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Table of Contents

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 September 30, 2011

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:  001-34029

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 x  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 October 27, 2011, there were 98,904,500 outstanding shares of the registrant’s $0.01 par value common stock.


Table of Contents

FEDERAL-MOGUL CORPORATION

Form 10-Q

For the Three and Nine Months Ended September 30, 2011

INDEX

 

     Page No.

Part I – Financial Information

    

Item 1 – Financial Statements

    

Consolidated Statements of Operations

       3  

Consolidated Balance Sheets

       4  

Consolidated Statements of Cash Flows

       5  

Notes to Consolidated Financial Statements

       6  

Forward-Looking Statements

       30  

Item  2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

       30  

Item 3 – Qualitative and Quantitative Disclosures about Market Risk

       47  

Item 4 – Controls and Procedures

       47  

Part II – Other Information

    

Item 1 – Legal Proceedings

       49  

Item 5 – Other Information

       49  

Item 6 – Exhibits

       49  

Signatures

       50  

Exhibits

    

 

2


Table of Contents

PART I

FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

FEDERAL-MOGUL CORPORATION

Consolidated Statements of Operations (Unaudited)

 

     Three Months  Ended
September 30
    Nine Months  Ended
September 30
 
     2011     2010     2011     2010  
     (Millions of Dollars, Except Per Share Amounts)  

Net sales

   $ 1,732      $ 1,544      $ 5,256      $ 4,631   

Cost of products sold

     (1,469     (1,306     (4,415     (3,865
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross margin

     263        238        841        766   

Selling, general and administrative expenses

     (172     (164     (522     (516

OPEB curtailment gains

            24               28   

Interest expense, net

     (32     (32     (95     (98

Amortization expense

     (12     (12     (36     (37

Equity earnings of non-consolidated affiliates

     7        6        27        24   

Restructuring expense, net

     (3     (1     (4     (7

Other (expense) income, net

     (6     1        (17     (22
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     45        60        194        138   

Income tax expense

     (9     (6     (40     (18
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     36        54        154        120   

Less net income attributable to noncontrolling interests

     (2     (1     (4     (4
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Federal-Mogul

   $ 34      $ 53      $ 150      $ 116   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income per common share:

        

Basic

   $ 0.34      $ 0.54      $ 1.52      $ 1.17   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 0.34      $ 0.53      $ 1.51      $ 1.17   
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

3


Table of Contents

FEDERAL-MOGUL CORPORATION

Consolidated Balance Sheets

 

     (Unaudited)
September  30
2011
    December 31
2010
 
     (Millions of Dollars)  
ASSETS     

Current assets:

    

Cash and equivalents

   $ 931      $ 1,105   

Accounts receivable, net

     1,195        1,075   

Inventories, net

     1,003        847   

Prepaid expenses and other current assets

     226        244   
  

 

 

   

 

 

 

Total current assets

     3,355        3,271   

Property, plant and equipment, net

     1,885        1,802   

Goodwill and indefinite-lived intangible assets

     1,424        1,431   

Definite-lived intangible assets, net

     447        484   

Investments in non-consolidated affiliates

     227        210   

Other noncurrent assets

     95        98   
  

 

 

   

 

 

 
   $ 7,433      $ 7,296   
  

 

 

   

 

 

 
LIABILITIES AND SHAREHOLDERS’ EQUITY     

Current liabilities:

    

Short-term debt, including current portion of long-term debt

   $ 90      $ 73   

Accounts payable

     750        660   

Accrued liabilities

     405        428   

Current portion of postemployment benefit liability

     47        47   

Other current liabilities

     169        143   
  

 

 

   

 

 

 

Total current liabilities

     1,461        1,351   

Long-term debt

     2,744        2,752   

Postemployment benefits

     1,137        1,172   

Long-term portion of deferred income taxes

     469        470   

Other accrued liabilities

     174        186   

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 September 30, 2011 and December 31, 2010)

     1        1   

Additional paid-in capital, including warrants

     2,150        2,150   

Accumulated deficit

     (202     (352

Accumulated other comprehensive loss

     (583     (505

Treasury stock, at cost

     (17     (17
  

 

 

   

 

 

 

Total Federal-Mogul shareholders’ equity

     1,349        1,277   
  

 

 

   

 

 

 

Noncontrolling interests

     99        88   
  

 

 

   

 

 

 

Total shareholders’ equity

     1,448        1,365   
  

 

 

   

 

 

 
   $ 7,433      $ 7,296   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

4


Table of Contents

FEDERAL-MOGUL CORPORATION

Consolidated Statements of Cash Flows (Unaudited)

 

     Nine Months Ended
September 30
 
     2011     2010  
     (Millions of Dollars)  

Cash Provided From (Used By) Operating Activities

    

Net income

   $ 154      $ 120   

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

    

Depreciation and amortization

     212        244   

Restructuring expense, net

     4        7   

Payments against restructuring liabilities

     (19     (26

Payments to settle non-debt liabilities subject to compromise, net

     (1     (16

Equity earnings of non-consolidated affiliates

     (27     (24

Cash dividends received from non-consolidated affiliates

     14        27   

Change in postemployment benefits, excluding OPEB curtailment gains

     (30     (23

OPEB curtailment gains

            (28

Loss on Venezuelan currency devaluation

            20   

Gain on sale of property, plant and equipment

            (2

Changes in operating assets and liabilities:

    

Accounts receivable

     (132     (188

Inventories

     (171     (36

Accounts payable

     90        117   

Other assets and liabilities

     30        63   
  

 

 

   

 

 

 

Net Cash Provided From Operating Activities

     124        255   

Cash Provided From (Used By) Investing Activities

    

Expenditures for property, plant and equipment

     (282     (166

Payments to acquire business

            (39

Net proceeds from the sale of property, plant and equipment

            2   
  

 

 

   

 

 

 

Net Cash Used By Investing Activities

     (282     (203

Cash Provided From (Used By) Financing Activities

    

Principal payments on term loans

     (22     (22

Decrease in other long-term debt

     (3     (2

Increase in short-term debt

     19        4   

Net remittances on servicing of factoring arrangements

            (13
  

 

 

   

 

 

 

Net Cash Used By Financing Activities

     (6     (33

Effect of foreign currency exchange rate fluctuations on cash

     (10     17   

Effect of Venezuelan currency devaluation on cash

            (16
  

 

 

   

 

 

 

Effect of foreign currency fluctuations on cash

     (10     1   

(Decrease) increase in cash and equivalents

     (174     20   

Cash and equivalents at beginning of period

     1,105        1,034   
  

 

 

   

 

 

 

Cash and equivalents at end of period

   $ 931      $ 1,054   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

5


Table of Contents

FEDERAL-MOGUL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

September 30, 2011

 

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, 2010. Operating results for the three and nine months ended September 30, 2011 are not necessarily indicative of the results that may be expected for the year ended December 31, 2011.

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 77% 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. 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.

Acquisition: In June 2010, the Company acquired 100% ownership of the Daros Group, a privately-owned supplier of high technology piston rings for large-bore engines used in industrial energy generation and commercial shipping, with manufacturing operations in China, Germany and Sweden, for $39 million in cash. The Company allocated the purchase price in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codifications (“ASC”) Topic 805, Business Combinations. The Company utilized a third party to assist in the fair value determination of certain components of the purchase price allocation, namely fixed assets and intangible assets. This acquisition is included in the Powertrain Energy reporting segment.

 

6


Table of Contents

Factoring of Trade Accounts Receivable: Federal-Mogul subsidiaries in Brazil, France, Germany, Italy, Japan, Spain and the United States are party to accounts receivable factoring and securitization facilities. Gross accounts receivable transferred under these facilities were $263 million and $211 million as of September 30, 2011 and December 31, 2010, respectively. Of those gross amounts, $262 million and $210 million, respectively, qualify as sales as defined in FASB ASC Topic 860, Transfers and Servicing. The remaining transferred receivables were pledged as collateral and 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 the terms of these facilities, the Company is not obligated to draw cash immediately upon the transfer of accounts receivable. Thus, as of both September 30, 2011 and December 31, 2010, the Company had outstanding transferred receivables for which cash of $1 million had not yet been drawn. Proceeds from the transfers of accounts receivable qualifying as sales were $1,335 million and $894 million for the nine months ended September 30, 2011 and 2010, respectively.

For the three and nine months ended September 30, 2011, expenses associated with transfers of receivables were $2 million and $7 million, respectively. For the three and nine months ended September 30, 2010, such expenses were $3 million and $5 million, respectively. These expenses were recorded in the consolidated statements of operations within “Other (expense) income, net.”

Where the Company receives a fee to service and monitor these transferred receivables, such fees are sufficient to offset the costs and as such, a servicing asset or liability is not incurred as a result of such activities.

Certain of the facilities contain terms that require the Company to share in the credit risk of the sold receivables. The maximum exposures to the Company associated with these certain facilities’ terms were $26 million and $32 million as of September 30, 2011 and December 31, 2010, respectively. The fair values of the exposures to the Company associated with these certain facilities’ terms were determined to be immaterial.

