge the variability of interest payments associated with its variable-rate term loans. Through these swap agreements, the Company has fixed its base interest and premium rate at a combined average interest rate of approximately 5.37% on the hedged principal amount of $1,190 million. As of March 31, 2010 and December 31, 2009, unrealized net losses of $62 million and $50 million, respectively, were recorded in “Accumulated other comprehensive loss” as a result of these hedges. As of March 31, 2010, losses of $35 million are expected to be reclassified from “Accumulated other comprehensive loss” to consolidated statement of operations within the next 12 months.

These interest rate swaps reduce the Company’s overall interest rate risk. However, due to the remaining outstanding borrowings on the Company’s Debt Facilities and other borrowing facilities that continue to have variable interest rates, management believes that interest rate risk to the Company could be material if there are significant adverse changes in interest rates.

Commodity Price Risk

The Company’s production processes are dependent upon the supply of certain raw materials that are exposed to price fluctuations on the open market. The primary purpose of the Company’s commodity price forward contract activity is to manage the volatility associated with forecasted purchases. The Company monitors its commodity price risk exposures regularly to maximize the overall effectiveness of its commodity forward contracts. Principal raw materials hedged include natural gas, copper, nickel, lead, platinum, high-grade aluminum and aluminum alloy. Forward contracts are used to mitigate commodity price risk associated with raw materials, generally related to purchases forecast for up to fifteen months in the future.

The Company had commodity price hedge contracts outstanding with combined notional values of $38 million and $28 million at March 31, 2010 and December 31, 2009, respectively, of which substantially all mature within one year. Of these outstanding contracts, $38 million and $26 million in combined notional values at March 31, 2010 and December 31, 2009, respectively, were designated as hedging instruments for accounting purposes. Unrealized net gains of $7 million and $5 million were recorded in “Accumulated other comprehensive loss” as of March 31, 2010 and December, 31, 2009, respectively.

Foreign Currency Risk

The Company manufactures and sells its products in North America, South America, Asia, Europe and Africa. As a result, the Company's financial results could be significantly affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets in which the Company manufactures and sells its products. The Company's operating results are primarily exposed to changes in exchange rates between the U.S. dollar and European currencies.

The Company generally tries to use natural hedges within its foreign currency activities, including the matching of revenues and costs, to minimize foreign currency risk. Where natural hedges are not in place, the Company considers managing certain aspects of its foreign currency activities and larger transactions through the use of foreign currency options or forward contracts. Principal currencies hedged have historically included the euro, British pound, Japanese yen and Canadian dollar. The Company had notional values of $20 million and $10 million of foreign currency hedge contracts outstanding at March 31, 2010 and December 31, 2009, respectively, of which all mature in less than one year and substantially all were designated as hedging instruments for accounting purposes. Immaterial unrealized net gains and losses were recorded in “Accumulated other comprehensive loss” as of March 31, 2010 and December 31, 2009, respectively.

Other

The Company presents its derivative positions and any related material collateral under master netting agreements on a net basis. For derivatives designated as cash flow hedges, changes in the time value are excluded from the assessment of hedge effectiveness. Unrealized gains and losses associated with ineffective hedges, determined using the hypothetical derivative method, are recognized in “Other (expense) income, net.” Derivative gains and losses included in “Accumulated other comprehensive loss” for effective hedges are reclassified into operations upon recognition of the hedged transaction. Derivative gains and losses associated with undesignated hedges are recognized in “Other (expense) income, net” for outstanding hedges and “Cost of products sold” upon hedge maturity. The Company’s undesignated hedges are primarily commodity hedges and such hedges have become undesignated mainly due to forecasted volume declines.

 
11

 

Concentrations of Credit Risk

Financial instruments, which potentially subject the Company to concentrations of credit risk, consist primarily of accounts receivable and cash investments. The Company's customer base includes virtually every significant global light and commercial vehicle manufacturer and a large number of distributors, installers and retailers of automotive aftermarket parts. The Company's credit evaluation process and the geographical dispersion of sales transactions help to mitigate credit risk concentration. No individual customer accounted for more than 5% of the Company’s sales during the quarter ended March 31, 2010. The Company requires placement of cash in financial institutions evaluated as highly creditworthy.

The following table discloses the fair values and balance sheet locations of the Company’s derivative instruments:

   
Asset Derivatives
 
Liability Derivatives
 
   
Balance Sheet
Location
 
March 31
2010
   
December 31
2009
 
Balance Sheet
Location
 
March 31
2010
   
December 31
2009
 
   
(Millions of Dollars)
 
Derivatives designated as cash flow hedging instruments:
                             
Interest rate swap contracts
      $     $  
Other current
liabilities
  $ (35 )   $ (34 )
                     
Other noncurrent
liabilities
    (27 )     (16 )
Commodity contracts
 
Other current
assets
    8       6  
Other current
assets
    (1 )     (1 )
        $ 8     $ 6       $ (63 )   $ (51 )
                                       
