XNAS:FDML Federal-Mogul Corp Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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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 June 30, 2012

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 July 26, 2012, 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 Six Months Ended June 30, 2012

INDEX

 

     Page No.

Part I – Financial Information

  

Item 1 – Financial Statements

  

Consolidated Statements of Operations

     3

Consolidated Statements of Comprehensive (Loss) Income

     4

Consolidated Balance Sheets

     5

Consolidated Statements of Cash Flows

     6

Notes to Consolidated Financial Statements

     7

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

   45

Item 4 – Controls and Procedures

   46

Part II – Other Information

  

Item 1 – Legal Proceedings

   47

Item 4 – Mine Safety Disclosures

   47

Item 5 – Other Information

   47

Item 6 – Exhibits

   47

Signatures

   48

Exhibits

  

 

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PART I

FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

FEDERAL-MOGUL CORPORATION

Consolidated Statements of Operations (Unaudited)

 

    Three Months  Ended
June 30
         Six Months  Ended
June 30
 
    2012     2011          2012     2011  
    (Millions of Dollars, Except Per Share Amounts)  

Net sales

    $      1,704          $      1,800             $      3,468          $      3,524     

Cost of products sold

           (1,449              (1,501                 (2,937             (2,946   

Gross margin

               255          299             531          578     

Selling, general and administrative expenses

              (174)         (173)            (363)         (350)    

Adjustment of assets to fair value

              (119)         (3)            (121)         (3)    

Interest expense, net

                (32)         (32)            (64)         (63)    

Amortization expense

                (12)         (12)            (24)         (24)    

Equity earnings of non-consolidated affiliates

                 12          10             22          20     

Restructuring expense, net

                  (8)         —             (14)         (1)    

Other expense, net

                  (8                     (7                        (9                     (8   

(Loss) income before income taxes

                (86)         82             (42)         149     

Income tax benefit (expense)

                 29                     (17                        20                     (31   

Net (loss) income

    (57)         65             (22)         118     

Less net income attributable to noncontrolling interests

                  (2                     (1                        (4                     (3   

Net (loss) income attributable to Federal-Mogul

    $          (59        $           64             $         (26        $         115     

(Loss) income per common share:

          

Basic

    $      (0.60        $        0.65             $      (0.26        $        1.16     

Diluted

    $      (0.60        $        0.64             $      (0.26        $        1.15     

See accompanying notes to consolidated financial statements.

 

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FEDERAL-MOGUL CORPORATION

Consolidated Statements of Comprehensive (Loss) Income (Unaudited)

 

             Three Months Ended                    Six Months Ended        
     June 30    June 30
             2012                   2011                    2012                   2011        
     (Millions of Dollars)

Net (loss) income

   $           (57)   $                65    $              (22)   $           118

Other comprehensive (loss) income:

         

Foreign currency translation adjustments and other

              (104)                     30                    (20)                110

Hedge instruments:

         

Net unrealized hedging gains arising during period

                  (5)                   (16)                      (2)                (17)

Reclassification of net hedging losses included in net (loss) income during period

                  12                      8                      24                 14

Income taxes

                  (7)                    —                      (7)                 —

Hedge instruments, net of tax

                 —                     (8)                      15                  (3)

Postemployment benefits:

         

Reclassification of net postemployment benefits costs included in net (loss) income during period

                   5                     2                      13                     4

Income taxes

                  (5)                   —                      (5)                   —

Postemployment benefits, net of tax

                  —                     2                       8                     4

Other comprehensive (loss) income, net of tax

               (104)                    24                       3                 111

Comprehensive (loss) income

               (161)                    89                    (19)                 229

Less comprehensive loss (income) attributable to noncontrolling interests

                    4                     (1)                      (1)                   (6)

Comprehensive (loss) income attributable to Federal-Mogul

   $          (157)   $                88    $              (20)   $            223

See accompanying notes to consolidated financial statements.

 

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FEDERAL-MOGUL CORPORATION

Consolidated Balance Sheets

 

       (Unaudited)  
June 30
2012
    December 31 
2011
     (Millions of Dollars)
ASSETS          

Current assets:

         

Cash and equivalents

   $ 716         $ 953     

Accounts receivable, net

     1,399           1,186     

Inventories, net

     988           956     

Prepaid expenses and other current assets

     190           204     
  

 

 

      

 

 

   

Total current assets

     3,293           3,299     

Property, plant and equipment, net

     1,862           1,855     

Goodwill and other indefinite-lived intangible assets

     1,018           1,115     

Definite-lived intangible assets, net

     410           434     

Investments in non-consolidated affiliates

     248           228     

Other noncurrent assets

     110           98     
  

 

 

      

 

 

   
   $ 6,941         $ 7,029     
  

 

 

      

 

 

   
LIABILITIES AND SHAREHOLDERS’ EQUITY          

Current liabilities:

         

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

   $ 77         $ 88     

Accounts payable

     752           767     

Accrued liabilities

     416           367     

Current portion of postemployment benefits liability

     43           43     

Other current liabilities

     166           165     
  

 

 

      

 

 

   

Total current liabilities

     1,454           1,430     

Long-term debt

     2,737           2,741     

Postemployment benefits liability

     1,194           1,229     

Long-term portion of deferred income taxes

     395           434     

Other accrued liabilities

     127           142     

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

   June 30, 2012 and December 31, 2011)

     1           1     

Additional paid-in capital, including warrants

     2,150           2,150     

Accumulated deficit

     (468        (442  

Accumulated other comprehensive loss

     (733        (739  

Treasury stock, at cost

     (17        (17  
  

 

 

      

 

 

   

Total Federal-Mogul shareholders’ equity

     933           953     
  

 

 

      

 

 

   

Noncontrolling interests

     101           100     
  

 

 

      

 

 

   

Total shareholders’ equity

     1,034           1,053     
  

 

 

      

 

 

   
   $         6,941         $         7,029     
  

 

 

      

 

 

   

See accompanying notes to consolidated financial statements.

 

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FEDERAL-MOGUL CORPORATION

Consolidated Statements of Cash Flows (Unaudited)

 

           Six Months Ended      
June 30
         2012                 2011       
     (Millions of Dollars)

Cash Provided From (Used By) Operating Activities

         

Net (loss) income

   $ (22      $ 118     

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

         

Depreciation and amortization

     140           139     

Adjustment of assets to fair value

     121           3     

Insurance proceeds related to Thailand flood

     12               

Equity earnings of non-consolidated affiliates

     (22        (20  

Cash dividends received from non-consolidated affiliates

     1               

Change in postemployment benefits

     (20        (11  

Restructuring expense, net

     14           1     

Payments against restructuring liabilities

     (9        (14  

Deferred tax benefit

     (48        (1  

Gain from sales of property, plant and equipment

     (1            

Changes in operating assets and liabilities:

         

Accounts receivable

     (220        (113  

Inventories

     (40        (148  

Accounts payable

     45           141     

Other assets and liabilities

     42           (5  
  

 

 

      

 

 

   

Net Cash (Used By) Provided From Operating Activities

     (7        90     

Cash Provided From (Used By) Investing Activities

         

Expenditures for property, plant and equipment

     (223        (177  

Insurance proceeds related to Thailand flood

     18               

Net proceeds from sales of property, plant, and equipment

     2               

Capital investment in non-consolidated affiliate

     (1            
  

 

 

      

 

 

   

Net Cash Used By Investing Activities

     (204        (177  

Cash Provided From (Used By) Financing Activities

         

Principal payments on term loans

     (15        (15  

Decrease in other long-term debt

               (2  

(Decrease) increase in short-term debt

     (9        11     

Net (remittances) proceeds on servicing of factoring arrangements

     (3        5     
  

 

 

      

 

 

   

Net Cash Used By Financing Activities

     (27        (1  

Effect of foreign currency exchange rate fluctuations on cash

     1           25     

Decrease in cash and equivalents

     (237        (63  

Cash and equivalents at beginning of period

     953           1,105     
  

 

 

      

 

 

   

Cash and equivalents at end of period

   $   716         $ 1,042     
  

 

 

      

 

 

   

See accompanying notes to consolidated financial statements.

 

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FEDERAL-MOGUL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

June 30, 2012

 

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, 2011. Operating results for the three and six months ended June 30, 2012 are not necessarily indicative of the results that may be expected for the year ended December 31, 2012.

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.

Icahn Sourcing LLC (“Icahn Sourcing”) is an entity formed and controlled by Carl C. Icahn, the Chairman of the Company’s Board, in order to leverage the potential buying power of a group of entities with which Mr. Icahn either owns or otherwise has a relationship in negotiating with a wide range of suppliers of goods, services, and tangible and intangible property. The Company is a member of the buying group and, as such, is afforded the opportunity to purchase goods, services and property from vendors with whom Icahn Sourcing has negotiated rates and terms. Icahn Sourcing does not guarantee that the Company will purchase any goods, services or property from any such vendors, and the Company is under no obligation to do so. The Company does not pay Icahn Sourcing any fees or other amounts with respect to the buying group arrangement and Icahn Sourcing neither sells to nor buys from any

 

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member of the buying group. The Company has purchased a variety of goods and services as a member of the buying group at prices and on terms that it believes are more favorable than those which would be achieved on a stand-alone basis, however, these purchases are not material to the consolidated financial statements.