Equity and Comprehensive Income: The following table presents a rollforward of the changes in equity for the nine months ended September 30, 2011, including changes in the components of comprehensive income (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, 2010

   $ 1,365      $ 1,277      $ 88   

Comprehensive income:

      

Net income

     154        150        4   

Foreign currency translation adjustments and other

     (66     (63     (3

Hedge instruments, net of tax

     (18     (18       

Postemployment benefits, net of tax

     3        3          
  

 

 

   

 

 

   

 

 

 
     73        72        1   

Capital investment in subsidiary by non-controlling shareholder

     10               10   
  

 

 

   

 

 

   

 

 

 

Equity balance as of September 30, 2011

   $ 1,448      $ 1,349      $ 99   
  

 

 

   

 

 

   

 

 

 

New Accounting Pronouncements: In January 2010, the FASB issued Accounting Standards Update (“ASU”) No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. This ASU requires additional disclosures regarding fair value measurements, including the amount and reasons for transfers between levels within the fair value hierarchy and more detailed information regarding the inputs and valuation techniques used in determining the fair value of assets and liabilities classified as either Level 2 or Level 3 within the fair value hierarchy. In addition, this ASU clarifies previous guidance related to the level at which fair value disclosures should be disaggregated. The adoption of these components of this new guidance was effective January 1, 2010. This ASU further requires entities to report Level 3 rollforward activity on a gross basis effective January 1, 2011. These additional disclosure requirements, to the extent applicable, have been reflected in Note 5.

 

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Table of Contents

In April 2011, the FASB issued ASU No. 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring. This ASU provides guidance on whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring. The Company does not expect the provisions of this ASU to have a material effect on its financial position, results of operations or cash flows.

In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. This ASU makes changes to fair value principles related to premiums and discounts and the measurement of financial instruments, requires new disclosures with a focus on level 3 measurements and makes clarifications regarding the definition of a principal market. The Company does not expect the provisions of this ASU to have a material effect on its financial position, results of operations or cash flows.

In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. This ASU will change the manner in which entities present comprehensive income in their financial statements. The Company will adopt this new guidance effective January 1, 2012.

In September 2011, the FASB issued ASU No. 2011-08, Intangibles – Goodwill and Other (Topic 350): Testing Goodwill for Impairment. This ASU will allow for the option to perform a qualitative assessment that may allow companies to forego the annual two-step impairment test for goodwill. The guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 with early adoption permitted. The Company will not elect early adoption of this ASU.

In September 2011, the FASB issued ASU No. 2011-09, Compensation – Retirement Benefits – Multiemployer Plans (Subtopic 715-80): Disclosures about an Employer’s Participation in a Multiemployer Plan. This ASU requires enhanced disclosures for multiemployer pension plan and is effective for annual periods ending after December 15, 2011. The Company does not expect the provisions of this ASU to have any disclosure impact.

 

2.

RESTRUCTURING

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.

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.

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 non-U.S. locations. Thus, restructuring programs appear to be ongoing when, in fact, terminations and other activities have been substantially completed.

 

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Table of Contents

Management expects to finance its restructuring programs 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 following table provides a quarterly summary of the Company’s consolidated restructuring liabilities and related activity as of and for the nine months ended September 30, 2011 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, 2010

   $ 11      $ 7      $ 1      $ 3      $ 2      $ 24   

Provisions

            1               1               2   

Reversals

                          (1            (1

Payments

     (1     (2     (1     (1     (1     (6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2011

     10        6               2        1        19   

Provisions

     2        1                             3   

Reversals

     (3                                 (3

Payments

     (5     (2            (1            (8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at June 30, 2011

     4        5               1        1        11   

Provisions

     1               2                      3   

Payments

     (2     (1     (2                   (5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2011

   $ 3      $ 4      $      $ 1      $ 1      $ 9   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The following table provides a quarterly summary of the Company’s consolidated restructuring liabilities and related activity for each type of exit cost as of and for the nine months ended September 30, 2011. As the table indicates, facility closure costs are typically paid within the quarter of incurrence.

 

   

Employee

Costs

   

Facility

Costs

   

Total

 
    (Millions of Dollars)  

Balance at December 31, 2010

  $ 24      $      $ 24   

Provisions

    1        1        2   

Reversals

    (1            (1

Payments

    (5     (1     (6
 

 

 

   

 

 

   

 

 

 

Balance at March 31, 2011

    19               19   

Provisions

    1        2        3   

Reversals

    (3            (3

Payments

    (6     (2     (8
 

 

 

   

 

 

   

 

 

 

Balance at June 30, 2011

    11               11   

Provisions

    2        1        3   

Payments

    (4     (1     (5
 

 

 

   

 

 

   

 

 

 

Balance at September 30, 2011

  $ 9      $      $ 9   
 

 

 

   

 

 

   

 

 

 

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 $4 million were reversed during the nine months ended September 30, 2011. 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.

 

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Table of Contents

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.

The following table provides a quarterly summary of the Company’s Restructuring 2009 liabilities and related activity as of and for the nine months ended September 30, 2011 by reporting segment:

 

         PTE             PTSB             VSP             GA         Corporate          Total      
     (Millions of Dollars)  

Balance at December 31, 2010

   $ 8      $ 7      $ 1      $ 2      $       $ 18   

Provisions

            1                              1   

Reversals

                          (1             (1

Payments

     (1     (2     (1                    (4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at March 31, 2011

     7        6               1                14   

Provisions

     1        1                              2   

Reversals

     (3                                  (3

Payments

     (3     (2            (1             (6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at June 30, 2011

     2        5                              7   

Provisions

     1                                     1   

Payments

     (1     (1                           (2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at September 30, 2011

   $ 2      $ 4      $      $      $       $ 6   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

The following table provides a quarterly summary of the Company’s Restructuring 2009 liabilities and related activity for each type of exit cost as of and for the nine months ended September 30, 2011. As the table indicates, facility closure costs are typically paid within the quarter of incurrence.

 

   

Employee

Costs

   

Facility

Costs

   

Total

 
    (Millions of Dollars)  

Balance at December 31, 2010

  $ 18      $      $ 18   

Provisions

    1               1   

Reversals

    (1            (1

Payments

    (4            (4
 

 

 

   

 

 

   

 

 

 

Balance at March 31, 2011

    14               14   

Provisions

    1        1        2   

Reversals

    (3            (3

Payments

    (5     (1     (6
 

 

 

   

 

 

   

 

 

 

Balance at June 30, 2011

    7               7   

Provisions

           1        1   

Payments

    (1     (1     (2
 

 

 

   

 

 

   

 

 

 

Balance at September 30, 2011

  $ 6      $      $ 6   
 

 

 

   

 

 

   

 

 

 

 

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Table of Contents

The Company has incurred total expenses of $157 million since the inception of this program, of which $148 million were employee costs and $9 million were facility closure costs. The Company does not expect to incur any additional costs under the Restructuring 2009 Program. Cumulative net charges related to Restructuring 2009 are as follows (in millions of dollars):

 

     Total
Incurred
Costs
 

Powertrain Energy

   $ 46   

Powertrain Sealing and Bearings

     60   

Vehicle Safety and Protection

     34   

Global Aftermarket

     11   

Corporate

     6   
  

 

 

 
   $ 157   
  

 

 

 

Other Restructuring Activities

During the three and nine months ended September 30, 2011, the Company recorded $2 million and $4 million, respectively, in net restructuring expenses outside of Restructuring 2009, of which $2 million related to employee costs for the three months ended September 30, 2011 and $2 million relates to each of employee costs and facility closure costs for the nine months ended September 30, 2011.

 

3.

OTHER (EXPENSE) INCOME, NET

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

 

    Three Months  Ended
September 30
    Nine Months  Ended
September 30
 
    2011     2010     2011     2010  
    (Millions of Dollars)  

Foreign currency exchange

  $ (1   $ (1   $ (6   $ (23

Accounts receivable discount expense

    (2     (3     (7     (5

Adjustment of assets to fair value

           1        (3     (7

Other

    (3     4        (1     13   
 

 

 

   

 

 

   

 

 

   

 

 

 
  $ (6   $ 1      $ (17   $ (22
 

 

 

   

 

 

   

 

 

   

 

 

 

Foreign currency exchange: The Company recognized $1 million and $6 million in foreign currency exchange losses during the three and nine months ended September 30, 2011. This was due to unfavorable foreign currency volatility in regions where the transactional currency differs from the functional currency.

The Company recognized $1 million and $23 million in foreign currency exchange losses during the three and nine months ended September 30, 2010.

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 had 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.

 

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Table of Contents

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 requires any change in the U.S. dollar value of bolivar denominated monetary assets and liabilities to be recognized directly in earnings.

On January 8, 2010, the Venezuelan government devalued its currency. During the nine months ended September 30, 2010, the Company recorded $20 million in foreign currency exchange expense due to this currency devaluation.

The remaining Venezuelan cash balance of $12 million as of September 30, 2011 is expected to be used to pay intercompany balances for the purchase of product and to pay dividends, subject to local government restrictions.

Adjustment of assets to fair value: The Company recorded $3 million in impairment charges during the second quarter of 2011, of which $2 million related to the establishment of an asset retirement obligation (see Note 5) for a Powertrain Energy (“PTE”) facility that is closed. As the fair value of the facility did not support the capitalization of this asset retirement obligation, it was impaired. The remaining $1 million in impairment charges recorded during the second quarter of 2011 was made up of immaterial fixed assets impairments at several Company facilities.

The Company’s reassessment of an asset retirement obligation at a Global Aftermarket facility was $1 million less than the Company’s previous assessment based upon revised information. This resulted in the reversal of the excess accrual of $1 million through impairment during the third quarter of 2010, where the offset to such liability was originally recorded.