Derivatives not designated as hedging instruments:
                                     
Commodity contracts
 
Other current
assets
  $     $ 1                    

The following tables disclose the effect of the Company’s derivative instruments on the consolidated statement of operations for the three months ended March 31, 2010 (in millions of dollars):

Derivatives Designated
as Hedging Instruments
 
Amount of
Gain (Loss)
Recognized in
OCI on 
Derivatives
(Effective
Portion)
   
Location of Gain
(Loss) Reclassified
from AOCI into
Income (Effective
Portion)
 
Amount of Gain
(Loss) Reclassified
from AOCI into
Income (Effective
Portion)
 
                 
Interest rate swap contracts
  $ (21 )  
Interest expense, net
  $ (9 )
Commodity contracts
    3    
Cost of products sold
    1  
    $ (18 )       $ (8 )

Derivatives Not Designated
as Hedging Instruments
 
Location of Gain
(Loss) Recognized in
Income on Derivatives
 
Amount of Gain
(Loss) Recognized
in Income on
Derivatives
 
Commodity contracts
 
Cost of products sold
  $ 1  
 
 
12

 

The following tables disclose the effect of the Company’s derivative instruments on the consolidated statement of operations for the three months ended March 31, 2009 (in millions of dollars):

Derivatives Designated
as Hedging Instruments
 
Amount of
Gain (Loss)
Recognized in
OCI on 
Derivatives
(Effective
Portion)
   
Location of Gain
(Loss) Reclassified
from AOCI into
Income (Effective
Portion)
 
Amount of Gain
(Loss) Reclassified
from AOCI into
Income (Effective
Portion)
   
Location of Gain
(Loss) Recognized
in Income on
Derivatives
(Ineffective Portion
and Amount
Excluded from
Effectiveness
Testing)
 
Amount of Gain
(Loss) Recognized
in Income on
Derivatives
(Ineffective Portion
and Amount
Excluded from
Effectiveness
Testing)
 
   
Interest rate swap contracts
  $ (8 )  
Interest expense, net
  $ (9 )       $  
Commodity contracts
    6    
Cost of products sold
    (8 )  
Other income, net
    1  
Foreign currency contracts
    1    
Cost of products sold
    1            
    $ (1 )       $ (16 )       $ 1  
 
Derivatives Not Designated
as Hedging Instruments
 
Location of Gain
(Loss) Recognized in
Income on Derivatives
 
Amount of Gain
(Loss) Recognized
in Income on
Derivatives
 
Commodity contracts
 
Cost of products sold
  $ (2 )
Commodity contracts
 
Other income, net
    (3 )
        $ (5 )
 
5.
FAIR VALUE MEASUREMENTS
 
FASB ASC Topic 820, Fair Value Measurements and Disclosures, clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based upon assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, FASB ASC Topic 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

Level 1:
Observable inputs such as quoted prices in active markets;

Level 2:
Inputs, other than quoted prices in active markets, that are observable either directly or indirectly; and

Level3:
Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

An asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs.

Assets and liabilities measured at fair value are based on one or more of the following three valuation techniques noted in FASB ASC Topic 820:

A.
Market approach: Prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.

B.
Cost approach: Amount that would be required to replace the service capacity of an asset (replacement cost).

 
13

 

C.
Income approach: Techniques to convert future amounts to a single present amount based upon market expectations (including present value techniques, option-pricing and excess earnings models).

Assets and liabilities remeasured and disclosed at fair value on a recurring basis at March 31, 2010 and December 31, 2009 are set forth in the table below:
 
   
Asset /
         
Valuation
 
   
(Liability)
   
Level 2
   
Technique
 
   
(Millions of Dollars)
       
March 31, 2010:
                 
Interest rate swap contracts
  $ (62 )   $ (62 )    
C
 
Commodity contracts
    7       7      
C
 
                         
December 31, 2009:
                       
Interest rate swap contracts
    (50 )     (50 )    
C
 
Commodity contracts
    6       6      
C
 

The Company calculates the fair value of its interest rate swap contracts, commodity contracts and foreign currency contracts using quoted interest rate curves, quoted commodity forward rates and quoted currency forward rates, respectively, to calculate forward values, and then discounts the forward values.

The discount rates for all derivative contracts are based on quoted swap interest rates or bank deposit rates. For contracts which, when aggregated by counterparty, are in a liability position, the rates are adjusted by the credit spread that market participants would apply if buying these contracts from the Company’s counterparties.

In addition to items that are measured at fair value on a recurring basis, the Company also has assets and liabilities that are measured at fair value on a nonrecurring basis. As these assets and liabilities are not measured at fair value on a recurring basis, they are not included in the tables above. Assets and liabilities that are measured at fair value on a nonrecurring basis include long-lived assets (see Note 3), investments in non-consolidated affiliates (see Note 8) and conditional asset retirement obligations (see Note 13). The Company has determined that the fair value measurements included in each of these assets and liabilities rely primarily on the Company’s assumptions as observable inputs are not available. As such, the Company has determined that each of these fair value measurements reside within Level 3 of the fair value hierarchy.