Factoring of Trade Accounts Receivable:  Federal-Mogul subsidiaries in Brazil, France, Germany, Italy and the United States are party to accounts receivable factoring and securitization facilities. Amounts factored under these facilities consist of the following:

 

      June 30       December 31       
    2012     2011     
    (Millions of Dollars)     
      
      

Gross accounts receivable factored

  $       207        $         203       

Gross accounts receivable factored, qualifying as sales

    207          202       

Undrawn cash on factored accounts receivable

    —          —       

Proceeds from the factoring of accounts receivable qualifying as sales and expenses associated with the factoring of receivables are as follows:

     Three Months  Ended
June 30
     Six Months  Ended
June 30
 
          2012                2011                2012                2011       
     (Millions of Dollars)  
           

Proceeds from factoring qualifying as sales

   $       363         $       510           $       776         $       923       

Expenses associated with factoring of receivables

     2           3             3           5       

Certain of the facilities contain terms that require the Company to share in the credit risk of the factored receivables. The maximum exposures to the Company associated with these certain facilities’ terms were $23 million as of both June 30, 2012 and December 31, 2011. The fair values of the exposures to the Company associated with these certain facilities’ terms were determined to be immaterial.

Accounts receivables factored but not qualifying as a sale, as defined in the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 860, Transfers and Servicing, 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 the current portion of long-term debt.” The expenses associated with receivables factoring are recorded in the consolidated statements of operations within “Other expense, 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.

Noncontrolling Interests: The following table presents a rollforward of the changes in noncontrolling interests for the six months ended June 30, 2012 (in millions of dollars):

 

   

Equity balance of non-controlling interests as of December 31, 2011

  $ 100     

Comprehensive income:

   

Net income

    4     

Foreign currency translation adjustments and other

    (3  
 

 

 

   
    1     
 

 

 

   

 

Equity balance of non-controlling interests as of June 30, 2012

  $         101     
 

 

 

   

New Accounting Pronouncements:  In May 2011, the FASB issued Accounting Standards Codification (“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. This guidance is effective for fiscal years beginning after December 15, 2011. The Company’s adoption of this ASU effective January 1, 2012 had no impact on its financial position, results of operations or cash flows.

 

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In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income (“ASU 2011-05”). This ASU changes the manner in which entities present comprehensive income in their financial statements. This guidance is effective for fiscal years beginning after December 15, 2011. The Company adopted this new guidance effective January 1, 2012. In December 2011, the FASB issued ASU No. 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. The Company complied with this deferral as it adopted ASU 2011-05 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 allows 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.

In December 2011, the FASB issued ASU No. 2011-11, Balance Sheet (Topic 210) – Disclosures about Offsetting Assets and Liabilities. This ASU requires companies to disclose both gross and net information about instruments and transactions eligible for offset in the statement of financial position as well as instruments and transactions subject to an agreement similar to a master netting arrangement. This guidance is effective retrospectively for interim and annual periods beginning on or after January 1, 2013. The Company anticipates the adoption of this guidance will have minimal impact to its current disclosures.

 

2. RESTRUCTURING

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

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

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.

 

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The following table provides a quarterly summary of the Company’s consolidated restructuring liabilities and related activity as of and for the six months ended June 30, 2012 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, 2011

   $ 2         $ 4         $         $ 1         $ 1         $         8     

Provisions

     2                               4                     6     

Payments

     (2                            (4        (1        (7  
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

      

 

 

   

Balance at March 31, 2012

     2           4                     1                     7     

Provisions

               1           7                               8     

Payments

     (1                            (1                  (2  

Reclassification to pension liability

                         (5                            (5  
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

      

 

 

   

Balance at June 30, 2012

   $         1         $         5         $         2         $       —         $       —         $         8     
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

      

 

 

   

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 six months ended June 30, 2012. 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, 2011

  $ 8      $      $ 8   

Provisions

    5        1        6   

Payments

    (6     (1     (7
 

 

 

   

 

 

   

 

 

 

Balance at March 31, 2012

    7               7   

Provisions

    8               8   

Payments

    (2            (2

Reclassification to pension liability

    (5            (5
 

 

 

   

 

 

   

 

 

 

Balance at June 30, 2012

  $       8      $      —      $       8   
 

 

 

   

 

 

   

 

 

 

Restructuring 2012

In June 2012, the Company announced a restructuring plan (“Restructuring 2012”) to reduce or eliminate capacity at several high cost VSP facilities and transfer production to lower cost locations. Restructuring 2012 is anticipated to be completed within two years. In connection with Restructuring 2012, the Company expects to incur restructuring charges totaling approximately $42 million.

Net charges by type of exit cost are as follows:

 

    Total
  Expected 
Costs
   Second
     Quarter  
2012
   Estimated
Additional
Charges
    (Millions of dollars)

Employee costs

  $ 31         $ 7         $ 24     

Facility costs

    11                     11     
 

 

 

      

 

 

      

 

 

   
  $         42         $         7         $         35     
 

 

 

      

 

 

      

 

 

   

 

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Table of Contents

Other Restructuring

Of the $7 million in net restructuring expenses outside of Restructuring 2012 that were recognized during the six months ended June 30, 2012, $4 million related to headcount reduction actions associated with the Global Aftermarket.

 

3. OTHER EXPENSE, NET

The specific components of “Other expense net” are as follows:

 

    Three Months Ended
June  30
   Six Months Ended
June  30
          2012                2011                2012                2011      
    (Millions of Dollars)

Foreign currency exchange

  $          (4)    $          (5)    $          (6)    $          (6)

Accounts receivable discount expense

              (2)                (3)                (3)                (5)

Other

              (2)                  1                —                  3
  $          (8)    $          (7)    $          (9)    $          (8)

 

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. Since the interest rate swaps hedge the variability of interest payments on variable debt rate with the same terms, they qualify for cash flow hedge accounting treatment. As of June 30, 2012 and December 31, 2011, unrealized net losses of $28 million and $44 million, respectively, were recorded in “Accumulated other comprehensive loss” as a result of these hedges. As of June 30, 2012, losses of $27 million are expected to be reclassified from “Accumulated other comprehensive loss” to the consolidated statement of operations within the next 12 months.

These interest rate swaps reduce the Company’s overall interest rate risk. However, due to the remaining outstanding borrowings on the Company’s Debt Facilities and other borrowing facilities that continue to have variable interest rates, management believes that interest rate risk to the Company could be material if there are significant adverse changes in interest rates. To the extent that interest rates change by 25 basis points, the Company’s annual interest expense would show a corresponding change of approximately $6 million, $7 million and $2 million for years 2013 – 2015, the term of the Company’s variable-rate term loans.

Commodity Price Risk

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

 

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Table of Contents

The Company had commodity price hedge contracts outstanding with combined notional values of $78 million and $117 million at June 30, 2012 and December 31, 2011, respectively, of which substantially all mature within one year. Of these outstanding contracts, $73 million and $117 million in combined notional values at June 30, 2012 and December 31, 2011, respectively, were designated as hedging instruments for accounting purposes. Unrealized net losses of $7 million and $15 million were recorded in “Accumulated other comprehensive loss” as of June 30, 2012 and December 31, 2011, respectively.

Foreign Currency Risk

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

The Company generally tries to use natural hedges within its foreign currency activities, including the matching of revenues and costs, to minimize foreign currency risk. Where natural hedges are not in place, the Company considers managing certain aspects of its foreign currency activities and larger transactions through the use of foreign currency options or forward contracts. Principal currencies hedged have historically included the euro, British pound and Polish zloty. The Company had notional values of $78 million and $27 million of foreign currency hedge contracts outstanding at June 30, 2012 and December 31, 2011, respectively, of which substantially all mature in less than one year. Of these outstanding contracts, $14 million and $27 million in combined notional values at June 30, 2012 and December 31, 2011, respectively, were designated as cash flow hedging instruments for accounting purposes. Unrealized net gains of $1 million and $3 million were recorded in “Accumulated other comprehensive loss” as of June 30, 2012 and December 31, 2011, respectively, for the contracts designated as hedging instruments. During the quarter ended June 30, 2012, the Company entered into foreign currency contracts, with combined notional value of approximately $64 million, in order to offset fluctuations in consolidated earnings caused by changes in currency rates used to translate earnings at foreign subsidiaries into U.S. dollars. These contracts are not designated as hedging instruments for accounting purposes and are marked to market through the income statement. Immaterial gains related to these contracts were recorded in “Other expense, net” for the three and six months ended June 30, 2012.