The PTE reporting segment recorded $4 million in impairment charges during the second quarter of 2010, of which $3 million related to one PTE operating facility. The remaining $1 million in impairment charges recorded during the second quarter of 2010 was made up of immaterial fixed assets impairments at several PTE facilities.

The Company recorded $4 million in impairment charges during the first quarter of 2010 related to the identification of equipment at a Vehicle Safety and Protection (“VSP”) operating facility that were no longer being used and were written off.

 

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 September 30, 2011 and December 31, 2010, unrealized net losses of $53 million and $70 million, respectively, were recorded in “Accumulated other comprehensive loss” as a result of these hedges. As of September 30, 2011, losses of $36 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 term loans 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. 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, $6 million, $7 million and $2 million for years 2012 – 2015, the term of the Company’s Debt Facilities.

 

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Table of Contents

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 high-grade aluminum, copper, natural gas, nickel, tin and zinc. 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 $133 million and $50 million at September 30, 2011 and December 31, 2010, respectively, of which substantially all mature within one year and substantially all were designated as hedging instruments for accounting purposes. Unrealized net losses of $23 million were recorded in “Accumulated other comprehensive loss” as of September 30, 2011. Unrealized net gains of $12 million were recorded in “Accumulated other comprehensive loss” as of December, 31, 2010.

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 and Polish zloty. The Company had notional values of $38 million and $20 million of foreign currency hedge contracts outstanding at September 30, 2011 and December 31, 2010, respectively, of which substantially all mature in less than one year and substantially all were designated as hedging instruments for accounting purposes. Unrealized net gains of $3 million were recorded in “Accumulated other comprehensive loss” as of September 30, 2011. Immaterial unrealized net losses were recorded in “Accumulated other comprehensive loss” as of December 31, 2010.

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.

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 direct sales during the nine months ended September 30, 2011. The Company requires placement of cash in financial institutions evaluated as highly creditworthy.

 

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Table of Contents

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

 

     Asset Derivatives      Liability Derivatives  
     Balance Sheet
Location
   September 30
2011
     December 31
2010
     Balance Sheet
Location
   September 30
2011
    December 31
2010
 
                 (Millions of Dollars)             

Derivatives designated as cash flow

 hedging instruments:

                

Interest rate swap contracts

      $       $       Other current

liabilities

   $ (36   $ (37
            Other noncurrent

liabilities

     (17     (33

Commodity contracts

   Other current

assets

             13       Other current

liabilities

     (24     (1

Foreign currency contracts

   Other current

liabilities

     3                             
     

 

 

    

 

 

       

 

 

   

 

 

 
      $ 3       $ 13          $ (77   $ (71
     

 

 

    

 

 

       

 

 

   

 

 

 

 

The following table discloses the effect of the Company’s derivative instruments on the consolidated statement of operations for the three months ended September 30, 2011:

 

 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 Loss
Recognized  in
Income  on
Derivatives
(Ineffective  Portion
and Amount
Excluded  from
Effectiveness
Testing)
   Amount of Loss
Recognized  in
Income  on
Derivatives
(Ineffective  Portion
and Amount
Excluded  from
Effectiveness
Testing)
 
           (Millions of Dollars)             

Interest rate swap contracts

   $ (2   Interest expense, net    $ (10      $   

Commodity contracts

     (21   Cost of products sold      2      Other (expense)
income, net
     (1

Foreign currency contracts

     4      Cost of products sold                  
  

 

 

      

 

 

      

 

 

 
   $ (19      $ (8      $ (1
  

 

 

      

 

 

      

 

 

 

The following table discloses the effect of the Company’s derivative instruments on the consolidated statement of operations for the three months ended September 30, 2010:

 

 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 Loss
Recognized  in
Income  on
Derivatives
(Ineffective  Portion
and Amount
Excluded  from
Effectiveness
Testing)
   Amount of Gain
Recognized  in
Income  on
Derivatives
(Ineffective  Portion
and Amount
Excluded  from
Effectiveness
Testing)
 
           (Millions of Dollars)             

Interest rate swap contracts

   $ (17   Interest expense, net    $ (10      $   

Commodity contracts

     9      Cost of products sold      2      Other (expense)
income, net
     1   

Foreign currency contracts

     (1                    
  

 

 

      

 

 

      

 

 

 
   $ (9      $ (8      $ 1   
  

 

 

      

 

 

      

 

 

 

 

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Table of Contents

The following table discloses the effect of the Company’s derivative instruments on the consolidated statement of operations for the nine months ended September 30, 2011:

 

 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 Loss
Recognized  in
Income on
Derivatives
(Ineffective Portion

and Amount
Excluded from
Effectiveness
Testing)
   Amount of Loss
Recognized  in
Income  on
Derivatives
(Ineffective  Portion
and Amount
Excluded  from
Effectiveness
Testing)
 
           (Millions of Dollars)             

Interest rate swap contracts

   $ (12   Interest expense, net    $ (29      $   

Commodity contracts

     (26   Cost of products sold      8      Other (expense)
income, net
     (1

Foreign currency contracts

     2      Cost of products sold      (1          
  

 

 

      

 

 

      

 

 

 
   $ (36      $ (22      $ (1
  

 

 

      

 

 

      

 

 

 

The following tables disclose the effect of the Company’s derivative instruments on the consolidated statement of operations for the nine months ended September 30, 2010:

 

 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)
 
     (Millions of Dollars)       

Interest rate swap contracts

   $ (59   Interest expense, net    $ (28

Commodity contracts

     7      Cost of products sold      5   

Foreign currency contracts

     1      Cost of products sold      1   
  

 

 

      

 

 

 
   $ (51      $ (22
  

 

 

      

 

 

 

 

5.

FAIR VALUE MEASUREMENTS

FASB ASC Topic 820, Fair Value Measurements and Disclosures (“FASB ASC 820”), 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 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

Level 3:

 

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.

 

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Table of Contents

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).

 

  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 September 30, 2011 and December 31, 2010 are set forth in the table below:

 

    Asset
(Liability)
        Level 2         Valuation
Technique
    
    (Millions of Dollars)           

September 30, 2011:

        

Interest rate swap contracts

  $ (53   $ (53   C   

Commodity contracts

    (24     (24   C   

Foreign currency contracts

 

    3        3      C   

December 31, 2010:

        

Interest rate swap contracts

  $ (70   $ (70   C   

Commodity contracts

    12        12      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.

Assets and liabilities measured at fair value on a nonrecurring basis during the nine months ended September 30, 2011 are set forth in the table below:

 

    Asset                 Valuation     
    (Liability)     Level 3     (Loss)     Technique     
    (Millions of Dollars)           

September 30, 2011:

          

Property, plant and equipment

  $ 6      $ 6      $ (3   C   

Asset retirement obligation

    (2     (2          C   

Property, plant and equipment with a carrying value of $9 million were written down to their fair value of $6 million, resulting in an impairment charge of $3 million, which was recorded within “Other (expense) income, net” for the nine months ended September 30, 2011. The Company determined the fair value of these assets by applying probability weighted, expected present value techniques to the estimated future cash flows using assumptions a market participant would utilize. The discount rate used is consistent with the Company’s goodwill fair value measurements.

An asset retirement obligation of $2 million was recorded during the nine months ended September 30, 2011. The fair value of this liability was determined with the assistance of an outside third party specialist.

 

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Table of Contents
6.

INVENTORIES

Inventories are stated at the lower of cost or market. Cost was determined by the first-in, first-out (“FIFO”) method at September 30, 2011 and December 31, 2010. 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 consist of the following:

 

     September  30
2011
    December  31
2010
     
      
     (Millions of Dollars)      

Raw materials

   $ 175      $ 178     

Work-in-process

     148        131     

Finished products

     768        624     
  

 

 

   

 

 

   
     1,091        933     

Inventory valuation allowance

     (88     (86  
  

 

 

   

 

 

   
   $ 1,003      $ 847     
  

 

 

   

 

 

   

 

7.

GOODWILL AND OTHER INTANGIBLE ASSETS

At September 30, 2011 and December 31, 2010, goodwill and other intangible assets consist of the following:

 

     September 30, 2011      December 31, 2010  
     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

   $ 542       $ (171    $ 371       $ 543       $ (143    $ 400   

Developed technology

     115         (39      76         115         (31      84   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 657       $ (210    $ 447       $ 658       $ (174    $ 484   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Goodwill and Indefinite-Lived Intangible Assets:

                 

Goodwill

         $ 1,110             $ 1,117   

Trademarks and brand names

           314               314   
        

 

 

          

 

 

 
         $ 1,424             $ 1,431   
        

 

 

          

 

 

 

During both of the three month periods ended September 30, 2011 and 2010, the Company recorded amortization expense of $12 million associated with definite-lived intangible assets. During the nine months ended September 30, 2011 and 2010, the Company recorded amortization expense of $36 million and $37 million, respectively, associated with definite-lived intangible assets. The Company utilizes the straight line method of amortization, recognized over the estimated useful lives of the assets.