6.
INVENTORIES

Inventories are stated at the lower of cost or market. Cost was determined by the first-in, first-out (“FIFO”) method at March 31, 2010 and December 31, 2009. Inventories are reduced by an allowance for excess and obsolete inventories based on management’s review of on-hand inventories compared to historical and estimated future sales and usage.

Net inventories consisted of the following:

   
March 31
   
December 31
 
   
2010
   
2009
 
   
(Millions of Dollars)
 
             
Raw materials
  $ 159     $ 151  
Work-in-process
    129       118  
Finished products
    634       630  
      922       899  
Inventory valuation allowance
    (80 )     (76 )
    $ 842     $ 823  
 
 
14

 

7.
GOODWILL AND OTHER INTANGIBLE ASSETS

At March 31, 2010 and December 31, 2009, goodwill and other intangible assets consist of the following:

   
March 31, 2010
   
December 31, 2009
 
   
Gross
Carrying
Amount
   
Accumulated
Amortization
   
Net
Carrying
Amount
   
Gross
Carrying
Amount
   
Accumulated
Amortization
   
Net
Carrying
Amount
 
   
(Millions of Dollars)
 
Definite-Lived Intangible Assets:
                                   
Customer relationships
  $ 525     $ (113 )   $ 412     $ 525     $ (104 )   $ 421  
Developed technology
    115       (24 )     91       115       (21 )     94  
    $ 640     $ (137 )   $ 503     $ 640     $ (125 )   $ 515  
                                                 
Goodwill and Indefinite-Lived Intangible Assets:
                                               
Goodwill
                  $ 1,073                     $ 1,073  
Trademarks and brand names
                    354                       354  
                    $ 1,427                     $ 1,427  
 
During each of the three months ended March 31, 2010 and 2009, the Company recorded amortization expense of $12 million associated with definite-lived intangible assets. The Company utilizes the straight line method of amortization, recognized over the estimated useful lives of the assets.

8.
INVESTMENTS IN NON-CONSOLIDATED AFFILIATES

The Company maintains investments in 14 non-consolidated affiliates, which are located in China, Germany, India, Italy, Korea, Turkey, the United Kingdom and the United States. The Company’s direct ownership in such affiliates ranges from approximately 1% to 50%. The aggregate investments in these affiliates were $216 million and $238 million at March 31, 2010 and December 31, 2009, respectively, and are included in the consolidated balance sheets as “Other noncurrent assets.”

Equity earnings of non-consolidated affiliates were $7 million and less than one million for the three months ended March 31, 2010 and 2009, respectively. During the three months ended March 31, 2010, these entities generated sales of approximately $147 million, net income of approximately $17 million and at March 31, 2010 had total net assets of approximately $454 million. Dividends received from non-consolidated affiliates by the Company for the three months ended March 31, 2010 were $20 million. The Company does not hold a controlling interest in an entity based on exposure to economic risks and potential rewards (variable interests) for which it is the primary beneficiary. Further, the Company’s joint ventures are businesses established and maintained in connection with its operating strategy and are not special purpose entities.

The Company holds a 50% non-controlling interest in a joint venture located in Turkey. This joint venture was established in 1995 for the purpose of manufacturing and marketing automotive parts, including pistons, piston rings, piston pins, and cylinder liners to OE and aftermarket customers. Pursuant to the joint venture agreement, the Company’s partner holds an option to put its shares to a subsidiary of the Company at the higher of the current fair value or at a guaranteed minimum amount. The term of the contingent guarantee is indefinite, consistent with the terms of the joint venture agreement. However, the contingent guarantee would not survive termination of the joint venture agreement.

The guaranteed minimum amount represents a contingent guarantee of the initial investment of the joint venture partner and can be exercised at the discretion of the partner. As of March 31, 2010, the total amount of the contingent guarantee, were all triggering events to occur, approximated $58 million. The Company believes that this contingent guarantee is substantially less than the estimated current fair value of the guarantees’ interest in the affiliate. As such, the contingent guarantee does not give rise to a contingent liability and, as a result, no amount is recorded for this guarantee. If this put option were exercised, the consideration paid and net assets acquired would be accounted for in accordance with business combination accounting guidance. Any value in excess of the guaranteed minimum amount of the put option would be the subject of negotiation between the Company and its joint venture partner.

 
15

 

The Company has determined that its investments in Chinese joint venture arrangements are considered to be “limited-lived” as such entities have specified durations ranging from 30 to 50 years pursuant to regional statutory regulations. In general, these arrangements call for extension, renewal or liquidation at the discretion of the parties to the arrangement at the end of the contractual agreement. Accordingly, a reasonable assessment cannot be made as to the impact of such arrangements on the future liquidity position of the Company.