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, 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, 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 6% of the Company’s direct sales during the six months ended June 30, 2012. 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
      June 30    
2012
  December 31
2011
   Balance Sheet
Location     
      June 30    
2012
  December  31
2011
    (Millions of Dollars)      

Derivatives designated as cash flow hedging instruments:

                   

Interest rate swap contracts

    $        $        Other current
    liabilities
  $ (27     $ (36  
            Other noncurrent
    liabilities
    (1       (8  

Commodity contracts

                      Other current
    liabilities
    (7       (16  

Foreign currency contracts

  Other current
    liabilities
    1          3                         
   

 

 

     

 

 

       

 

 

     

 

 

   
    $ 1        $ 3          $ (35     $ (60  
   

 

 

     

 

 

       

 

 

     

 

 

   

Derivatives not designated as cash flow hedging instruments:

                   

Commodity contracts

    $         —        $         —        Other current
    liabilities
  $ (1     $     
   

 

 

     

 

 

       

 

 

     

 

 

   

The following table discloses the effect of the Company’s derivative instruments on the consolidated statement of operations for the three months ended June 30, 2012:

 

 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

   $        

Interest expense, net

   $ (9  

Commodity contracts

     (6     

Cost of products sold

     (4  

Foreign currency contracts

     1        

Cost of products sold

     1     
  

 

 

         

 

 

   
   $ (5         $ (12  
  

 

 

         

 

 

   

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

 

 Derivatives Designated

as Hedging Instruments

   Amount of 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)
   Amount of Loss
Recognized in
Income on
Derivatives
(Ineffective Portion)
                (Millions of Dollars)                

Interest rate swap contracts

   $ (9      Interest expense, net    $ (9         $ —       

Commodity contracts

     (6      Cost of products sold      2         Other expense, net      (1  

Foreign currency contracts

     (1      Cost of products sold      (1           —       
  

 

 

         

 

 

         

 

 

   
   $ (16         $ (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 six months ended June 30, 2012:

 

 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

   $                (3)   

Interest expense, net

    $          (19)

Commodity contracts

                      2   

Cost of products sold

                 (6)

Foreign currency contracts

                     (1)   

Cost of products sold

                  1
   $                (2)        $          (24)

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

 

 Derivatives Designated

as Hedging Instruments

   Amount of 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)

   Amount of Loss
Recognized in
Income on
Derivatives
(Ineffective Portion)
          (Millions of Dollars)          

Interest rate swap contracts

   $              (10)   

Interest expense, net

   $            (19)           $           —

Commodity contracts

                    (5)   

Cost of products sold

                   6   

Other expense, net

                    (1)

Foreign currency contracts

                    (2)   

Cost of products sold

                  (1)                        —
   $              (17)       $            (14)           $             (1)

 

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.

 

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Table of Contents

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

Assets and liabilities measured at fair value are based on one or more of the following three valuation techniques noted in FASB ASC 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 June 30, 2012 and December 31, 2011 are set forth in the table below:

 

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

June 30, 2012:

           

Interest rate swap contracts

   $      (28)    $      (28)    C   

Commodity contracts

             (8)              (8)    C   

Foreign currency contracts

              1               1    C   

 

December 31, 2011:

           

Interest rate swap contracts

   $      (44)    $      (44)    C   

Commodity contracts

           (16)            (16)    C   

Foreign currency contracts

              3               3    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 measured at fair value on a nonrecurring basis during the six months ended June 30, 2012 are set forth in the table below:

 

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

June 30, 2012:

              

Property, plant and equipment

   $         20    $        20    $      (16)    C   

Trademarks and brand names

              45    $        45    $      (13)    C   

Property, plant and equipment with a carrying value of $36 million were written down to their fair value of $20 million, resulting in an impairment charge of $16 million, which was recorded within “Adjustment of assets to fair value” for the six months ended June 30, 2012. 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 and through the use of valuation specialists.

Trademarks and brand names with carrying values of $58 million were written down to their fair value of $45 million, resulting in an impairment charge of $13 million, which was recorded within “Adjustment of assets to fair

 

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Table of Contents

value” for the three and six months ended June 30, 2012. These fair values are based upon the prospective stream of hypothetical after-tax royalty cost savings discounted at rates that reflect the rates of return appropriate for these intangible assets.

 

6. INVENTORIES

Inventories are stated at the lower of cost or market. Cost was determined by the first-in, first-out (“FIFO”) method at June 30, 2012 and December 31, 2011. 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:

 

       June 30  
2012
     December 31
2011
      
     (Millions of Dollars)     
        

Raw materials

     $          183         $ 177      

Work-in-process

                 157           145      

Finished products

                 735           717      
     

 

 

    
              1,075           1,039      

Inventory valuation allowance

                 (87         (83)      
     

 

 

    
     $          988         $ 956      
     

 

 

    

 

7. GOODWILL AND OTHER INTANGIBLE ASSETS

At June 30, 2012 and December 31, 2011, goodwill and other indefinite-lived intangible assets consist of the following:

 

     June 30, 2012    December 31, 2011
     Gross
Carrying

Amount
   Accumulated
Impairment
   Net
Carrying
Amount
   Gross
Carrying

Amount
   Accumulated
Impairment
   Net
Carrying
Amount
     (In Millions of Dollars)

Goodwill

   $  1,348      $    (594)    $     754    $  1,340      $    (502)    $     838

Trademarks and brand names

          432            (168)           264           432            (155)           277
   $  1,780      $    (762)    $  1,018    $  1,772      $    (657)    $  1,115

At June 30, 2012 and December 31, 2011, definite-lived intangible assets consist of the following:

 

     June 30, 2012    December 31, 2011
     Gross
Carrying

Amount
   Accumulated
Amortization
   Net
Carrying
Amount
   Gross
Carrying

Amount
   Accumulated
Amortization
   Net
Carrying
Amount
     (Millions of Dollars)

Developed technology

   $     115        $      (47)    $       68    $     115        $        (42)    $      73

Customer relationships

          541              (199)           342           541                (180)          361
   $     656        $    (246)    $     410    $     656        $      (222)    $    434

 

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Table of Contents

The Company’s net goodwill balances by reporting segment as of June 30, 2012 and December 31, 2011 are as follows:

 

     June 30
2012
  December 31
2011
   
     (Millions of Dollars)  
      

Vehicle Safety and Protection

   $            370     $            454   

Powertrain Energy

                 290                   290   

Powertrain Sealing and Bearings

                   94                     94   
   $            754     $            838   

The following is a quarterly summary of the Company’s goodwill and other intangible assets (net) as of and for the six months ended June 30, 2012:

 

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

Balance at January 1, 2012

   $ 838      $ 277      $ 434     

Property, plant and equipment adjustment

     8                   

2011 impairment finalization

     (1                

Amortization expense

                   (12  

Foreign currency

     1               1     
  

 

 

   

 

 

   

 

 

   

Balance at March 31, 2012

     846        277        423     

Impairment

     (91     (13         

Amortization expense

                   (12  

Foreign currency

     (1            (1  
  

 

 

   

 

 

   

 

 

   

Balance at June 30, 2012

   $ 754      $ 264      $ 410     
  

 

 

   

 

 

   

 

 

   

Given the complexity of the calculation, the Company had not finalized “Step 2” of its annual goodwill impairment assessment for the year ended December 31, 2011 prior to filing its annual report on Form 10-K. The goodwill impairment charge recognized during the fourth quarter of 2011 was $259 million. During the quarter ended March 31, 2012, the Company completed this assessment, and recorded an additional $1 million goodwill impairment charge. The goodwill impairment charge was required to adjust the carrying value of goodwill to estimated fair value. The estimated fair value was determined based upon consideration of various valuation methodologies, including projected future cash flows discounted at rates commensurate with the risks involved, guideline transaction multiples, and multiples of current and future earnings.

In the first quarter of 2012, the Company increased goodwill and decreased property, plant and equipment (“PP&E”) by $8 million to correct for PP&E that were improperly valued in fresh-start accounting.

During the second quarter of 2012, the Company determined that goodwill impairment indicators existed in the Company’s friction reporting unit, including lower than expected profits and cash flows due to continued lower aftermarket volumes, further product mix shifts and pressure on margins. In response to these trends, the Company’s board of directors approved a restructuring plan to reduce or eliminate capacity at several high cost facilities and transfer production to lower cost locations.

The friction reporting unit goodwill was tested for impairment in accordance with the FASB ASC Topic 350, Intangibles – Goodwill and Other. This impairment analysis compares the fair value of reporting unit to the related carrying value, and impairment charges are recorded for any excess of carrying values over fair values. As the fair

 

17


Table of Contents

value of the friction reporting unit exceeded its carrying value, the implied fair value of goodwill was calculated as the excess of the estimated fair value of the reporting unit over the fair value of its net assets. These fair values are based upon consideration of various valuation methodologies, including projected future cash flows discounted at rates commensurate with the risks involved, guideline transaction multiples, and multiples of current and future earnings. The fair value of friction reporting unit did not support the recorded goodwill and accordingly the Company recognized a full impairment charge of $91 million for the three and six months ended June 30, 2012.