 

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Table of Contents

The following is a quarterly summary of the Company’s goodwill and other intangible assets (net) as of and for the nine months ended September 30, 2011:

 

     Goodwill     Other
Indefinite-
Lived
Intangibles
     Definite-
Lived
Intangibles
(Net)
 
     (Millions of Dollars)  

Balance at January 1, 2011

   $ 1,117      $ 314       $ 484   

Tax adjustment

     (6               

Amortization expense

                    (12

Foreign currency

     1                  
  

 

 

   

 

 

    

 

 

 

Balance at March 31, 2011

     1,112        314         472   

Amortization expense

                    (12
  

 

 

   

 

 

    

 

 

 

Balance at June 30, 2011

     1,112        314         460   

Amortization expense

                    (12

Foreign currency

     (2             (1
  

 

 

   

 

 

    

 

 

 

Balance at September 30, 2011

   $ 1,110      $ 314       $ 447   
  

 

 

   

 

 

    

 

 

 

During the first quarter of 2011, the Company corrected $6 million of tax adjustments that were improperly recorded to goodwill.

 

8.

INVESTMENTS IN NON-CONSOLIDATED AFFILIATES

The Company maintains investments in several non-consolidated affiliates, which are located in China, France, Germany, India, Italy, Korea, Turkey and the United States. The Company’s direct ownership in such affiliates ranges from approximately 2% to 50%. The aggregate investments in these affiliates were $227 million and $210 million at September 30, 2011 and December 31, 2010, respectively. 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 following table represents amounts reflected in the Company’s financial statements related to non-consolidated affiliates:

 

     Three Months  Ended
September 30
     Nine Months  Ended
September 30
 
     2011      2010      2011      2010  
     (Millions of Dollars)  

Equity earnings of non-consolidated affiliates

   $ 7       $ 6       $ 27       $ 24   

Cash dividends received from non-consolidated affiliates

     14         3         14         27   

 

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Table of Contents

The following table presents selected aggregated financial information of the non-consolidated affiliates:

 

    Nine Months  Ended
September 30
 
    2011     2010  
    (Millions of Dollars)  

Net sales

  $ 556      $ 453   

Net income

    67        58   

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 original equipment 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 September 30, 2011, the total amount of the contingent guarantee, were all triggering events to occur, approximated $62 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.

 

9.

ACCRUED LIABILITIES

Accrued liabilities consist of the following:

 

    September  30
2011
    December  31
2010
 
   
    (Millions of Dollars)  

Accrued compensation

  $ 188      $ 190   

Accrued rebates

    98        123   

Non-income taxes payable

    37        23   

Accrued income taxes

    30        28   

Accrued product returns

    24        23   

Accrued professional services

    15        13   

Restructuring liabilities

    9        24   

Accrued warranty

    3        3   

Other

    1        1   
 

 

 

   

 

 

 
  $ 405      $ 428   
 

 

 

   

 

 

 

 

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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 nine 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, $6 million, $7 million and $2 million for years 2012 – 2015, the term of the Company’s Debt Facilities.

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 base interest and premium rate at a combined average interest rate 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.

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 both the three and nine months ended September 30, 2011 and 2010, the Company recognized $6 million and $17 million, respectively, in interest expense associated with the amortization of this fair value adjustment.

Debt consists of the following:

 

     September  30
2011
    December  31
2010
 
    
     (Millions of Dollars)  

Debt Facilities:

    

Revolver

   $      $   

Tranche B term loan

     1,886        1,901   

Tranche C term loan

     963        970   

Debt discount

     (80     (97

Other debt, primarily foreign instruments

     65        51   
  

 

 

   

 

 

 
     2,834        2,825   

Less: short-term debt, including current maturities of long-term debt

     (90     (73
  

 

 

   

 

 

 

Total long-term debt

   $ 2,744      $ 2,752   
  

 

 

   

 

 

 

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.

 

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The revolving credit facility has an available borrowing base of $540 million and $528 million as of September 30, 2011 and December 31, 2010, respectively. The Company had $41 million and $43 million of letters of credit outstanding at September 30, 2011 and December 31, 2010, respectively, 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 September 30, 2011 and December 31, 2010, the estimated fair values of the Company’s Debt Facilities were $2,603 million and $2,701 million, respectively. The estimated fair values were $166 million lower at September 30, 2011 and $73 million lower at December 31, 2010 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 September 30, 2011 and December 31, 2010. 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 Postemployment Benefits” or “OPEB”) for certain employees and retirees around the world. Components of net periodic benefit cost (credit) for the three months ended September 30 are as follows:

 

     Pension Benefits     Other Postemployment  
     United States Plans     Non-U.S. Plans     Benefits  
     2011     2010     2011     2010     2011     2010  
     (Millions of Dollars)  

Service cost

   $ 5      $ 5      $ 2      $ 2      $      $   

Interest cost

     15        15        5        4        5        5   

Expected return on plan assets

     (14     (13     (1     (1              

Amortization of actuarial loss

     6        7                               

Amortization of prior service credit

                                 (4     (4

OPEB curtailment gains

                                        (24
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic benefit cost (credit)

   $ 12      $ 14      $ 6      $ 5      $ 1      $ (23
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Components of net periodic benefit cost for the nine months ended September 30 are as follows:

 

     Pension Benefits     Other Postemployment  
     United States Plans     Non-U.S. Plans     Benefits  
     2011     2010     2011     2010     2011     2010  
     (Millions of Dollars)  

Service cost

   $ 15      $ 16      $ 6      $ 6      $      $   

Interest cost

     44        45        14        12        15        17   

Expected return on plan assets

     (42     (37     (3     (3              

Amortization of actuarial loss

     18        19                               

Amortization of prior service credit

                                 (12     (7

OPEB curtailment gains

                                        (28
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic benefit cost (credit)

   $ 35      $ 43      $ 17      $ 15      $ 3      $ (18
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

On May 6, 2010, the Company approved an amendment to its U.S. Welfare Benefit Plan which eliminated Other Postemployment Benefits (“OPEB”) for certain salaried and non-union hourly employees and retirees effective July 1, 2010. Given that this event eliminated the accrual of defined benefits for a significant number of active participants, the Company re-measured its OPEB obligation. Since this plan change reduced benefits attributable to employee service already rendered, it was treated as a negative plan amendment, which created a $162 million prior service credit in accumulated other comprehensive income (“AOCI”). The corresponding reduction in the average remaining future service period to the full eligibility date of the remaining active plan participants also triggered the recognition of a $4 million curtailment gain which was recognized in the consolidated statements of operations during the second quarter of 2010. It should be noted that the calculation of the curtailment excluded the newly created prior service credit.

 

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On July 23, 2010, in contract negotiations with a union at one of the Company’s U.S. manufacturing locations, the union offered up the elimination of its retiree medical benefits, which was accepted by the Company with no other change in retiree benefits in return. Since this plan change reduced benefits attributable to employee service already rendered, it was treated as a negative plan amendment, which created a $2 million prior service credit in AOCI. The corresponding reduction in the average remaining future service period to the full eligibility date of the remaining active plan participants also triggered the recognition of a $24 million curtailment gain which was recognized in the consolidated statements of operations during the third quarter of 2010.

 

12.

INCOME TAXES

Income Taxes

For the nine months ended September 30, 2011, the Company recorded income tax expense of $40 million on income before income taxes of $194 million. This compares to income tax expense of $18 million on income before income taxes of $138 million in the same period of 2010. The income tax expense for the nine months ended September 30, 2011 differs from statutory rates due primarily to pre-tax income taxed at rates lower than the U.S. statutory rate, income in jurisdictions with no tax expense due to offsetting valuation allowance releases, tax refund from prior years, release of uncertain tax positions due to audit settlement, the impact of tax law changes enacted in international jurisdictions, and a tax benefit recorded in continuing operations pursuant to an exception to the intraperiod tax allocation rules, partially offset by pre-tax losses with no tax benefits. The income tax expense for the nine months ended September 30, 2010 differs from the U.S. statutory rate due primarily to pre-tax income taxed at rates lower than the U.S. statutory rate, income in jurisdictions with no tax expense due to offsetting valuation allowance releases, and the reversal of a valuation allowance against net deferred assets of a subsidiary, partially offset by pre-tax losses with no tax benefits.

The Company believes that it is reasonably possible that its unrecognized tax benefits in multiple jurisdictions, which primarily relates to transfer pricing, corporate reorganization and various other matters, may decrease by approximately $349 million within the next 12 months due to audit settlements or statute expirations, of which approximately $55 million, if recognized, could impact the effective tax rate.

In conjunction with the Company’s ongoing review of its actual results and anticipated future earnings, the Company reassesses the possibility of releasing valuation allowances. Based upon this assessment, the Company has concluded that there is more than a remote possibility that existing valuation allowances in certain jurisdictions of up to $230 million as of September 30, 2011 could be released within the next 12 months. If releases of such valuation allowances occur, it may have a significant impact on net income in the quarter in which it is deemed appropriate to release the reserve.

 

13.

COMMITMENTS AND CONTINGENCIES

Environmental Matters

The Company is a defendant in lawsuits filed, or the recipient of administrative orders issued or demand letters received, 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 remedial laws. These laws provide that responsible parties may be liable to pay for remediating contamination resulting from hazardous substances that were discharged into the environment by them, by prior owners or occupants of property they currently own or operate, or by others to whom they sent such substances for treatment or other disposition at third party locations. 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.

 

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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 potential 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 and/or federal or state environmental laws. 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 $17 million and $19 million at September 30, 2011 and December 31, 2010, respectively, and are included in the consolidated balance sheets as follows:

 

     September 30
2011
     December 31
2010
 
     (Millions of Dollars)  

Other current liabilities

   $ 4       $ 5   

Other accrued liabilities (noncurrent)

     13         14   
  

 

 

    

 

 

 
   $ 17       $ 19   
  

 

 

    

 

 

 

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 September 30, 2011, management estimates that reasonably possible material additional losses above and beyond management’s best estimate of required remediation costs as recorded approximate $44 million.