9.
ACCRUED LIABILITIES

Accrued liabilities consisted of the following:

   
March 31
   
December 31
 
   
2010
   
2009
 
   
(Millions of Dollars)
 
             
Accrued compensation 
  $ 176     $ 153  
Accrued rebates
    83       100  
Restructuring liabilities
    42       55  
Non-income taxes payable
    41       37  
Accrued income taxes
    24       23  
Accrued product returns
    20       22  
Accrued professional services
    13       11  
Accrued warranty
    8       7  
Accrued Chapter 11 and U.K. Administration expenses
    1       2  
    $ 408     $ 410  

10.
DEBT

On December 27, 2007, the Company entered into a Term Loan and Revolving Credit Agreement (the “Debt Facilities”) with Citicorp U.S.A. Inc. as Administrative Agent, JPMorgan Chase Bank, N.A. as Syndication Agent and certain lenders. The Debt Facilities include a $540 million revolving credit facility (which is subject to a borrowing base and can be increased under certain circumstances and subject to certain conditions) and a $2,960 million term loan credit facility divided into a $1,960 million tranche B loan and a $1,000 million tranche C loan. The obligations under the revolving credit facility mature December 27, 2013 and bear interest for the first six months at LIBOR plus 1.75% or at the alternate base rate (“ABR,” defined as the greater of Citibank, N.A.’s announced prime rate or 0.50% over the Federal Funds Rate) plus 0.75%, and thereafter shall be adjusted in accordance with a pricing grid based on availability under the revolving credit facility. Interest rates on the pricing grid range from LIBOR plus 1.50% to LIBOR plus 2.00% and ABR plus 0.50% to ABR plus 1.00%. The tranche B term loans mature December 27, 2014 and the tranche C term loans mature December 27, 2015. The tranche C term loans are subject to a pre-payment premium, should the Company choose to prepay the loans prior to December 27, 2011. All Debt Facilities term loans bear interest at LIBOR plus 1.9375% or at the alternate base rate (as previously defined) plus 0.9375% at the Company’s election. To the extent that interest rates change by 25 basis points, the Company’s annual interest expense would show a corresponding change of approximately $4 million.

The Company, during 2008, entered into a series of five-year interest rate swap agreements with a total notional value of $1,190 million to hedge the variability of interest payments associated with its variable-rate term loans under the Debt Facilities. Through these swap agreements, the Company has fixed its combined interest and premium rate at an average of approximately 5.37% on the hedged principal amount of $1,190 million. Since the interest rate swaps hedge the variability of interest payments on variable rate debt with the same terms, they qualify for cash flow hedge accounting treatment.

 
16

 

The Debt Facilities were initially negotiated and agreement was reached on the majority of significant terms in early 2007. Between the time the terms were agreed in early 2007 and December 27, 2007, interest rates charged on similar debt instruments for companies with similar debt ratings and capitalization levels rose to higher levels. As such, when applying the provisions of fresh-start reporting, the Company estimated a fair value adjustment of $163 million for the available borrowings under the Debt Facilities. This estimated fair value was recorded within the fresh-start reporting, and is being amortized as interest expense over the terms of each of the underlying components of the Debt Facilities. During each of the three month periods ended March 31, 2010 and 2009, the Company recognized $6 million in interest expense associated with the amortization of this fair value adjustment.

Debt consisted of the following:

   
March 31
   
December 31
 
   
2010
   
2009
 
   
(Millions of Dollars)
 
Debt Facilities:
           
Revolver 
  $     $  
Tranche B term loan
    1,916       1,921  
Tranche C term loan
    978       980  
Debt discount 
    (113 )     (119 )
Other debt, primarily foreign instruments
    74       75  
      2,855       2,857  
Less: short-term debt, including current maturities of long-term debt
    (97 )     (97 )
Total long-term debt
  $ 2,758     $ 2,760  

The obligations of the Company under the Debt Facilities are guaranteed by substantially all of the domestic subsidiaries and certain foreign subsidiaries of the Company, and are secured by substantially all personal property and certain real property of the Company and such guarantors, subject to certain limitations. The liens granted to secure these obligations and certain cash management and hedging obligations have first priority.

The Debt Facilities contain certain affirmative and negative covenants and events of default, including, subject to certain exceptions, restrictions on incurring additional indebtedness, mandatory prepayment provisions associated with specified asset sales and dispositions, and limitations on i) investments; ii) certain acquisitions, mergers or consolidations; iii) sale and leaseback transactions; iv) certain transactions with affiliates; and v) dividends and other payments in respect of capital stock.

The total commitment and amounts outstanding on the revolving credit facility are as follows:

   
March 31
   
December 31
 
   
2010
   
2009
 
   
(Millions of Dollars)
 
             
Current Contractual Commitment
  $ 540     $ 540  
                 
Outstanding:
               
   Revolving credit facility
  $     $  
   Letters of credit
           
Total outstanding
  $     $  
                 
Borrowing Base on Revolving Credit Facility:
               
   Current borrowings
  $     $  
   Letters of credit
           
   Available to borrow
    493       470  
Total borrowing base
  $ 493     $ 470  
 
 
17

 

The Company had $50 million of letters of credit outstanding at March 31, 2010 and December 31, 2009, all pertaining to the term loan credit facility. To the extent letters of credit associated with the revolving credit facility are issued, there is a corresponding decrease in borrowings available under this facility.