Based upon the impairment indicators noted above, the Company performed a trademarks and brand names impairment analysis in accordance with the subsequent measurement provisions of FASB ASC Topic 350, Intangibles – Goodwill and Other. This impairment analysis compares the fair values of these assets to the related carrying values, and impairment charges are recorded for any excess of carrying values over fair values. These fair values are based upon the prospective stream of hypothetical after-tax royalty cost savings discounted at rates that reflect the rates of return appropriate for these intangible assets. Based upon this analysis, the Company recognized a $13 million impairment charge for the three and six months ended June 30, 2012.

The Company utilizes the straight line method of amortization, recognized over the estimated useful lives of the assets.

 

8. INVESTMENTS IN NON-CONSOLIDATED AFFILIATES

The Company maintains investments in several non-consolidated affiliates, which are located in China, France, Germany, India, Italy, Korea, Turkey and the United States. 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 represents the Company’s aggregate investments and direct ownership in these affiliates:

 

    

June 30

      2012      

    

December 31

        2011      

      
     (Millions of Dollars)     
        

Investments in non-consolidated affiliates

     $          248              $             228        

 

Direct ownership percentages

     2% to 50%            2% to 50%      

The following table represents amounts reflected in the Company’s financial statements related to non-consolidated affiliates:

 

    

Three Months Ended

                June 30             

    

Six Months Ended

                 June 30             

 
        2012                2011               2012                2011      
     (Millions of Dollars)  

Equity earnings of non-consolidated affiliates

     $         12            $           10           $         22            $          20      

Cash dividends received from non-consolidated affiliates

     1            —           1            —      

 

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Table of Contents

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

 

     Three Months Ended      Six Months Ended      
     June 30      June 30  
     2012        2011      2012        2011  
     (Millions of Dollars)  

Statements of Operations

           

Sales

   $         195         $         191         $         393         $         375     

Gross margin

     43           37           85           74     

Income from continuing operations

     31           29           60           56     

Net income

     27           25           52           49     

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 June 30, 2012, the total amount of the contingent guarantee, were all triggering events to occur, approximated $59 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:

    

    June 30    

2012

   

December 31

2011

 
  

 

 

   

 

 

 
     (Millions of Dollars)  

Accrued compensation

     $              185          $              163     

Accrued rebates

     105          109     

Non-income taxes payable

     44          25     

Accrued income taxes

     30          24     

Accrued product returns

     23          21     

Accrued professional services

     15          14     

Restructuring liabilities

     8          8     

Accrued warranty

     5          2     

Other

                         1                                1     
     $            416          $              367     

 

10. DEBT

On December 27, 2007, the Company entered into a Term Loan and Revolving Credit Agreement (the “Debt Facilities”) with Citicorp U.S.A. Inc. as Administrative Agent, JPMorgan Chase Bank, N.A. as Syndication Agent and certain lenders. The Debt Facilities include a $540 million revolving credit facility (which is subject to a borrowing base and can be increased under certain circumstances and subject to certain conditions) and a $2,960 million term loan credit facility divided into a $1,960 million tranche B loan and a $1,000 million tranche C loan. The obligations under the revolving credit facility mature December 27, 2013 and bear interest for the first six months at LIBOR plus 1.75% or at the alternate base rate (“ABR,” defined as the greater of Citibank, N.A.’s

 

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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. 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 $6 million, $7 million and $2 million for years 2013 – 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. Interest expense associated with the amortization of this fair value adjustment, recognized in the Company’s consolidated statements of operations, consists of the following:

 

         Three Months Ended     
June 30
          Six Months Ended     
June 30
 
     2012      2011      2012      2011  
     (Millions of Dollars)  

Amortization of fair value adjustment

   $         6           $         6           $         11           $         12       

Debt consists of the following:

 

         June 30            December 31
         2012            2011      
     (Millions of Dollars)      

Debt Facilities:

           

Revolver

   $           $ —       

Tranche B term loan

     1,872             1,882     

Tranche C term loan

     955             960     

Debt discount

     (63          (74  

Other debt, primarily foreign instruments

     50             61     
  

 

 

        

 

 

   
     2,814             2,829     

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

     (77          (88  
  

 

 

        

 

 

   

Total long-term debt

   $       2,737           $       2,741     
  

 

 

        

 

 

   

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. Per the terms of the credit facility, $50 million of the Tranche C Term Loan proceeds were deposited in a Term Letter of Credit Account.

 

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The revolving credit facility has an available borrowing base of $478 million and $496 million as of June 30, 2012 and December 31, 2011, respectively. The Company had $40 million and $38 million of letters of credit outstanding at June 30, 2012 and December 31, 2011, 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.

Estimated fair values of the Company’s Debt Facilities were:

 

     Estimated
Fair
Value
(Level 1)
    Carrying
Value in
Excess of
Fair Value
    Valuation
Technique
    
     (Millions of Dollars)         
               

June 30, 2012:

         

Debt Facilities

   $ 2,690          $ 74          A   
                     

December 31, 2011:

         

Debt Facilities

   $     2,660          $       108          A   

Fair market values are developed by the use of estimates obtained from brokers and other appropriate valuation techniques based on information available as of June 30, 2012 and December 31, 2011. The fair value estimates do not necessarily reflect the values the Company could realize in the current markets. Refer to Note 5, Fair Value Measurements, for definitions of input levels and valuation techniques.

 

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 for the three months ended June 30 are as follows:

 

     Pension Benefits    Other Postemployment
       United States Plans            Non-U.S. Plans          Benefits
         2012            2011            2012            2011            2012            2011    
     (Millions of Dollars)

Service cost

   $          5    $          5    $          2    $          2    $        —    $        —

Interest cost

             14              14                4                4                4                5

Expected return on plan assets

            (13)             (14)               (1)               (1)              —              —

Amortization of actuarial loss

               8                6              —              —              —              —

Amortization of prior service credit

             —              —              —              —               (4)               (4)

Net periodic benefit cost

   $        14    $        11    $          5    $          5    $        —    $          1

 

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Components of net periodic benefit cost for the six months ended June 30 are as follows:

 

     Pension Benefits    Other Postemployment
       United States Plans            Non-U.S. Plans          Benefits
         2012            2011            2012            2011            2012            2011    
     (Millions of Dollars)

Service cost

   $        10    $        10    $          4    $          4    $        —    $        —

Interest cost

             28              29                9                9                8              10

Expected return on plan assets

            (26)             (28)              (2)              (2)              —              —

Amortization of actuarial loss

             17              12              —              —              —              —

Amortization of prior service credit

             —              —              —              —              (8)              (8)

Settlement gain

              (1)              —              —              —              —              —

Net periodic benefit cost

   $        28    $        23    $        11    $        11    $        —    $          2

 

12. INCOME TAXES

Income Taxes

For the six months ended June 30, 2012, the Company recorded an income tax benefit of $20 million on a loss before income taxes of $42 million. This compares to income tax expense of $31 million on income before income taxes of $149 million in the same period of 2011. The income tax benefit for the six months ended June 30, 2012 differs from statutory rates due primarily to a goodwill impairment with no tax benefit and pre-tax losses with no tax benefit, partially offset by 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, release of uncertain tax positions due to audit settlements, valuation allowance release in Germany, a tax benefit recorded in continuing operations pursuant to an exception to the intraperiod tax allocation rules and a tax benefit recorded related to a special economic zone tax incentive in Poland. The income tax expense for the six months ended June 30, 2011 differs from statutory rates due primarily to pre-tax income taxed at rates lower than the US statutory tax rate, income in jurisdictions with no tax expense due to offsetting valuation allowance releases, and release of uncertain tax positions due to audit settlements, 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 may decrease in the next 12 months due to audit settlements or statute expirations. During the three and six months ended June 30, 2012, a tax position became effectively settled and decreased unrecognized tax benefits by $298 million, of which only $19 million was included in the income tax benefit due to the impact of valuation allowances.

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. The factors considered by management in its determination of the probability of the realization of the deferred tax assets include but are not limited to: recent adjusted historical financial results; historical taxable income; projected future taxable income; the expected timing of the reversals of existing temporary differences; and tax planning strategies. Based upon this assessment, the Company has concluded based on available evidence that the deferred tax assets in Germany are more likely than not to be realized. Based upon this conclusion, a valuation allowance was reversed, a portion of which is expected to be realized through current year ordinary income and is therefore included in the annual effective rate. The remaining portion relates to the anticipated realization in future years and is therefore recognized as a discrete event in the three months ended June 30, 2012.

The Company has also concluded that there is more than a remote possibility that existing valuation allowances of up to $260 million as of June 30, 2012 could be released within the next 12 months. If releases of such valuation allowances occur, they 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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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.