Asset Retirement Obligations

The Company records asset retirement obligations (“ARO”) in accordance with FASB ASC Topic 410, Asset Retirement and Environmental Obligations. The Company’s primary ARO activities relate to the removal of hazardous building materials at its facilities. The Company records an ARO 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. ARO 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 $25 million at September 30, 2011 and December 31, 2010, for ARO, primarily related to anticipated costs of removing hazardous building materials, and has considered impairment issues that may result from capitalization of these ARO amounts.

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 ARO and impairment issues.

 

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

 

    September 30
2011
    December 31
2010
 
    (Millions of Dollars)  

Other current liabilities

  $ 1      $ 9   

Other accrued liabilities (noncurrent)

    24        16   
 

 

 

   

 

 

 
  $ 25      $ 25   
 

 

 

   

 

 

 

The Company has conditional asset retirement obligations (“CARO”), 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.

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) INCOME

The Company’s comprehensive (loss) income consists of the following:

 

     Three Months Ended
September 30
    Nine Months Ended
September 30
 
     2011     2010     2011     2010  
     (Millions of Dollars)  

Net income attributable to Federal-Mogul

   $ 34      $ 53      $ 150      $ 116   

Foreign currency translation adjustments and other

     (169     140        (63     17   

Hedge instruments

     (12     (2     (15     (29

Income taxes

     (3            (3       
  

 

 

   

 

 

   

 

 

   

 

 

 

Hedge instruments, net of tax

     (15     (2     (18     (29

Postemployment benefits

     2        (29     6        116   

Income taxes

     (3            (3       
  

 

 

   

 

 

   

 

 

   

 

 

 

Postemployment benefits, net of tax

     (1     (29     3        116   
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ (151   $ 162      $ 72      $ 220   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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 September 30, 2011.

 

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16.

STOCK-BASED COMPENSATION

CEO Stock-Based Compensation Agreement

On March 23, 2010, the Company entered into the Second Amended and Restated Employment Agreement, which extended José Maria Alapont’s employment with the Company for three years. Also on March 23, 2010, the Company amended and restated the Stock Option Agreement by and between the Company and Mr. Alapont dated as of February 15, 2008 (the “Restated Stock Option Agreement”). The Restated Stock Option Agreement removed Mr. Alapont’s put option to sell stock received from a stock option exercise to the Company for cash. The Restated Stock Option Agreement provides for pay out of any exercise of Mr. Alapont’s stock options 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 four million stock 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 stock options were fully vested as of March 23, 2010, no further expense related to these options will be recognized. These options had intrinsic values of zero and $5 million as of September 30, 2011 and December 31, 2010, respectively. These options expire on December 27, 2014. None of the four million stock options have been exercised or forfeited as of September 30, 2011.

The Company revalued Mr. Alapont’s Deferred Compensation Agreement, which was also amended and restated on March 23, 2010, resulting in a revised fair value of $8 million at September 30, 2011. The amended and restated agreement included no changes that impacted the accounting for this agreement. Since the revised and restated agreement continue to provide for net cash settlement at the option of Mr. Alapont, it continues to be treated as a liability award as of September 30, 2011 and through its eventual payout. The amount of the payout shall be equal to approximately $10 million (500,000 shares of stock multiplied by the March 23, 2010 stock price of $19.46), offset by 75% of the intrinsic value of any exercise by Mr. Alapont of two million of the options noted above (“options connected to deferred compensation”). During the three months ended September 30, 2011 and 2010, the Company recognized $2 million in expense and immaterial income, respectively, associated with Mr. Alapont’s Deferred Compensation Agreement. During the nine months ended September 30, 2011, the Company recognized $1 million in expense associated with Mr. Alapont’s Deferred Compensation Agreement. During the nine months ended September 30, 2010, the Company recognized $7 million in expense associated with Mr. Alapont’s stock options and Deferred Compensation Agreement. The Deferred Compensation Agreement had intrinsic values of $10 million and $8 million as of September 30, 2011 and December 31, 2010, respectively. The December 31, 2010 intrinsic value of $8 million is derived under the assumption that the two million options connected to deferred compensation were exercised as of that date because the market price of the Company’s common shares was greater than the exercise price of the options on December 31, 2010.

The September 30, 2011 deferred compensation fair value was estimated using the Monte Carlo valuation model with the following assumptions:

 

Exercise price

     N/A      

Expected volatility

     65%      

Expected dividend yield

     0%      

Risk-free rate over the estimated expected option life

     0.21%      

Expected life (in years)

     1.62      

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 life. 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 equal to one-half of the time to the end of the term.

 

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Table of Contents

Stock Appreciation Rights

A summary of the Company’s stock appreciation rights (“SARs”) activity as of and for the nine months ended September 30, 2011 is as follows:

 

                  Weighted         
           Weighted      Average         
           Average      Remaining      Aggregate  
           Exercise      Contractual      Intrinsic  
     SARs     Price      Life      Value  
     (Thousands)            (Years)      (Millions)  

Outstanding at January 1, 2011

     401      $ 17.16         

Granted

     1,039        21.03         

Exercised

     (11     19.14         

Forfeited

     (5     19.61         
  

 

 

   

 

 

       

Outstanding at March 31, 2011

     1,424      $ 19.96         4.6       $ 7   

Granted

     4        21.03         

Exercised

     (22     19.74         

Forfeited

     (3     19.78         
  

 

 

   

 

 

       

Outstanding at June 30, 2011

     1,403      $ 19.97         4.5       $ 4   

Forfeited

     (1     20.15         
  

 

 

   

 

 

       

Outstanding at September 30, 2011

     1,402      $ 19.97         4.2       $   
  

 

 

   

 

 

    

 

 

    

 

 

 

Exercisable at September 30, 2011

     358      $ 19.74         4.2       $   
  

 

 

   

 

 

    

 

 

    

 

 

 

In February 2011 and 2010, the Company granted approximately 1,039,000 and 437,000 SARs, respectively, to certain employees. The SARs granted in February 2011 (“2011 SARs”) vested 25.0% on grant date and 25.0% on each of the next three anniversaries of the grant date. The SARs granted in February 2010 (“2010 SARs”) vest 33.3% on each of the three anniversaries of the grant date. All SARs 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 2011 SARs and the 2010 SARs at September 30, 2011 resulting in fair values of $5 million and $2 million, respectively. The Company recognized SARs income of $2 million and $1 million for the three and nine months ended September 30, 2011, respectively. SARs expense for the three and nine months ended September 30, 2010 was immaterial and $1 million, respectively.

The September 30, 2011 SARs fair values were estimated using the Black-Scholes valuation model with the following assumptions:

 

     2011 SARs      2010 SARs  

Exercise price

     $21.03             $17.16       

Expected volatility

     65%             65%       

Expected dividend yield

     0%             0%       

Risk-free rate over the estimated expected life

     0.37%             0.26%       

Expected life (in years)

     2.72             2.00       

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 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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Table of Contents
17.

INCOME PER COMMON SHARE

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

 

     Three Months  Ended
September 30
     Nine Months  Ended
September 30
 
     2011      2010      2011      2010  
     (Millions of Dollars, Except Per Share Amounts)  

Net income attributable to Federal-Mogul shareholders

   $ 34         $ 53         $ 150         $ 116     

Weighted average shares outstanding, basic (in millions)

     98.9         98.9         98.9         98.9   

Incremental shares on assumed conversion of stock options (in millions)

     —           —           0.4         —     

Incremental shares on assumed conversion of deferred compensation stock (in millions)

     0.5         0.5         0.3         0.5   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares outstanding, including dilutive shares (in millions)

     99.4         99.4         99.6         99.4   

Net income per share attributable to Federal-Mogul:

           

Basic

   $ 0.34       $ 0.54       $ 1.52       $ 1.17   

Diluted

   $ 0.34       $ 0.53       $ 1.51       $ 1.17   

Warrants to purchase 6,951,871 common shares were not included in the computation of diluted earnings per share for the three and nine months ended September 30, 2011 and 2010 because the exercise price was greater than the average market price of the Company’s common shares during these periods. Options to purchase 4,000,000 common shares were not included in the computation of diluted earnings per share for the three months ended September 30, 2011 and for the three and nine months ended September 30, 2010 because the exercise price was greater than the average market price of the Company’s common shares during these periods.

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, expense associated with U.S. based funded pension plans and OPEB curtailment gains or losses.