As of March 31, 2010 and December 31, 2009, the estimated fair values of the Company’s Debt Facilities were $2,683 and $2,444 million, respectively. The estimated fair values were $98 million lower at March 31, 2010 and $338 million lower at December 31, 2009 than their respective carrying values. Fair market values are developed by the use of estimates obtained from brokers and other appropriate valuation techniques based on information available as of March 31, 2010 and December 31, 2009. The fair value estimates do not necessarily reflect the values the Company could realize in the current markets.
 
11.
PENSIONS AND OTHER POSTEMPLOYMENT BENEFITS

The Company sponsors several defined benefit pension plans (“Pension Benefits”) and health care and life insurance benefits (“Other Benefits”) for certain employees and retirees around the world. Components of net periodic benefit cost for the three months ended March 31 are as follows:

   
Pension Benefits
             
   
United States Plans
   
Non-U.S. Plans
   
Other Benefits
 
   
2010
   
2009
   
2010
   
2009
   
2010
   
2009
 
   
(Millions of Dollars)
 
Service cost
  $ 6     $ 6     $ 2     $ 2     $     $  
Interest cost
    15       16       4       4       7       8  
Expected return on plan assets
    (12 )     (11 )     (1 )     (1 )            
Amortization of actuarial loss
    6       8                          
Net periodic benefit cost
  $ 15     $ 19     $ 5     $ 5     $ 7     $ 8  
 
On March 23, 2010, the Patient Protection and Affordable Care Act was signed into law and on March 30, 2010, a companion bill, the Health Care and Education Reconciliation Act of 2010, was also signed into law. These bills contain provisions which could impact the Company’s accounting for retiree medical benefits in future periods, however, the extent of that impact, if any, cannot be determined until regulations are promulgated under these bills and additional interpretations of these bills become available. The Company will continue to assess the accounting implications of these bills.  See Note 12, Income Taxes, below for further discussion on the impact of these bills.

12.
INCOME TAXES

For the three months ended March 31, 2010, the Company recorded an income tax benefit of $7 million on income before income taxes of $10 million. This compares to income tax expense of $4 million on a loss before income taxes of $97 million in the same period of 2009. The income tax benefit for the three months ended March 31, 2010 differs from statutory rates due primarily to non-recognition of income tax benefits on certain operating losses and the reversal of a valuation allowance against net deferred tax assets of a Belgium subsidiary.

The Company believes that it is reasonably possible that its unrecognized tax benefits in multiple jurisdictions, which primarily relate to transfer pricing, corporate reorganization and various other matters, may decrease by approximately $300 million in the next 12 months due to audit settlements or statute expirations, of which approximately $30 million, if recognized, could impact the effective tax rate.

On March 23, 2010, the Patient Protection and Affordable Care Act was signed into law and on March 30, 2010, a companion bill, the Health Care and Education Reconciliation Act of 2010, was also signed into law. These bills will reduce the tax deduction available to the Company to the extent of receipt of the Medicare Part D subsidy. Although this legislation does not take effect until 2012, the Company is required to recognize the impact in the financial statements in the period in which it is signed. Due to the full valuation allowance recorded against deferred tax assets in the United States, this legislation will not impact the Company’s 2010 effective tax rate.

 
18

 

13.
COMMITMENTS AND CONTINGENCIES

Environmental Matters

The Company is a defendant in lawsuits filed, or the recipient of administrative orders issued, in various jurisdictions pursuant to the Federal Comprehensive Environmental Response Compensation and Liability Act of 1980 (“CERCLA”) or other similar national, provincial or state environmental laws. These laws require responsible parties to pay for remediating contamination resulting from hazardous substances that were discharged into the environment by them, by prior owners or occupants of their property, or by others to whom they sent such substances for treatment or other disposition. The Company has been notified by the United States Environmental Protection Agency, other national environmental agencies, and various provincial and state agencies that it may be a potentially responsible party (“PRP”) under such laws for the cost of remediating hazardous substances pursuant to CERCLA and other national and state or provincial environmental laws. PRP designation typically requires the funding of site investigations and subsequent remedial activities.

Many of the sites that are likely to be the costliest to remediate are often current or former commercial waste disposal facilities to which numerous companies sent wastes. Despite the joint and several liability which might be imposed on the Company under CERCLA and some of the other laws pertaining to these sites, the Company’s share of the total waste sent to these sites has generally been small. The Company believes its exposure for liability at these sites is limited.

The Company has also identified certain other present and former properties at which it may be responsible for cleaning up or addressing environmental contamination, in some cases as a result of contractual commitments. The Company is actively seeking to resolve these actual and potential statutory, regulatory and contractual obligations. Although difficult to quantify based on the complexity of the issues, the Company has accrued amounts corresponding to its best estimate of the costs associated with such regulatory and contractual obligations on the basis of available information from site investigations and best professional judgment of consultants.