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, are included in the consolidated balance sheets as follows:

 

     June 30
2012
   December 31
2011
    
     (Millions of Dollars)   
        

Other current liabilities

   $              5        $              5   

Other accrued liabilities (noncurrent)

                 10                      11   
   $            15        $            16   

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 June 30, 2012, management estimates that reasonably possible material additional losses above and beyond management’s best estimate of required remediation costs as recorded approximate $41 million.

 

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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.

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.

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 maintains ARO liabilities in the consolidated balance sheets as follows:

 

     June 30
2012
        December 31
2011
    
     (Millions of Dollars)   
           

Other current liabilities

   $              1           $              1       

Other accrued liabilities (noncurrent)

                 20                         21       
   $            21           $            22       

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. WARRANTS

On December 27, 2007, the Company issued 6,951,871 warrants to purchase 6,951,871 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 June 30, 2012.

 

15. STOCK-BASED COMPENSATION

CEO Stock-Based Compensation Agreement

Effective March 31, 2012, José Maria Alapont retired as president and chief executive officer of the Company. Mr. Alapont’s retirement had no accounting impact on either the stock options or the deferred compensation agreement discussed below.

 

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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 4,000,000 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 was recognized subsequent to that date. These options had an intrinsic value of zero as December 31, 2011. These options expired on June 29, 2012.

Mr. Alapont’s Deferred Compensation Agreement was also amended and restated on March 23, 2010. The amended and restated agreement included no changes that impacted the accounting for this agreement. Since the revised and restated agreement continues to provide for net cash settlement at the option of Mr. Alapont, it continues to be treated as a liability award as of June 30, 2012 and through its eventual payout, which will occur promptly following October 1, 2012. The amount of the payout shall be $9.7 million (500,000 shares of stock multiplied by the March 23, 2010 stock price of $19.46). The Company recognized $1 million in expense for both the three and six month periods ended June 30, 2012 associated with Mr. Alapont’s Deferred Compensation Agreement. The Company recognized $1 million in expense and immaterial income for the three and six month periods ended June 30, 2011, respectively, associated with Mr. Alapont’s Deferred Compensation Agreement. The Deferred Compensation Agreement had an intrinsic value of $9.7 million as of both June 30, 2012 and December 31, 2011.

Stock Appreciation Rights

A summary of the Company’s stock appreciation rights (“SARs”) activity as of and for the six months ended June 30, 2012 is as follows:

 

         SARs        

Weighted

Average

Exercise

    Price    

    

Weighted

Average

Remaining

Contractual

      Life       

    

Aggregate

Intrinsic

    Value    

      
     (Thousands)             (Years)      (Millions)     
              

Outstanding at January 1, 2012

     1,388              $    19.96           3.9             $       —           

Granted

     809                  17.64              

Forfeited

              (44)                   17.60              

Outstanding at March 31, 2012

     2,153                  19.14           4.1             $       —           

Forfeited

              (79)                   17.21              

Outstanding at June 30, 2012

           2,074              $    19.21                        3.9              $       —           
              

Exercisable at June 30, 2012

              864              $    19.46                        3.7              $       —           

In February 2012, 2011 and 2010, the Company granted approximately 809,000, 1,039,000 and 437,000 SARs, respectively, to certain employees. The SARs granted in February 2012 (“2012 SARs”) and 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 2012 SARs, the 2011 SARs and the 2010 SARs

 

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at June 30, 2012 resulting in fair values of $2.2 million, $1.6 million and $0.4 million, respectively. The Company recognized SARs income of $4 million and $3 million for the three and six months ended June 30, 2012, respectively. The Company recognized SARs income of $1 million and SARs expense of $1 million for the three and six months ended June 30, 2011, respectively.

The June 30, 2012 SARs fair values were estimated using the Black-Scholes valuation model with the following assumptions:

 

     2012 SARs     2011 SARs     2010 SARs     

Exercise price

      $17.64         $21.03         $17.16    

Expected volatility

      58%         58%         58%    

Expected dividend yield

      0%         0%         0%    

Risk-free rate over the estimated expected life

      0.41%         0.32%         0.25%    

Expected life (in years)

      2.96         2.11         1.43    

Expected volatility is based on the average of five-year historical volatility and implied volatility for a group of comparable auto industry 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.

 

16. (LOSS) INCOME PER COMMON SHARE

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

 

       Three Months Ended    
June 30
          Six Months Ended    
June 30
       2012        2011             2012        2011  
     (Millions of Dollars, Except Per Share Amounts)

Net (loss) income attributable to Federal-Mogul shareholders

   $      (59)      $        64       $      (26)    $      115

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)

            —                0.7                —                0.6

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

              0.5                  0.2                  0.5                0.2

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

            99.4              99.8                99.4              99.7

Net (loss) income per share attributable to Federal-Mogul:

              

Basic

   $      (0.60)     $        0.65       $      (0.26)    $        1.16

Diluted

   $      (0.60)     $        0.64       $      (0.26)    $        1.15

The Company recognized a net loss for the three and six months ended June 30, 2012. As a result, diluted loss per share is the same as basic loss per share for these periods as any potentially dilutive securities would reduce the loss per share.

Warrants to purchase 6,951,871 common shares were not included in the computation of weighted average shares outstanding, including dilutive shares, for the three and six months ended June 30, 2012 and 2011 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, which expired on June 29, 2012, were not included in the computation of weighted average shares outstanding, including dilutive shares, for the three and six months ended June 30, 2012 because the exercise price was greater than the average market price of the Company’s common shares during these periods.

 

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The 500,000 common shares issued in connection with the Deferred Compensation Agreement described in Note 15 are excluded from the basic earnings per share calculation as required by FASB ASC Topic 710, Compensation.

 

17. THAILAND MANUFACTURING FACILITY FLOOD

In October 2011, a flood occurred at the Company’s Vehicle Safety and Protection manufacturing facility in Ayutthaya, Thailand. This facility was partially submerged in the flood waters for a period of approximately six weeks, resulting in extensive damage to the facility and the loss of substantially all of its related equipment and inventory. A substantial portion of the operations at the facility are currently suspended.

In addition to other coverage, the Company believes its insurance policies provide for replacement of damaged property, sales value of destroyed inventory, reimbursement for losses due to interruption of business operations, and reimbursement of expenditures incurred to restore operations. In February and April 2012, the Company received cash advances from its insurance carrier of $25 million and $5 million, respectively. The table below provides, by insurance coverage stream, the amount of insurance recoverable recorded as of December 31, 2011 (in millions of dollars):

 

     

Real and personal property:

     

Property, plant and equipment

   $             13      

Inventory

     6      

Incremental costs incurred to restore operations

     2      
  

 

 

    
   $ 21      
  

 

 

    

The following table presents a rollforward of the insurance recoverable for the six months ended June 30, 2012 (in millions of dollars):

 

    

Insurance recoverable as of December 31, 2011

   $ 21     

Cash advance from insurance carrier

               (30  

Incremental costs incurred to restore operations

     9     
  

 

 

   

Insurance recoverable as of June 30, 2012

   $     
  

 

 

   

The insurance recoverable of $21 million as of December 31, 2011 is classified within the balance sheet as “Prepaid expenses and other current assets.”

 

18. PENDING ACQUISITION

On June 29, 2012, the Company entered into a definitive agreement to purchase the BERU spark plug business from BorgWarner Inc. This transaction is currently pending customary closing conditions and consultations, including competition authorities. This pending acquisition will add approximately $80 million in annualized sales to the Company.

 

19. SUBSEQUENT EVENT

During July 2012, as a result of union negotiations, retiree medical benefits were amended at one of the Company’s U.S. manufacturing locations. Given that this event will eliminate the accrual of defined benefits for a significant number of active participants, the Company expects to recognize a pre-tax Other Postemployment Benefits (“OPEB”) curtailment gain of approximately $50 million during the third quarter of 2012.

 

20. 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.

 

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The Company evaluates reporting segment performance principally on a non-GAAP Operational EBITDA basis. Management believes that Operational EBITDA provides supplemental information for management and investors to evaluate the operating performance of its business. Management uses, and believes that investors benefit from referring to Operational EBITDA in assessing the Company’s operating results, as well as in planning, forecasting and analyzing future periods as this financial measure approximates the cash flow associated with the operational earnings of the Company. Additionally, Operational EBITDA presents measures of corporate performance exclusive of the Company’s capital structure and the method by which assets were acquired and financed. 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. The reporting segments bear a service cost allocation related to the U.S. based funded pension plan with an equal offset in Corporate EBITDA so that total expense is excluded from total Company EBITDA.