 

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

 

     Three Months Ended September 30  
     Net Sales      Cost of Products Sold      Gross Margin  
     2011      2010      2011      2010      2011     2010  
     (Millions of Dollars)  

Powertrain Energy

   $ 583       $ 469       $ 509       $ 415       $ 74      $ 54   

Powertrain Sealing and Bearings

     312         271         279         245         33        26   

Vehicle Safety and Protection

     259         231         201         172         58        59   

Global Aftermarket

     578         573         477         472         101        101   

Corporate

                     3         2         (3     (2
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 
   $ 1,732       $ 1,544       $ 1,469       $ 1,306       $ 263      $ 238   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 
     Nine Months Ended September 30  
     Net Sales      Cost of Products Sold      Gross Margin  
     2011      2010      2011      2010      2011     2010  
     (Millions of Dollars)  

Powertrain Energy

   $ 1,751       $ 1,359       $ 1,526       $ 1,192       $ 225      $ 167   

Powertrain Sealing and Bearings

     965         820         855         736         110        84   

Vehicle Safety and Protection

     773         693         591         509         182        184   

Global Aftermarket

     1,767         1,759         1,437         1,425         330        334   

Corporate

                     6         3         (6     (3
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 
   $ 5,256       $ 4,631       $ 4,415       $ 3,865       $ 841      $ 766   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

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

 

     Three Months Ended
September 30
    Nine Months Ended
September 30
 
     2011     2010     2011     2010  
     (Millions of Dollars)     (Millions of Dollars)  

Powertrain Energy

   $ 81      $ 66      $ 250      $ 207   

Powertrain Sealing and Bearings

     34        24        95        76   

Vehicle Safety and Protection

     48        56        155        173   

Global Aftermarket

     58        65        200        224   

Corporate

     (55     (47     (156     (179
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Operational EBITDA

     166        164        544        501   

Depreciation and amortization

     (73     (82     (212     (244

Interest expense, net

     (32     (32     (95     (98

Expense associated with U.S. based funded pension plans

     (11     (13     (33     (39

Restructuring expense, net

     (3     (1     (4     (7

Adjustment of assets to fair value

            1        (3     (7

OPEB curtailment gain

            24               28   

Income tax expense

     (9     (6     (40     (18

Other

     (2     (1     (3     4   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 36      $ 54      $ 154      $ 120   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Total assets by reporting segment are as follows:

 

     September 30
2011
     December 31
2010
 
     (Millions of Dollars)  

Powertrain Energy

   $ 1,982       $ 1,813   

Powertrain Sealing and Bearings

     953         856   

Vehicle Safety and Protection

     1,614         1,578   

Global Aftermarket

     1,983         1,908   

Corporate

     901         1,141   
  

 

 

    

 

 

 
   $ 7,433       $ 7,296   
  

 

 

    

 

 

 

19. SUBSEQUENT EVENT

In October 2011, operations at the Company’s Vehicle Safety and Protection manufacturing facility in Thailand have temporarily ceased due to flooding. It is currently uncertain when production can be resumed and the extent of the property loss, however, the Company maintains insurance for such events.

 

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FORWARD-LOOKING STATEMENTS

Certain statements contained or incorporated in this Quarterly Report on Form 10-Q which are not statements of historical fact constitute “Forward-Looking Statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Reform Act”). Forward-looking statements give current expectations or forecasts of future events. Words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “seek” and other words and terms of similar meaning in connection with discussions of future operating or financial performance signify forward-looking statements. The Company also, from time to time, may provide oral or written forward-looking statements in other materials released to the public. Such statements are made in good faith by the Company pursuant to the “Safe Harbor” provisions of the Reform Act.

Any or all forward-looking statements included in this report or in any other public statements may ultimately be incorrect. Forward-looking statements may involve known and unknown risks, uncertainties and other factors, which may cause the actual results, performance, experience or achievements of the Company to differ materially from any future results, performance, experience or achievements expressed or implied by such forward-looking statements. The Company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events, or otherwise.

All of the forward-looking statements are qualified in their entirety by reference to the factors discussed under “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 (the “Annual Report”) filed on February 23, 2011, as well as the risks and uncertainties discussed elsewhere in the Annual Report and this report. Other factors besides those listed could also materially affect the Company’s business.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management’s Discussion and Analysis of financial condition and results of operations (“MD&A”) should be read in conjunction with the MD&A included in the Company’s Annual Report.

Overview

Federal-Mogul Corporation is a leading global supplier of technology and innovation in vehicle and industrial products for fuel economy, emissions reduction, alternative energies, environment and safety systems. The Company serves the world’s foremost original equipment manufacturers and servicers (“OE”) of automotive, light, medium and heavy-duty commercial vehicles, off-road, agricultural, marine, rail, aerospace, power generation and industrial equipment, as well as the worldwide aftermarket. During the nine months ended September 30, 2011, the Company derived 66% of its sales from the OE market and 34% from the aftermarket. The Company seeks to participate in both of these markets by leveraging its original equipment product engineering and development capability, manufacturing know-how, and expertise in managing a broad and deep range of replacement parts to service the aftermarket. The Company believes that it is uniquely positioned to effectively manage the life cycle of a broad range of products to a diverse customer base.

Federal-Mogul has established a global presence and conducts its operations through various manufacturing, distribution and technical centers that are wholly-owned subsidiaries or partially-owned joint ventures. During the nine months ended September 30, 2011, the Company derived 36% of its sales in the United States and 64% internationally. The Company has operations in established markets including Canada, France, Germany, Italy, Japan, Spain, Sweden, the United Kingdom and the United States, and emerging markets including Argentina, Brazil, China, Czech Republic, Hungary, India, Korea, Mexico, Poland, Russia, South Africa, Thailand, Turkey and Venezuela. The attendant risks of the Company’s international operations are primarily related to currency fluctuations, changes in local economic and political conditions, and changes in laws and regulations.

 

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Federal-Mogul offers its customers a diverse array of market-leading products for OE and replacement parts (“aftermarket”) applications, including pistons, piston rings, piston pins, cylinder liners, valve seats and guides, ignition products, dynamic seals, bonded piston seals, combustion and exhaust gaskets, static gaskets and seals, rigid heat shields, engine bearings, industrial bearings, bushings and washers, transmission components, brake disc pads, brake linings, brake blocks, element resistant systems protection sleeving products, acoustic shielding, flexible heat shields, brake system components, chassis products, wipers, fuel pumps and lighting.

The Company operates in an extremely competitive industry, driven by global vehicle production volumes and part replacement trends. Business is typically awarded to the supplier offering the most favorable combination of cost, quality, technology and service. Customers continue to demand periodic cost reductions that require the Company to continually assess, redefine and improve its operations, products, and manufacturing capabilities to maintain and improve profitability. Management continues to develop and execute initiatives to meet the challenges of the industry and to achieve its strategy for sustainable global profitable growth.

For a more detailed description of the Company’s business, products, industry, operating strategy and associated risks, refer to the Annual Report.

Results of Operations

Consolidated Results – Three Months Ended September 30, 2011 vs. Three Months Ended September 30, 2010

Net sales by reporting segment are:

 

     Three Months  Ended
September 30
 
     2011      2010  
     (Millions of Dollars)  

Powertrain Energy

   $ 583       $ 469   

Powertrain Sealing and Bearings

     312         271   

Vehicle Safety and Protection

     259         231   

Global Aftermarket

     578         573   
  

 

 

    

 

 

 
   $ 1,732       $ 1,544   
  

 

 

    

 

 

 

The percentage of net sales by group and region for the three months ended September 30, 2011 and 2010 are listed below. “PTE,” “PTSB,” “VSP,” and “GA” represent Powertrain Energy, Powertrain Sealing and Bearings, Vehicle Safety and Protection, and Global Aftermarket, respectively.

 

     PTE     PTSB     VSP     GA     Total      
2011             

United States and Canada

     22     32     32     60     38  

Europe

     56     51     42     23     42  

Rest of World

 

     22     17     26     17     20  
2010             

United States and Canada

     23     36     32     64     42  

Europe

     56     48     44     22     40  

Rest of World

     21     16     24     14     18  

 

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Cost of products sold by reporting segment is:

 

    Three Months  Ended
September 30
     
    2011     2010      
    (Millions of Dollars)      

Powertrain Energy

  $ 509      $ 415     

Powertrain Sealing and Bearings

    279        245     

Vehicle Safety and Protection

    201        172     

Global Aftermarket

    477        472     

Corporate

    3        2     
 

 

 

   

 

 

   
  $ 1,469      $ 1,306     
 

 

 

   

 

 

   

Gross margin by reporting segment is:

 

    Three Months  Ended
September 30
     
    2011     2010      
    (Millions of Dollars)      

Powertrain Energy

  $ 74      $ 54     

Powertrain Sealing and Bearings

    33        26     

Vehicle Safety and Protection

    58        59     

Global Aftermarket

    101        101     

Corporate

    (3     (2  
 

 

 

   

 

 

   
  $ 263      $ 238     
 

 

 

   

 

 

   

Net sales increased by $188 million, or 12%, to $1,732 million for the third quarter of 2011 from $1,544 million in the same period of 2010. The impact of the U.S. dollar weakening, primarily against the euro, increased reported sales by $70 million.

In general, light and commercial vehicle OE production increased in most regions and, when combined with market share gains in all regions across all three manufacturing segments, resulted in increased OE sales of $118 million. Aftermarket sales decreased by $13 million due to sales decreases in North America, partially offset by sales increases in all other regions. Net customer price increases were $13 million.

Cost of products sold increased by $163 million to $1,469 million for the third quarter of 2011 compared to $1,306 million in the same period of 2010. The impact of the relative weakness of the U.S. dollar increased cost of products sold by $57 million. Manufacturing, labor and variable overhead costs increased by $104 million as a direct consequence of the higher production volumes. Additional increases were increased materials and services sourcing costs of $8 million and unfavorable productivity, net of labor and benefits inflation, of $5 million. These increases were partially offset by decreased depreciation of $11 million.

Gross margin increased by $25 million to $263 million, or 15.2% of sales, for the third quarter of 2011 compared to $238 million, or 15.4% of sales, in the same period of 2010. This increase was due to currency movements of $13 million, customer price increases of $13 million, decreased depreciation of $11 million and gross margin impact of sales volume/mix of $1 million, partially offset by increased materials and services sourcing costs of $8 million and unfavorable productivity, net of benefits and labor inflation, of $5 million.