Total environmental liabilities, determined on an undiscounted basis, were $21 million and $22 million at March 31, 2010 and December 31, 2009, respectively, and are included in the consolidated balance sheets as follows:

   
March 31
   
December 31
 
   
2010
   
2009
 
   
(Millions of Dollars)
 
             
Other current liabilities
  $ 6     $ 7  
Other accrued liabilities (noncurrent)
    15       15  
    $ 21     $ 22  

Management believes that recorded environmental liabilities will be adequate to cover the Company’s estimated liability for its exposure in respect to such matters. In the event that such liabilities were to significantly exceed the amounts recorded by the Company, the Company’s results of operations and financial condition could be materially affected. At March 31, 2010, management estimates that reasonably possible material additional losses above and beyond management’s best estimate of required remediation costs as recorded approximate $43 million.

Conditional Asset Retirement Obligations

The Company records conditional asset retirement obligations (“CARO”) in accordance with FASB ASC Topic 410, Asset Retirement and Environmental Obligations. The Company’s primary CARO activities relate to the removal of hazardous building materials at its facilities. The Company records a CARO at fair value upon initial recognition when the amount can be reasonably estimated, typically upon the expectation that an operating site may be closed or sold. CARO fair values are determined based on the Company’s determination of what a third party would charge to perform the remediation activities, generally using a present value technique. The Company has identified sites with contractual obligations and several sites that are closed or expected to be closed and sold. In connection with these sites, the Company has accrued $29 million and $30 million as of March 31, 2010 and December 31, 2009, respectively, for CARO, primarily related to anticipated costs of removing hazardous building materials, and has considered impairment issues that may result from capitalization of CARO.

 
19

 

The Company has additional CARO, also primarily related to removal costs of hazardous materials in buildings, for which it believes reasonable cost estimates cannot be made at this time because the Company does not believe it has a reasonable basis to assign probabilities to a range of potential settlement dates for these retirement obligations. Accordingly, the Company is currently unable to determine amounts to accrue for CARO at such sites.

For those sites that the Company identifies in the future for closure or sale, or for which it otherwise believes it has a reasonable basis to assign probabilities to a range of potential settlement dates, the Company will review these sites for both CARO and impairment issues.

Liabilities for CARO are included in the consolidated balance sheets as follows:

   
March 31
   
December 31
 
   
2010
   
2009
 
   
(Millions of Dollars)
 
             
Other current liabilities
  $ 13     $ 14  
Other accrued liabilities (noncurrent)
    16       16  
    $ 29     $ 30  

Other Matters

The Company is involved in other legal actions and claims, directly and through its subsidiaries. Management does not believe that the outcomes of these other actions or claims are likely to have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.
 
14.
COMPREHENSIVE LOSS

The Company’s comprehensive loss consists of the following:

   
Three Months Ended
 
   
March 31
 
   
2010
   
2009
 
   
(Millions of Dollars)
 
             
Net income (loss) attributable to Federal-Mogul
  $ 15     $ (101 )
                 
Foreign currency translation adjustments and other
    (33 )     (98 )
                 
Hedge instruments
    (10 )     16  
Income taxes
          (6 )
Hedge instruments, net of tax
    (10 )     10  
                 
Postemployment benefits
    7       7  
Income taxes
           
Postemployment benefits, net of tax
    7       7  
                 
    $ (21 )   $ (182 )
 
 
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15.
WARRANTS

On December 27, 2007, the Company issued 6,951,871 warrants to purchase common shares of the Company at an exercise price equal to $45.815, exercisable through December 27, 2014. All of these warrants remain outstanding as of March 31, 2010.
 
16.
STOCK-BASED COMPENSATION

CEO Stock-Based Compensation Agreement

On February 2, 2005, the Predecessor Company entered into a five-year employment agreement with José Maria Alapont, effective March 23, 2005, whereby Mr. Alapont was appointed as the Predecessor Company’s president and chief executive officer. Mr. Alapont served as chairman of the board of the directors of the Company from June 2005 to December 2007. In connection with this agreement, the Plan Proponents agreed to amend the Plan to provide that the Successor Company would grant to Mr. Alapont stock options equal to at least 4% of the value of the Successor Company at the reorganization date (the “Employment Agreement Options”). The Employment Agreement Options vest ratably over the life of the employment agreement, such that one fifth of the Employment Agreement Options vest on each anniversary of the employment agreement effective date. For purposes of estimating fair value, the Employment Agreement Options were deemed to expire on December 27, 2014.

Additionally, one-half of the Employment Agreement Options had an additional feature allowing for the exchange of one half of the options for shares of stock of the Successor Company, at the exchange equivalent of four options for one share of Common Stock. The Employment Agreement Options without the exchange feature are referred to herein as “plain vanilla options” and those Employment Agreement Options with the exchange feature are referred to as “options with exchange.”