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

 

    

Three Months Ended June 30

    

Net Sales

 

Cost of Products Sold

   Gross Margin
    

2012

   2011       2012    2011    2012    2011
     (Millions of Dollars)

Powertrain Energy

   $        565       $        597        $      (494)      $      (515)      $          71       $          82   

Powertrain Sealing and Bearings

             312                 333                (274)              (294)                  38                   39   

Vehicle Safety and Protection

             261                 258                (210)              (196)                  51                   62   

Global Aftermarket

             566                 612                (469)              (493)                  97                 119   

Corporate

               —                   —                    (2)                  (3)                  (2)                  (3)  
   $     1,704       $     1,800        $   (1,449)      $   (1,501)      $        255       $        299   
    

Six Months Ended June 30

    

Net Sales

 

Cost of Products Sold

   Gross Margin
    

2012

   2011       2012    2011    2012    2011
     (Millions of Dollars)

Powertrain Energy

   $     1,167    $     1,169     $   (1,021)    $   (1,018)    $        146    $        151

Powertrain Sealing and Bearings

             637              652             (560)            (576)                77                76

Vehicle Safety and Protection

             536              514             (426)            (389)              110              125

Global Aftermarket

          1,128           1,189             (929)            (960)              199              229

Corporate

               —                —                 (1)                (3)                (1)                (3)
   $     3,468    $     3,524     $   (2,937)    $   (2,946)    $        531    $        578

 

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

 

           Three Months Ended    
June 30
          Six Months Ended       
June 30
             2012                   2011                   2012                   2011        
     (Millions of Dollars)   (Millions of Dollars)

Powertrain Energy

   $          77   $          89   $        163   $        168

Powertrain Sealing and Bearings

               33               33               63               62

Vehicle Safety and Protection

               38               54               84             107

Global Aftermarket

               60               74             125             143

Corporate

             (49)             (50)           (108)           (102)

Total Operational EBITDA

             159             200             327             378

Depreciation and amortization

             (71)             (71)           (140)           (139)

Interest expense, net

             (32)             (32)             (64)             (63)

Adjustment of assets to fair value

           (119)               (3)           (121)               (3)

Expense associated with U.S. based funded pension plans

             (14)             (11)             (28)             (22)

Restructuring expense, net

               (8)               —             (14)               (1)

Income tax benefit (expense)

               29             (17)               20             (31)

Other

               (1)               (1)               (2)               (1)

Net (loss) income

   $        (57)   $          65   $        (22)   $        118

Total assets by reporting segment are as follows:

 

         June 30  
      2012      
       December 31
      2011      
     (Millions of Dollars)

Powertrain Energy

   $         2,001       $        1,955 

Powertrain Sealing and Bearings

                 964                    922 

Vehicle Safety and Protection

              1,267                 1,329 

Global Aftermarket

              2,022                 1,931 

Corporate

                 687                    892 
   $         6,941       $        7,029 

 

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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, 2011 (the “Annual Report”) filed on February 28, 2012, 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 six months ended June 30, 2012, the Company derived 67% of its sales from the OE market and 33% 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 six months ended June 30, 2012, the Company derived 38% of its sales in the United States and 62% internationally. The Company has operations in established markets including Canada, France, Germany, Italy, Japan, Spain, Sweden, the United Kingdom and the United States, and developing 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.

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,

 

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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.

As previously announced, the Company’s board of directors decided to segment the Company’s operations into two separate and independent divisions. One division will focus primarily on the manufacture and sale of powertrain products to original equipment manufacturers (“OE Division”), while the other will consist of the Company’s global aftermarket as well as its brake, chassis and wipers businesses (“Global Aftermarket Division”). The Company has initiated several actions in connection with the creation of these two operating divisions, including the hiring of a Chief Executive Officer for the Global Aftermarket division and the identification of facilities that will be managed by each division.

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 June 30, 2012 vs. Three Months Ended June 30, 2011

Net sales by reporting segment are:

 

    

Three Months Ended

June 30

        
    

    2012  

  

2011

  
     (Millions of Dollars)   
         

Powertrain Energy

    $     565    $       597     

Powertrain Sealing and Bearings

           312             333     

Vehicle Safety and Protection

           261             258     

Global Aftermarket

           566             612     
    $  1,704    $    1,800     

 

The percentage of net sales by group and region for the three months ended June 30, 2012 and 2011 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    
2012                         

United States and Canada

       24%          36%          35%          63%          41%  

Europe

       54%          46%          41%          22%          40%  

Rest of World

       22%          18%          24%          15%          19%  
2011                         

United States and Canada

       22%          32%          29%          61%          37%  

Europe

       58%          53%          50%          24%          45%  

Rest of World

       20%          15%          21%          15%          18%  

 

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Cost of products sold by reporting segment is:

 

    

Three Months Ended

            June 30              

 
             2012           2011     
     (Millions of Dollars)  

Powertrain Energy

     $   (494)          $   (515)    

Powertrain Sealing and Bearings

     (274)          (294)    

Vehicle Safety and Protection

     (210)          (196)    

Global Aftermarket

     (469)          (493)    

Corporate

              (2                  (3   
     $(1,449         $(1,501   

Gross margin by reporting segment is:

 

    

Three Months Ended

             June 30             

 
        2012           2011       
     (Millions of Dollars)  

Powertrain Energy

     $        71          $        82     

Powertrain Sealing and Bearings

     38          39     

Vehicle Safety and Protection

     51          62     

Global Aftermarket

     97          119     

Corporate

              (2                   (3   
     $      255          $      299     

Net sales decreased by $96 million, or 5%, to $1,704 million for the second quarter of 2012 from $1,800 million in the same period of 2011. The impact of the U.S. dollar strengthening, primarily against the euro, decreased reported sales by $114 million.

OE sales volumes increased by $37 million due to new business launches, partially offset by net market volume declines, primarily in Europe. Aftermarket sales decreased by $17 million due to sales decreases in Europe and North America. Net unfavorable customer pricing decreased Company sales by $2 million.

Cost of products sold decreased by $52 million to $1,449 million for the second quarter of 2012 compared to $1,501 million in the same period of 2011. The impact of the relative strength of the U.S. dollar decreased cost of products sold by $98 million. The Company noted materials and services sourcing savings of $23 million and favorable productivity of $2 million. Manufacturing, labor and variable overhead costs increased by $66 million as a direct consequence of sales volume/mix. Additional increases were higher depreciation of $4 million and increased pension expense of $1 million.

Gross margin decreased by $44 million to $255 million, or 15.0% of sales, for the second quarter of 2012 compared to $299 million, or 16.6% of sales, in the same period of 2011. The favorable impact on margin of new program launches was more than offset by the impact of production volume declines, primarily in Europe, and a shift in mix towards lower margin products, resulting in a net $46 million decrease in gross margin. Other factors contributing to the decreased margin were currency movements of $16 million, increased depreciation of $4 million, net unfavorable customer pricing of $2 million and increased pension expense of $1 million, partially offset by materials and services sourcing savings of $23 million and favorable productivity of $2 million.

 

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Reporting Segment Results – Three Months Ended June 30, 2012 vs. Three Months Ended June 30, 2011

The following table provides a reconciliation of changes in sales, cost of products sold, gross margin and operational EBITDA for the three months ended June 30, 2012 compared with the three months ended June 30, 2011 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. The reporting segments bear a service cost allocation related to the U.S. based funded pension plan with an equal offset in Corporate EBITDA so that total expense is excluded from total Company EBITDA.

 

          PTE             PTSB           VSP             GA           Corporate          Total    
    (Millions of Dollars)

Sales

                       

Three months ended June 30, 2011

    $ 597       $ 333       $ 258       $ 612       $       $ 1,800  

Sales volumes

      18         (1 )       20         (17 )               20  

Customer pricing

      (3 )       2                 (1 )               (2 )

Foreign currency

      (47 )       (22 )       (17 )       (28 )               (114 )
   

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

Three months ended June 30, 2012

    $       565       $       312       $       261       $       566       $       —       $     1,704  
   

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 
    PTE   PTSB   VSP   GA   Corporate   Total

Cost of Products Sold

                       

Three months ended June 30, 2011

    $ (515 )     $ (294 )     $ (196 )     $ (493 )     $ (3 )     $ (1,501 )

Sales volumes / mix

      (27 )       (4 )       (29 )       (6 )               (66 )

Productivity, net of inflation

      3         (1 )       (2 )               2         2  

Materials and services sourcing

      7         4         2         9         1         23  

Depreciation

      (3 )       (1 )       1                 (1 )       (4 )

Pension

                                      (1 )       (1 )

Foreign currency

      41         22         14         21                 98  
   

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

Three months ended June 30, 2012

    $ (494 )     $ (274 )     $ (210 )     $ (469 )     $ (2 )     $ (1,449 )
   

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 
    PTE   PTSB   VSP   GA   Corporate   Total

Gross Margin

   

Three months ended June 30, 2011

    $ 82       $ 39       $ 62       $ 119       $ (3 )     $ 299  

Sales volumes / mix

      (9 )       (5 )       (9 )       (23 )               (46 )

Customer pricing

      (3 )       2                 (1 )               (2 )

Productivity, net of inflation

      3         (1 )       (2 )               2         2  

Materials and services sourcing

      7         4         2         9         1         23  

Depreciation

      (3 )       (1 )       1                 (1 )       (4 )