 

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Reporting Segment Results – Three Months Ended September 30, 2011 vs. Three Months Ended September 30, 2010

The following table provides a reconciliation of changes in sales, cost of products sold, gross margin and Operational EBITDA for the three months ended September 30, 2011 compared with the three months ended September 30, 2010 for each of the Company’s reporting segments. 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, expense associated with U.S. based funded pension plans and OPEB curtailment gains or losses.

 

         PTE              PTSB              VSP              GA          Corporate          Total      
     (Millions of Dollars)  

Sales

                 

Three months ended September 30, 2010

   $ 469       $ 271       $ 231       $ 573       $       $ 1,544   

Sales volumes

     79         22         17         (13              105   

Customer pricing

     7         5         (2      3                 13   

Foreign currency

     28         14         13         15                 70   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Three months ended September 30, 2011

   $ 583       $ 312       $ 259       $ 578       $       $ 1,732   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     PTE      PTSB      VSP      GA      Corporate      Total  

Cost of Products Sold

                 

Three months ended September 30, 2010

   $ 415       $ 245       $ 172       $ 472       $ 2       $ 1,306   

Sales volumes / mix

     60         24         17         3                 104   

Productivity, net of inflation

     6                 (1      (2      2         5   

Materials and services sourcing

     7         1         8         (7      (1      8   

Depreciation

     (3      (3      (5                      (11

Foreign currency

     24         12         10         11                 57   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Three months ended September 30, 2011

   $ 509       $ 279       $ 201       $ 477       $ 3       $ 1,469   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     PTE      PTSB      VSP      GA      Corporate      Total  

Gross Margin

  

Three months ended September 30, 2010

   $ 54       $ 26       $ 59       $ 101       $ (2    $ 238   

Sales volumes / mix

     19         (2              (16              1   

Customer pricing

     7         5         (2      3                 13   

Productivity, net of inflation

     (6              1         2         (2      (5

Materials and services sourcing

     (7      (1      (8      7         1         (8

Depreciation

     3         3         5                         11   

Foreign currency

     4         2         3         4                 13   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Three months ended September 30, 2011

   $ 74       $ 33       $ 58       $ 101       $ (3    $ 263   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     PTE      PTSB      VSP      GA      Corporate      Total  

Operational EBITDA

  

Three months ended September 30, 2010

   $ 66       $ 24       $ 56       $ 65       $ (47    $ 164   

Sales volumes / mix

     19         (2              (16              1   

Customer pricing

     7         5         (2      3                 13   

Productivity – Cost of products sold

     (6              1         2         (2      (5

Productivity – SG&A

     (1      2         (1      (3      (3      (6

Productivity – Other

             1         1         1                 3   

Sourcing – Cost of products sold

     (7      (1      (8      7         1         (8

Sourcing – SG&A

                                     1         1   

Sourcing – Other

                                     (2      (2

Stock-based compensation expense

                                     (1      (1

Foreign currency

     6         6         2                 (2      12   

Other

     (3      (1      (1      (1              (6
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Three months ended September 30, 2011

   $ 81       $ 34       $ 48       $ 58       $ (55    $ 166   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

Depreciation and amortization

                    (73

Interest expense, net

                    (32

Expense associated with U.S. based funded pension plans

                    (11

Restructuring expense, net

                    (3

Income tax expense

                    (9

Other

                    (2
                 

 

 

 

Net income

                  $ 36   
                 

 

 

 

 

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Powertrain Energy

Sales increased by $114 million, or 24%, to $583 million for the third quarter of 2011 from $469 million in the same period of 2010. PTE generates approximately 80% of its revenue outside the United States and the resulting currency movements increased reported sales by $28 million. Sales volumes increased by $79 million due to OE production volume increases and market share gains in all regions. Customer pricing increased sales by $7 million.

Cost of products sold increased by $94 million to $509 million for the third quarter of 2011 compared to $415 million in the same period of 2010. This increase was due to a $60 million increase directly associated with improved sales volume, currency movements of $24 million, increased materials and services sourcing costs of $7 million and unfavorable productivity, net of labor and benefits inflation, of $6 million, partially offset by a decrease in depreciation of $3 million.

Gross margin increased by $20 million to $74 million, or 12.7% of sales, for the third quarter of 2011 compared to $54 million, or 11.5% of sales, for the third quarter of 2010. The favorable impact of increased sales volumes contributed to a $19 million increase in gross margin. Other factors contributing to the improved margin were customer price increases of $7 million, currency movements of $4 million and decreased depreciation of $3 million. These increases were partially offset by increased materials and services sourcing costs of $7 million and unfavorable productivity, net of labor and benefits inflation, of $6 million.

Operational EBITDA increased by $15 million to $81 million for the third quarter of 2011 from $66 million in the same period of 2010. The impact of increased sales volumes of $19 million, customer price increases of $7 million and currency movements of $6 million were partially offset by unfavorable productivity, net of labor and benefits inflation, of $7 million, increased materials and services sourcing costs of $7 million and other decreases of $3 million.

Powertrain Sealing and Bearings

Sales increased by $41 million, or 15%, to $312 million for the third quarter of 2011 from $271 million in the same period of 2010. PTSB generates approximately 70% of its revenue outside the United States and the resulting currency movements increased reported sales by $14 million. Sales volumes increased by $22 million due to OE production volume increases and market share gains in all regions. Customer pricing increased sales by $5 million.

Cost of products sold increased by $34 million to $279 million for the third quarter of 2011 compared to $245 million in the same period of 2010. This was due to a $24 million increase directly associated with sales volume/mix, currency movements of $12 million and increased materials and services sourcing costs of $1 million, partially offset by decreased depreciation of $3 million.

Gross margin increased by $7 million to $33 million, or 10.6% of sales, for the third quarter of 2011 compared to $26 million, or 9.6% of sales, for the third quarter of 2010. This increase was due to customer price increases of $5 million, decreased depreciation of $3 million and currency movements of $2 million, partially offset by unfavorable sales mix contributing to a decreased gross margin of $2 million and increased materials and services sourcing costs of $1 million.

Operational EBITDA increased by $10 million to $34 million for the third quarter of 2011 from $24 million in the same period of 2010. This was due to currency movements of $6 million, customer price increases of $5 million, and favorable productivity in excess of labor and benefits inflation of $3 million, partially offset by unfavorable sales mix of $2 million, other decreases of $1 million and increased materials and services sourcing costs of $1 million.

Vehicle Safety and Protection

Sales increased by $28 million, or 12%, to $259 million for the third quarter of 2011 from $231 million in the same period of 2010. Approximately 70% of VSP sales are generated outside the United States and the resulting currency movements increased reported sales by $13 million. Sales volumes rose by $17 million due to increased OE production and market share gains in all regions. Continued customer pricing pressure reduced sales by $2 million.

 

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Table of Contents

Cost of products sold increased by $29 million to $201 million for the third quarter of 2011 compared to $172 million in the same period of 2010. This was due to a $17 million increase directly associated with sales volume/mix, currency movements of $10 million, and increased materials and services sourcing costs of $8 million, partially offset by decreased depreciation of $5 million and favorable productivity in excess of labor and benefits inflation of $1 million.

Gross margin decreased by $1 million to $58 million, or 22.4% of sales, for the third quarter of 2011 compared to $59 million, or 25.5% of sales, for the third quarter of 2010. This decrease was due to increased materials and services sourcing costs of $8 million and customer price decreases of $2 million, partially offset by decreased depreciation of $5 million, currency movements of $3 million, and favorable productivity in excess of labor and benefits inflation of $1 million.

Operational EBITDA decreased by $8 million to $48 million for the third quarter of 2011 from $56 million in the same period of 2010. This decrease was due to increased materials services sourcing costs of $8 million, customer price decreases of $2 million and other decreases of $1 million, partially offset by currency movements of $2 million and favorable productivity in excess of labor and benefits inflation of $1 million.

Global Aftermarket

Sales increased by $5 million, or 1%, to $578 million for the third quarter of 2011, from $573 million in the same period of 2010. This increase was due to currency movements of $15 million and favorable customer pricing of $3 million, offset by lower sales volumes of $13 million.

Cost of products sold increased by $5 million to $477 million for the third quarter of 2011 compared to $472 million in the same period of 2010. This increase was due to currency movements of $11 million and a $3 million increase directly associated with unfavorable sales mix, partially offset by decreased materials and services sourcing costs of $7 million and favorable productivity in excess of labor and benefits inflation of $2 million.

Gross margin was $101 million, or 17.5% of sales, for the third quarter of 2011 compared to $101 million, or 17.6% of sales, in the same period of 2010. This was due to improved materials and services sourcing of $7 million, customer price increases of $3 million, currency movements of $4 million and favorable productivity in excess of labor and benefits inflation of $2 million, offset by lower sales volume and unfavorable sales mix, which decreased gross margin by $16 million.

Operational EBITDA decreased by $7 million to $58 million for the third quarter of 2011 from $65 million in the same period of 2010. This decrease was due to lower sales volume and unfavorable sales mix, which decreased gross margin by $16 million, and currency movements of $1 million, partially offset by customer price increases of $3 million and decreased materials and services sourcing costs of $7 million.