On the Effective Date and in accordance with the Plan, the Company granted to Mr. Alapont stock options to purchase four million shares of Successor Company Common Stock at an exercise price of $19.50 (the “Granted Options”). Pursuant to the Stock Option Agreement dated as of December 27, 2007 between the Company and Mr. Alapont (the “Initial CEO Stock Option Agreement”), the Granted Options did not have an exchange feature. In lieu of “options with exchange” under the Employment Agreement Options, the Successor Company entered into a deferred compensation agreement with Mr. Alapont intended to be the economic equivalent of the options with exchange. Under the terms of this deferred compensation agreement, Mr. Alapont is entitled to certain distributions of Common Stock, or, at the election of Mr. Alapont, certain distributions of cash upon certain events as set forth in the Deferred Compensation Agreement dated as of December 27, 2007 between the Company and Mr. Alapont (the “Deferred Compensation Agreement”). The amount of the distributions is equal to the fair value of 500,000 shares of Common Stock, subject to certain adjustments and offsets, determined on March 23, 2010.

On February 14, 2008, the Company entered into Amendment No. 1 to the Initial CEO Stock Option Agreement, dated as of February 14, 2008 (the “Amendment”). Pursuant to the Amendment, the exercise price for the granted options was increased to $29.75 per share. On February 15, 2008, the Initial CEO Stock Option Agreement as amended was cancelled by mutual written agreement of the Company and Mr. Alapont. On February 15, 2008, the Company entered into a new Stock Option Agreement with Mr. Alapont dated as of February 15, 2008 (the “New CEO Stock Option Agreement”). The New CEO Stock Option Agreement grants Mr. Alapont a non-transferable, non-qualified option (the “CEO Option”) to purchase up to 4,000,000 shares of the Company’s Common Stock subject to the terms and conditions described below. The exercise price for the CEO Option is $19.50 per share, which is at least equal to the fair market value of a share of the Company’s Common Stock on the date of grant of the CEO Option. In no event may the CEO Option be exercised, in whole or in part, after December 27, 2014. The CEO Option became fully vested on March 23, 2010. These transactions were undertaken to comply with Internal Revenue Code Section 409A in connection with the implementation of Mr. Alapont’s employment agreement. The grant of the CEO Option was approved by the Company’s shareholders effective July 28, 2008.
 
 
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On March 23, 2010, the Company entered into the Second Amended and Restated Employment Agreement, which extended Mr. Alapont’s employment with the Company for three years. Also on March 23, 2010, the Company amended and restated the CEO Option (the “Restated Stock Option Agreement”). The Restated Stock Option Agreement removed Mr. Alapont’s put option to sell stock received from an option exercise to the Company for cash. The Restated Stock Option Agreement provides for pay out of any exercise of the CEO Option in stock or, at the election of the Company, in cash. The awards were previously accounted for as liability awards based on the optional cash exercise feature, however the accounting impact associated with this modification is that the options are now considered an equity award as of March 23, 2010.

The Company revalued the options granted to Mr. Alapont at March 23, 2010, resulting in a revised fair value of $27 million. This amount was reclassified from “Other accrued liabilities” to “Additional paid-in capital” due to their equity award status. As these options are fully vested, no further expense related to the options will be recognized. The Company revalued the Deferred Compensation Agreement, which was also amended and restated on March 23, 2010, at March 31, 2010, resulting in a revised fair value of $7 million. Since this agreement provides for net cash settlement at the option of Mr. Alapont, it continues to be treated as a liability award as of March 31, 2010 and through its eventual payout. During the three months ended March 31, 2010 and 2009, the Company recognized $6 million and $3 million, respectively, in expense associated with the CEO Option and Deferred Compensation Agreement. Key assumptions and related option-pricing models used by the Company are summarized in the following table:

   
March 23, 2010
   
March 31, 2010
 
         
Options Connected
       
   
Plain Vanilla
   
To Deferred
   
Deferred
 
   
Options
   
Compensation
   
Compensation
 
                   
Valuation model
 
Black-Scholes
   
Monte Carlo
   
Monte Carlo
 
Expected volatility
    58 %     58 %     59 %
Expected dividend yield
    0 %     0 %     0 %
Risk-free rate over the estimated expected option life
    1.18 %     1.18 %     1.25 %
Expected option life (in years)
    2.38       2.38       2.38  

Expected volatility is based on the average of five-year historical volatility and implied volatility for a group of auto industry comparator companies as of the measurement date. Risk-free rate is determined based upon U.S. Treasury rates over the estimated expected option lives. Expected dividend yield is zero as the Company has not paid dividends to holders of its common stock in the recent past nor does it expect to do so in the future. Expected option lives are equal to one-half of the time to the end of the option term.