Pension

                                      (1 )       (1 )

Foreign currency

      (6 )               (3 )       (7 )               (16 )
   

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

Three months ended June 30, 2012

    $ 71       $ 38       $ 51       $ 97       $ (2 )     $ 255  
   

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 
    PTE   PTSB   VSP   GA   Corporate   Total

Operational EBITDA

   

Three months ended June 30, 2011

    $ 89       $ 33       $ 54       $ 74       $ (50 )     $ 200  

Sales volumes / mix

      (9 )       (5 )       (9 )       (23 )               (46 )

Customer pricing

      (3 )       2                 (1 )               (2 )

Productivity – Cost of products sold

      3         (1 )       (2 )               2         2  

Productivity – SG&A

      (2 )               (1 )       3         (9 )       (9 )

Sourcing – Cost of products sold

      7         4         2         9         1         23  

Sourcing – SG&A

                                      1         1  

Sourcing – Other

                                      (1 )       (1 )

Equity earnings in non-consolidated affiliates

                              2                 2  

Stock-based compensation expense

                                      2         2  

Foreign currency

      (7 )       1         (3 )       (4 )       2         (11 )

Other

      (1 )       (1 )       (3 )               3         (2 )
   

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

Three months ended June 30, 2012

    $ 77       $ 33       $ 38       $ 60       $ (49 )     $ 159  
   

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

Depreciation and amortization

                          (71 )

Interest expense, net

                          (32 )

Adjustment of assets to fair value

                          (119 )

Expense associated with U.S. based funded pension plans

                          (14 )

Restructuring expense, net

                          (8 )

Income tax benefit

                          29  

Other

                          (1 )
                       

 

 

 

Net loss

                        $ (57 )
                       

 

 

 

 

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Powertrain Energy

Sales decreased by $32 million, or 5%, to $565 million for the second quarter of 2012 from $597 million in the same period of 2011. PTE generates approximately 75% of its revenue outside the United States and the resulting currency movements decreased reported sales by $47 million. Sales volumes increased by $18 million due to new business launches, partially offset by net market volume declines, primarily in Europe. Customer pricing decreased sales by $3 million.

Cost of products sold decreased by $21 million to $494 million for the second quarter of 2012 compared to $515 million in the same period of 2011. This decrease was due to currency movements of $41 million, materials and services sourcing savings of $7 million and favorable productivity of $3 million, partially offset by a $27 million increase directly associated with sales volume/mix and an increase in depreciation of $3 million.

Gross margin decreased by $11 million to $71 million, or 12.6% of sales, for the second quarter of 2012 compared to $82 million, or 13.7% of sales, for the second quarter of 2011. The favorable impact on margin of new program launches was more than offset by the impact of production volume declines, primarily in Europe, and a shift in mix towards lower margin products, resulting in a net $9 million decrease in gross margin. Other factors contributing to the decreased margin were currency movements of $6 million, customer price decreases of $3 million and increased depreciation of $3 million. These decreases were partially offset by materials and services sourcing savings of $7 million and favorable productivity of $3 million.

Operational EBITDA decreased by $12 million to $77 million for the second quarter of 2012 from $89 million in the same period of 2011. The favorable impact of new program launches was more than offset by the impact of production volume declines, primarily in Europe, and a shift in mix towards lower margin products, resulting in a net $9 million decrease. Other factors contributing to the decrease were currency movements of $7 million, customer price decreases of $3 million and other decreases of $1 million, partially offset by materials and services sourcing savings of $7 million and favorable productivity of $1 million.

Powertrain Sealing and Bearings

Sales decreased by $21 million, or 6%, to $312 million for the second quarter of 2012 from $333 million in the same period of 2011. PTSB generates approximately 65% of its revenue outside the United States and the resulting currency movements decreased reported sales by $22 million. Sales volumes decreased by $1 million due to net market volume declines, primarily in Europe, mostly offset by new business launches. Customer pricing increased sales by $2 million.

Cost of products sold decreased by $20 million to $274 million for the second quarter of 2012 compared to $294 million in the same period of 2011. This was due to currency movements of $22 million, and decreased materials and services sourcing costs of $4 million, partially offset by a $4 million increase directly associated with sales volume/mix, unfavorable productivity of $1 million and increased depreciation of $1 million.

Gross margin decreased by $1 million to $38 million, or 12.2% of sales, for the second quarter of 2012 compared to $39 million, or 11.7% of sales, for the second quarter of 2011. The favorable impact on margin of new program launches was more than offset by the impact of production volume declines, primarily in Europe, and a shift in mix towards lower margin products, resulting in a net $5 million decrease in gross margin. Other factors contributing to the margin decrease include unfavorable productivity of $1 million and increased depreciation of $1 million. These decreases were mostly offset by decreased materials and services sourcing costs of $4 million and customer price increases of $2 million.

Operational EBITDA remained flat for the second quarter of 2012 from $33 million in the same period of 2011. The favorable impact of new program launches was more than offset by the impact of production volume declines, primarily in Europe, and a shift in mix towards lower margin products, resulting in a net $5 million decrease. Other factors contributing to the decrease were unfavorable productivity of $1 million and other decreases of $1 million offset by decreased materials and services sourcing costs of $4 million, customer price increases of $2 million and currency movements of $1 million.

 

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Vehicle Safety and Protection

Sales increased by $3 million, or 1%, to $261 million for the second quarter of 2012 from $258 million in the same period of 2011. Sales volumes increased by $20 million due to new business launches, partially offset by net market volume declines, primarily in Europe. Approximately 65% of VSP sales are generated outside the United States and the resulting currency movements decreased reported sales by $17 million.

Cost of products sold increased by $14 million to $210 million for the second quarter of 2012 compared to $196 million in the same period of 2011. This was due to a $29 million increase directly associated with sales volume/mix and unfavorable productivity of $2 million, partially offset by currency movements of $14 million, decreased materials and services sourcing costs of $2 million and decreased depreciation of $1 million.

Gross margin decreased by $11 million to $51 million, or 19.5% of sales, for the second quarter of 2012 compared to $62 million, or 24.0% of sales, for the second quarter of 2011. The favorable impact on margin of new program launches was more than offset by the impact of production volume declines, primarily in Europe, and a shift in mix towards lower margin products, resulting in a net $9 million decrease in gross margin. Other decreases include currency movements of $3 million and unfavorable productivity of $2 million. These decreases were partially offset by materials and services sourcing savings of $2 million and lowered depreciation expense of $1 million.

Operational EBITDA decreased by $16 million to $38 million for the second quarter of 2012 from $54 million in the same period of 2011. The favorable impact of new program launches was more than offset by the impact of production volume declines, primarily in Europe, and a shift in mix towards lower margin products, resulting in a net $9 million decrease. Other decreases include unfavorable productivity of $3 million, currency movements of $3 million, and other decreases of $3 million, partially offset by decreased materials and services sourcing costs of $2 million.

Global Aftermarket

Sales decreased by $46 million, or 8%, to $566 million for the second quarter of 2012, from $612 million in the same period of 2011. This decrease was due to currency movements of $28 million, lower sales volumes of $17 million due to sales decreases in Europe and North America, partially offset by sales increases in all other regions, and net customer price decreases of $1 million.

Cost of products sold decreased by $24 million to $469 million for the second quarter of 2012 compared to $493 million in the same period of 2011. This decrease was due to currency movements of $21 million and materials and services sourcing savings of $9 million, partially offset by a $6 million increase directly associated with sales volume/mix.

Gross margin decreased by $22 million to $97 million, or 17.1% of sales, for the second quarter of 2012 compared to $119 million, or 19.4% of sales, in the same period of 2011. This was due to a net unfavorable sales volume/mix impact of $23 million, currency movements of $7 million and net customer price decreases of $1 million, partially offset by improved materials and services sourcing of $9 million.

Operational EBITDA decreased by $14 million to $60 million for the second quarter of 2012 from $74 million in the same period of 2011. This decrease was due to a net unfavorable sales volume/mix impact of $23 million, currency movements of $4 million and net customer price decreases of $1 million, partially offset by decreased materials and services sourcing costs of $9 million, favorable productivity of $3 million and favorable equity earnings in non-consolidated affiliates of $2 million.

Corporate

Operational EBITDA increased by $1 million to $(49) million for the second quarter of 2012 compared to $(50) million in the same period of 2011. This was due to an increase in costs, inclusive of labor and benefits inflation, of $7 million, being mostly offset by decreased stock-based compensation expense of $2 million, currency movements of $2 million, decreased materials and services sourcing costs of $1 million and other increases of $3 million.

 

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Selling, General and Administrative Expenses

Selling, general and administrative expenses (“SG&A”) were $174 million, or 10.2% of net sales, for the second quarter of 2012 as compared to $173 million, or 9.6% of net sales, for the same quarter of 2011.