Corporate

Operational EBITDA decreased by $8 million to $(55) million for the third quarter of 2011 compared to $(47) million in the same period of 2010. This was due to increased costs, net of labor and benefits inflation, of $5 million, currency movements of $2 million and increased stock-based compensation expense of $1 million.

Selling, General and Administrative Expenses

Selling, general and administrative expenses (“SG&A”) were $172 million, or 9.9% of net sales, for the third quarter of 2011 as compared to $164 million, or 10.6% of net sales, for the same quarter of 2010. This $8 million increase was due to currency movements of $6 million, increased costs, net of labor and benefits inflation, of $6 million and increased stock-based compensation expense of $1 million, partially offset by lower pension and other postemployment benefits expense of $3 million, materials and services sourcing savings of $1 million and reduced depreciation expense of $1 million.

 

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The Company maintains technical centers throughout the world designed to integrate the Company’s leading technologies into advanced products and processes, to provide engineering support for all of the Company’s manufacturing sites, and to provide technological expertise in engineering and design development providing solutions for customers and bringing new, innovative products to market. Included in SG&A were research and development (“R&D”) costs, including product and validation costs, of $42 million for the third quarter of 2011 compared with $39 million for the same period in 2010. As a percentage of OE sales, R&D was 3.6% and 4.0% for the quarters ended September 30, 2011 and 2010, respectively.

OPEB Curtailment Gains

On July 23, 2010, in contract negotiations with a union at one of the Company’s U.S. manufacturing locations, the union offered up the elimination of its retiree medical benefits, which was accepted by the Company with no other change in retiree benefits in return. Since this plan change reduced benefits attributable to employee service already rendered, it was treated as a negative plan amendment, which created a $2 million prior service credit in accumulated other comprehensive income (“AOCI”). The corresponding reduction in the average remaining future service period to the full eligibility date of the remaining active plan participants also triggered the recognition of a $24 million curtailment gain which was recognized in the consolidated statements of operations during the third quarter of 2010.

Interest Expense, Net

Net interest expense was $32 million in both the third quarter of 2011 and 2010.

Restructuring Activities

The following is a summary of the Company’s consolidated restructuring liabilities and related activity as of and for the quarter ended September 30, 2011:

 

     PTE     PTSB     VSP         GA          Corporate      Total  
     (Millions of dollars)  

Balance at June 30, 2011

   $ 4      $ 5      $      $ 1       $ 1       $ 11   

Provisions

     1               2                        3   

Payments

     (2     (1     (2                     (5
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Balance at September 30, 2011

   $ 3      $ 4      $      $ 1       $ 1       $ 9   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Other (Expense) Income, Net

Other (expense) income, net was $(6) million in the third quarter of 2011 compared to $1 million for the third quarter of 2010.

Income Taxes

For the three months ended September 30, 2011, the Company recorded income tax expense of $9 million on income before income taxes of $45 million. This compares to income tax expense of $6 million on income before income taxes of $60 million in the same period of 2010. The income tax expense for the three months ended September 30, 2011 differs from statutory rates due primarily to pre-tax income taxed at rates lower than the U.S. statutory rate, income in jurisdictions with no tax expense due to offsetting valuation allowance releases, tax refund from prior years, the impact of tax law changes enacted in international jurisdictions, and a tax benefit recorded in continuing operations pursuant to an exception to the intraperiod tax allocation rules, partially offset by pre-tax losses with no tax benefits. The income tax expense for the three months ended September 30, 2010 differs from the U.S. statutory rate due primarily to pre-tax income taxed at rates lower than the U.S. statutory rate, income in jurisdictions with no tax expense due to offsetting valuation allowance releases, and the reversal of a valuation allowance against net deferred assets of a subsidiary, partially offset by pre-tax losses with no tax benefits.

In conjunction with the Company’s ongoing review of its actual results and anticipated future earnings, the Company reassesses the possibility of releasing valuation allowances. Based upon this assessment, the Company has concluded that there is more than a remote possibility that existing valuation allowances in certain jurisdictions of up to $230 million as of September 30, 2011 could be released within the next 12 months. If releases of such valuation allowances occur, it may have a significant impact on net income in the quarter in which it is deemed appropriate to release the reserve.

 

 

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Consolidated Results – Nine Months Ended September 30, 2011 vs. Nine Months Ended September 30, 2010

Net sales by reporting segment are:

 

     Nine Months  Ended
September 30
      
     2011      2010     
     (Millions of Dollars)     

 

Powertrain Energy

   $ 1,751       $ 1,359      

Powertrain Sealing and Bearings

     965         820      

Vehicle Safety and Protection

     773         693      

Global Aftermarket

     1,767         1,759      
  

 

 

    

 

 

    
   $ 5,256       $ 4,631      
  

 

 

    

 

 

    

The percentage of net sales by group and region for the nine months ended September 30, 2011 and 2010 are as follows:

 

       PTE       PTSB       VSP       GA       Total  
2011           

United States and Canada

   22%   32%   31%   61%   38%

Europe

   58%   52%   46%   23%   44%

Rest of World

   20%   16%   23%   16%   18%
2010           

United States and Canada

   22%   35%   30%   65%   42%

Europe

   58%   50%   48%   21%   41%

Rest of World

   20%   15%   22%   14%   17%

Cost of products sold by reporting segment is:

 

     Nine Months  Ended
September 30
      
     2011      2010     
     (Millions of Dollars)     

 

Powertrain Energy

   $ 1,526       $ 1,192      

Powertrain Sealing and Bearings

     855         736      

Vehicle Safety and Protection

     591         509      

Global Aftermarket

     1,437         1,425      

Corporate

     6         3      
  

 

 

    

 

 

    
   $ 4,415       $ 3,865      
  

 

 

    

 

 

    

 

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Gross margin by reporting segment is:

 

     Nine Months  Ended
September 30
     
     2011     2010    
     (Millions of Dollars)    

 

Powertrain Energy

   $ 225      $ 167     

Powertrain Sealing and Bearings

     110        84     

Vehicle Safety and Protection

     182        184     

Global Aftermarket

     330        334     

Corporate

     (6     (3  
  

 

 

   

 

 

   
   $ 841      $ 766     
  

 

 

   

 

 

   

Net sales increased by $625 million, or 13%, to $5,256 million for the nine months ended September 30, 2011 from $4,631 million in the same period of 2010. The impact of the U.S. dollar weakening, primarily against the euro, increased reported sales by $176 million.

In general, light and commercial vehicle OE production increased in all regions and, when combined with market share gains in all regions across all three manufacturing segments, resulted in increased OE sales of $448 million. Aftermarket sales decreased by $27 million due to sales decreases North America, partially offset by sales increases in all other regions. The acquisition of the Daros Group increased sales volume by $16 million. Net customer price increases were $12 million.

Cost of products sold increased by $550 million to $4,415 million for the nine months ended September 30, 2011 compared to $3,865 million in the same period of 2010. The impact of the relative weakness of the U.S. dollar increased cost of products sold by $156 million. Manufacturing, labor and variable overhead costs increased by $393 million as a direct consequence of the higher production volumes, inclusive of $12 million of such costs associated with the Daros Group. Additional increases were unfavorable productivity, net of labor and benefits inflation, of $20 million and increased materials and services sourcing costs of $18 million. These increases were partially offset by decreased depreciation of $36 million and reduced pension expense of $1 million.

Gross margin increased by $75 million to $841 million, or 16.0% of sales, for the nine months ended September 30, 2011 compared to $766 million, or 16.5% of sales, in the same period of 2010. This increase was due to sales volume increases, which increased gross margin by $40 million, decreased depreciation of $36 million, currency movements of $20 million, customer price increases of $12 million, $4 million directly related to the acquisition of the Daros Group and decreased pension expense of $1 million, partially offset by unfavorable productivity, net of benefits and labor inflation, of $20 million, and increased materials and services sourcing costs of $18 million.

 

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Reporting Segment Results – Nine Months Ended September 30, 2011 vs. Nine Months Ended September 30, 2010

The following table provides a reconciliation of changes in sales, cost of products sold, gross margin and Operational EBITDA for the nine months ended September 30, 2011 compared with the nine months ended September 30, 2010 for each of the Company’s reporting segments. 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, expense associated with U.S. based funded pension plans and OPEB curtailment gains or losses.

 

         PTE              PTSB              VSP              GA            Corporate            Total      
     (Millions of Dollars)  

Sales

                 

Nine months ended September 30, 2010

   $ 1,359       $ 820       $ 693       $ 1,759       $       $ 4,631   

Sales volumes

     295         102         51         (27              421   

Customer pricing

     14         11         (6      (7              12   

Daros acquisition

     16                                         16   

Foreign currency

     67         32         35         42                 176   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Nine months ended September 30, 2011

   $ 1,751       $ 965       $ 773       $ 1,767       $       $ 5,256   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     PTE      PTSB      VSP      GA      Corporate      Total  

Cost of Products Sold

                 

Nine months ended September 30, 2010

   $ 1,192       $ 736       $ 509       $ 1,425       $ 3       $ 3,865   

Sales volumes / mix

     233         92         50         6                 381   

Productivity, net of inflation

     21         5         (2      (7      3         20   

Materials and services sourcing

     15         2         15         (15      1         18   

Pension

                                     (1      (1

Depreciation

     (13      (10      (12      (1              (36

Daros acquisition

     12                                         12   

Foreign currency

     66         30         31         29                 156   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Nine months ended September 30, 2011

   $ 1,526       $ 855       $ 591       $ 1,437       $ 6       $ 4,415