Stock Appreciation Rights

On February 22, 2010, the Company granted, subject to stockholder approval, approximately 437,000 stock appreciation rights (“SARs”) to certain employees. The SARs vest over periods up to three years and have a term of five years from date of grant. The SARs are payable in cash or, at the election of the Company, in stock. As the Company anticipates paying out SARs exercises in the form of cash, the SARs are being treated as liability awards for accounting purposes. The Company valued the SARs at March 31, 2010, resulting in a fair value of $4 million. SARs expense for the three months ended March 31, 2010 was immaterial. The SARs fair value was estimated using the Black-Scholes valuation model with the following assumptions:

Exercise price
  $ 17.16  
Expected volatility
    59 %
Expected dividend yield
    0 %
Risk-free rate over the estimated expected option life
    1.89 %
Expected life (in years)
    3.41  

Expected volatility is based on the average of five-year historical volatility and implied volatility for a group of auto industry comparator companies as of the measurement date. Risk-free rate is determined based upon U.S. Treasury rates over the estimated expected option lives. Expected dividend yield is zero as the Company has not paid dividends to holders of its common stock in the recent past nor does it expect to do so in the future. Expected life is the average of the time until the award is fully vested and the end of the term.

 
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17.
INCOME (LOSS) PER COMMON SHARE

The following table sets forth the computation of basic and diluted income (loss) per common share:

   
Three Months Ended
 
   
March 31
 
   
2010
   
2009
 
   
(Millions of Dollars, Except
Per Share Amounts)
 
             
Net income (loss) attributable to Federal-Mogul shareholders
  $ 15     $ (101 )
                 
Weighted average shares outstanding, basic (in millions)
    98.9       98.9  
                 
Incremental shares on assumed conversion of deferred compensation stock (in millions)
    0.5       0.4  
                 
Weighted average shares outstanding, including dilutive shares (in millions)
    99.4       99.3  
                 
Net income (loss) per share attributable to Federal-Mogul:
               
Basic
  $ 0.15     $ (1.02 )
Diluted
  $ 0.15     $ (1.02 )

The Company had a loss for the three months ended March 31, 2009. As a result, diluted loss per common share is the same as basic loss per common share as any potentially dilutive securities would reduce the loss per common share.

Options and warrants to purchase 4,000,000 and 6,951,871 common shares, respectively, were not included in the computation of diluted earnings per share because the exercise prices were greater than the average market price of the Company’s common shares during the three months ended March 31, 2010 and 2009, respectively.

The 500,000 common shares issued in connection with the Deferred Compensation Agreement described in Note 16 are excluded from the basic earnings per share calculation as required by FASB ASC Topic 710, Compensation.
 
18.
OPERATIONS BY REPORTING SEGMENT

The Company's integrated operations are organized into five reporting segments generally corresponding to major product groups: Powertrain Energy, Powertrain Sealing and Bearings, Vehicle Safety and Protection, Global Aftermarket and Corporate.

The accounting policies of the reporting segments are the same as those of the Company. Revenues related to products sold from Powertrain Energy, Powertrain Sealing and Bearings, and Vehicle Safety and Protection to OE customers are recorded within the respective reporting segments. Revenues from such products sold to aftermarket customers are recorded within the Global Aftermarket segment. All product transferred into Global Aftermarket from other reporting segments is transferred at cost in the United States and at agreed-upon arm’s-length transfer prices internationally.

The Company evaluates reporting segment performance principally on a non-GAAP Operational EBITDA basis. Management believes that Operational EBITDA most closely approximates the cash flow associated with the operational earnings of the Company and uses Operational EBITDA to measure the performance of its operations. Operational EBITDA is defined as earnings before interest, income taxes, depreciation and amortization, and certain items such as restructuring and impairment charges, Chapter 11 and U.K. Administration related reorganization expenses, gains or losses on the sales of businesses and expense associated with U.S. based funded pension plans.

 
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Net sales, cost of products sold and gross margin information by reporting segment are as follows:

   
Three Months Ended March 31
 
   
Net Sales
   
Cost of Products Sold
   
Gross Margin
 
   
2010
   
2009
   
2010
   
2009
   
2010
   
2009
 
   
(Millions of Dollars)
 
                                     
Powertrain Energy
  $ 435     $ 309     $ 377     $ 294     $ 58     $ 15  
Powertrain Sealing and Bearings
    270       184       244       190       26       (6 )
Vehicle Safety and Protection
    231       162       170       127       61       35  
Global Aftermarket
    553       583       449       469       104       114  
Corporate
                (5 )           5        
    $ 1,489     $ 1,238     $ 1,235     $ 1,080     $ 254     $ 158  

Operational EBITDA by reporting segment and the reconciliation of Operational EBITDA to net income (loss) are as follows:

   
Three Months Ended
 
   
March 31
 
   
2010
   
2009
 
   
(Millions of Dollars)
 
             
Powertrain Energy
  $ 69     $ 21  
Powertrain Sealing and Bearings
    24       (4 )
Vehicle Safety and Protection
    57       33  
Global Aftermarket
    65       72  
Corporate
    (77 )     (52 )
Total Operational EBITDA
    138       70  
                 
Interest expense, net
    (33 )     (34