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 $44 million for the second quarter of 2012 compared with $43 million for the same period in 2011. As a percentage of OE sales, R&D was 3.9% and 3.6% for the quarters ended June 30, 2012 and 2011, respectively.

Adjustment of Assets to Fair Value

The Company recognized impairments of $119 million and $3 million for the three months ended June 30, 2012 and 2011, respectively. The 2012 impairment charge is comprised of $91 million of goodwill impairments, $15 million of PP&E impairments and $13 million of trademarks and brand name impairments.

Interest Expense, Net

Net interest expense was $32 million for both the three month periods ended June 30, 2012 and 2011.

Restructuring Activities

The following is a summary of the Company’s consolidated restructuring liabilities and related activity as of and for the quarter ended June 30, 2012:

 

         PTE         PTSB          VSP            GA        Corporate        Total  
     (Millions of dollars)

Balance at March 31, 2012

   $        2   $        4    $      —   $        1   $      —    $        7

Provisions

           —             1              7           —           —              8

Payments

            (1)           —            —            (1)           —             (2)

Reclassification to pension liability

           —           —             (5)           —           —             (5)

Balance at June 30, 2012

   $        1   $        5    $        2   $      —   $      —    $        8

 

Other Expense, Net

Other expense, net was $8 million for the three months ended June 30, 2012 compared to $7 million for the same period of 2011.

Income Taxes

For the three months ended June 30, 2012, the Company recorded an income tax benefit of $29 million on a loss before income taxes of $86 million. This compares to income tax expense of $17 million on income before income taxes of $82 million in the same period of 2011. The income tax benefit for the three months ended June 30, 2012 differs from statutory rates due primarily to a goodwill impairment with no tax benefit and pre-tax losses with no tax benefit, partially offset by 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, release of uncertain tax positions due to an audit settlement, valuation allowance release in Germany, a tax benefit recorded in continuing operations pursuant to an exception to the intraperiod tax allocation rules and a tax benefit recorded related to a special economic zone tax incentive in Poland. The income tax expense for the three months ended June 30, 2011 differs from statutory rates due primarily to pre-tax income taxed at rates lower than the U.S. statutory rate and income in jurisdictions with no tax expense due to offsetting valuation allowance releases, partially offset by pre-tax losses with no tax benefits.

 

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Consolidated Results – Six Months Ended June 30, 2012 vs. Six Months Ended June 30, 2011

Net sales by reporting segment are:

 

   

Six Months Ended

June 30

    
        2012        2011   
        (Millions of Dollars)   
            

Powertrain Energy

    $  1,167      $  1,169   

Powertrain Sealing and Bearings

           637             652   

Vehicle Safety and Protection

           536             514   

Global Aftermarket

        1,128          1,189   
    $  3,468      $  3,524   

The percentage of net sales by group and region for the six months ended June 30, 2012 and 2011 are as follows:

 

          PTE             PTSB             VSP               GA              Total    
2012                         

United States and Canada

       23%          35%          34%          63%          40%  

Europe

       55%          47%          42%          22%          41%  

Rest of World

       22%          18%          24%          15%          19%  
2011                         

United States and Canada

       22%          31%          30%          62%          38%  

Europe

       58%          53%          49%          23%          44%  

Rest of World

       20%          16%          21%          15%          18%  

 

Cost of products sold by reporting segment is:

 

   

Six Months Ended

June 30

        
        2012        2011   
        (Millions of Dollars)       
                

Powertrain Energy

    $(1,021)        $(1,018)     

Powertrain Sealing and Bearings

         (560)             (576)     

Vehicle Safety and Protection

         (426)             (389)     

Global Aftermarket

         (929)             (960)     

Corporate

             (1)                 (3)     
    $(2,937)        $(2,946)     

 

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Gross margin by reporting segment is:

 

 

   

  Six Months Ended  

June 30

        
          2012          2011   
        (Millions of Dollars)       
                         

Powertrain Energy

    $     146      $     151     

Powertrain Sealing and Bearings

             77               76     

Vehicle Safety and Protection

           110             125     

Global Aftermarket

           199             229     

Corporate

             (1)               (3)     
    $     531      $     578     

Net sales decreased by $56 million, or 2%, to $3,468 million for the six months ended June 30, 2012 from $3,524 million in the same period of 2011. The impact of the U.S. dollar strengthening, primarily against the euro, decreased reported sales by $159 million.

OE sales volumes increased by $125 million due to new business launches, partially offset by net market volume declines, primarily in Europe. Aftermarket sales decreased by $22 million due to sales decreases in Europe and North America, partially offset by sales increases in all other regions.

Cost of products sold decreased by $9 million to $2,937 million for the six months ended June 30, 2012 compared to $2,946 million in the same period of 2011. The impact of the relative strengthening of the U.S. dollar reduced cost of products sold by $135 million. Additional decreases were materials and services sourcing savings of $44 million and favorable productivity of $12 million. These decreases were mostly offset by increased manufacturing, labor and variable overhead costs of $174 million as a direct consequence of sales volume/mix, increased depreciation of $7 million and increased pension expense of $1 million.

Gross margin decreased by $47 million to $531 million, or 15.3% of sales, for the six months ended June 30, 2012 compared to $578 million, or 16.4% of sales, in the same period of 2011. The favorable impact on margin of new program launches was more than offset by the impact of production volume declines, primarily in Europe, and a shift in mix towards lower margin products, resulting in a net $71 million decrease in gross margin. Other factors contributing to the decreased margin were currency movements of $24 million, increased depreciation of $7 million and increased pension expense of $1 million, partially offset by materials and services sourcing savings of $44 million and favorable productivity of $12 million.

 

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Reporting Segment Results – Six Months Ended June 30, 2012 vs. Six Months Ended June 30, 2011

The following table provides a reconciliation of changes in sales, cost of products sold, gross margin and Operational EBITDA for the six months ended June 30, 2012 compared with the six months ended June 30, 2011 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. The reporting segments bear a service cost allocation related to the U.S. based funded pension plan with an equal offset in Corporate EBITDA so that total expense is excluded from total Company EBITDA.

 

          PTE             PTSB           VSP             GA           Corporate          Total    
    (Millions of Dollars)

Sales

   

Six months ended June 30, 2011

    $ 1,169       $ 652       $ 514       $ 1,189       $       $ 3,524  

Sales volumes

      72         9         44         (22 )               103  

Customer pricing

      (4 )       5         1         (2 )                

Foreign currency

      (70 )       (29 )       (23 )       (37 )               (159 )
   

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

Six months ended June 30, 2012

    $     1,167       $       637       $       536       $     1,128       $       —       $     3,468  
   

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 
    PTE   PTSB   VSP   GA   Corporate   Total

Cost of Products Sold

                       

Six months ended June 30, 2011

    $ (1,018 )     $ (576 )     $ (389 )     $ (960 )     $ (3 )     $ (2,946 )

Sales volumes / mix

      (81 )       (20 )       (57 )       (16 )               (174 )

Productivity, net of inflation

      8                 (2 )       4         2         12  

Materials and services sourcing

      14         10         2         17         1         44  

Pension

                                      (1 )       (1 )

Depreciation

      (6 )       (2 )       1                         (7 )

Foreign currency

      62         28         19         26                 135  
   

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

Six months ended June 30, 2012

    $ (1,021 )     $ (560 )     $ (426 )     $ (929 )     $ (1 )     $ (2,937 )
   

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 
    PTE   PTSB   VSP   GA   Corporate   Total

Gross Margin

                       

Six months ended June 30, 2011

    $ 151       $ 76       $ 125       $ 229       $ (3 )     $ 578  

Sales volumes / mix

      (9 )       (11 )       (13 )       (38 )               (71 )

Customer pricing

      (4 )       5         1         (2 )                

Productivity, net of inflation

      8                 (2 )       4         2         12  

Materials and services sourcing

      14         10         2         17         1         44  

Pension

                                      (1 )       (1 )

Depreciation

      (6 )       (2 )       1                         (7 )

Foreign currency

      (8 )       (1 )       (4 )       (11 )               (24 )
   

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

Six months ended June 30, 2012

    $ 146       $ 77       $ 110       $ 199       $ (1 )     $ 531  
   

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 
    PTE   PTSB   VSP   GA   Corporate   Total

Operational EBITDA

                       

Six months ended June 30, 2011

    $ 168       $ 62       $ 107       $ 143       $ (102 )     $ 378  

Sales volumes / mix

      (9 )       (11 )       (13 )       (38 )               (71 )

Customer pricing

      (4 )       5         1         (2 )                

Productivity – Cost of products sold

      8                 (2 )       4         2         12  

Productivity – SG&A

      (2 )       (1 )       (5 )       4         (14 )       (18 )

Sourcing – Cost of products sold

      14         10         2         17         1         44  

Sourcing – SG&A

                                      2         2  

Equity earnings of non-consolidated affiliates

      (1 )               1         3                 3  

Expense associated with future payments to retired CEO