Item 1B.
Unresolved Staff Comments.
None.
At September 30, 2006, our operating segments and discontinued operations and our joint ventures had the following facilities in the United States, Europe, South America, Canada, Mexico, Australia, South Africa and the Asia/Pacific region:
These facilities had an aggregate floor space of approximately 23.3 million square feet, substantially all of which is in use. We owned approximately 77% and leased approximately 23% of this floor space. Substantially all of our domestic plants and equipment are subject to liens securing our obligations under our $1.15 billion credit facilities with a group of banks (see Note 16 of the Notes to Consolidated Financial Statements under Item 8. Financial Statements and Supplementary Data). In the opinion of management, our properties have been well maintained, are in sound operating condition and contain all equipment and facilities necessary to operate at present levels. A summary of floor space of these facilities at September 30, 2006, is as follows:
Item 3.
Item 3.
Legal Proceedings
1. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Overview and Note 20 of the Notes to Consolidated Financial Statements under Item 8. Financial Statements and Supplementary Data for information with respect to three class action lawsuits filed against the company as a result of modifications made to its retiree medical benefits.
2. On October 5, 2006, ZF Meritor LLC, a joint venture between an ArvinMeritor subsidiary and ZF Friedrichshafen AG, filed a lawsuit against Eaton Corporation in the United States District Court for the District of Delaware, alleging that Eaton had engaged in exclusionary, anticompetitive conduct in the markets for heavy-duty truck transmissions, in violation of the U.S. antitrust laws. The plaintiffs seek an injunction prohibiting Eaton from engaging in such anticompetitive conduct and monetary damages.
3. See Note 23 of the Notes to Consolidated Financial Statements under Item 8. Financial Statements and Supplementary Data for information with respect to litigation related to alleged asbestos-related liabilities.
4. See Item 1. Business, “Environmental Matters” for information relating to environmental proceedings.
5. Various other lawsuits, claims and proceedings have been or may be instituted or asserted against ArvinMeritor or our subsidiaries relating to the conduct of our business, including those pertaining to product liability, intellectual property, safety and health, and employment matters. Although the outcome of litigation cannot be predicted with certainty and some lawsuits, claims or proceedings may be disposed of unfavorably to ArvinMeritor, management believes, after consulting with Vernon G. Baker, II, Esq., ArvinMeritor's General Counsel, that the disposition of matters that are pending will not have a material adverse effect on our business, financial condition or results of operations.
Item 4.
Item 4.
Submission of Matters to a Vote of Security Holders.
There were no matters submitted to a vote of security holders during the fourth quarter of fiscal year 2006.
Item 4A.
Executive Officers of the Registrant.
The name, age, positions and offices held with ArvinMeritor and principal occupations and employment during the past five years of each of our executive officers as of October 31, 2006, are as follows:
Charles G. McClure, Jr., 53 - Chairman of the Board, Chief Executive Officer and President since August 2004. Chief Executive Officer of Federal-Mogul Corporation (automotive component supplier) from July 2003 to July 2004; President and Chief Operating Officer of Federal-Mogul Corporation from January 2001 to July 2003.
Vernon G. Baker, II, 53 - Senior Vice President and General Counsel since July 2000.
Jeffrey A. Craig, 46 - Vice President and Controller since May 2006. President and Chief Executive Officer, Commercial Finance, of General Motors Acceptance Corporation (automotive and commercial finance, mortgage, real estate and insurance businesses) from 2001 to May 2006.
Linda M. Cummins, 59 - Senior Vice President, Communications, since July 2000.
James D. Donlon, III, 60 - Senior Vice President and Chief Financial Officer since April 2005. Senior Vice President and Chief Financial Officer of Kmart Corporation (retailer) from January 2004 to March 2005; Senior Vice President and Controller of the Chrysler Division of DaimlerChrysler AG (automotive) from 2001 to 2003.
Mary A. Lehmann, 47 - Vice President and Treasurer since January 2006. Assistant Treasurer of ArvinMeritor from 2004 to January 2006; Director, Affiliate Financing, of Ford Motor Company (automotive) from 2001 to 2004.
Perry L. Lipe, 60 - Senior Vice President and Chief Information Officer since July 2000.
Philip R. Martens, 46 - Senior Vice President and President, Light Vehicle Systems, since September 2006. President and Chief Operating Officer of Plastech Engineered Products, Inc. (automotive component supplier) from 2005 to 2006; Group Vice President, Product Creation, of Ford Motor Company (automotive) from 2003 to 2005; Vice President, North American Product Creation, of Ford Motor Company in 2003;Vice President, North American Product Development of Ford Motor Company from 2002 to 2003; and Managing Director, Planning, Design and Product Development of Mazda Motor Company (automotive) from 1999 to 2002.
Robert Ostrov, 57 - Senior Vice President, Human Resources, since September 2006. Vice President, Human Resources and Labor Relations, of FedEx Ground Package System, Inc. (shipping services), a subsidiary of FedEx Corporation, from 2005 to September 2006; Attorney, Arnold & Partners, from February 2003 to 2005; Senior Vice President, Human Resources, of TruServ Corporation (now True Value Company) (hardware, plumbing and heating supplies) from 1997 to February 2003.
Carsten J. Reinhardt, 39 - Senior Vice President and President, Commercial Vehicle Systems since September 2006. Chief Executive Officer and President of Detroit Diesel Corporation (a subsidiary of DaimlerChrysler AG) from March 2003 to August 2006; Plant Manager of the Portland Truck Manufacturing Plant of Freightliner LLC/Western Star Trucks (subsidiaries of DaimlerChrysler AG) from October 2002 to February 2003; Vice President and General Manager, Operations, of Western Star Trucks from March 2001 to September 2002.
Rakesh Sachdev, 50 - Senior Vice President, Corporate Development and Strategy, since April 2005. Vice President and Controller of ArvinMeritor from August 2003 to March 2005; Vice President and General Manager, Worldwide Braking Systems, of ArvinMeritor from December 2000 to July 2003.
H. H. “Buddy” Wacaser, 57 - Senior Vice President and President, Emissions Technology Group, since September 2006. President and Chief Executive Officer of Meridian Automotive Systems, Inc. (automotive component supplier) from 2002 to 2005; Executive Vice President of Meridian Automotive Systems, Inc. from 1997 to 2002.
Bonnie Wilkinson, 56 - Vice President and Secretary since November 2001.
There are no family relationships, as defined in Item 401 of Regulation S-K, between any of the above executive officers and any director, executive officer or person nominated to become a director or executive officer. No officer of ArvinMeritor was selected pursuant to any arrangement or understanding between him or her and any person other than ArvinMeritor. All executive officers are elected annually.
PART II
Item 5.
Item 5.
Market for the Registrant’s Common Equity and Related Stockholder Matters.
ArvinMeritor's common stock, par value $1 per share (“Common Stock”), is listed on the New York Stock Exchange (“NYSE”) and trades under the symbol "ARM." On October 31, 2006, there were 27,504 shareowners of record of ArvinMeritor's Common Stock.
The high and low sale prices per share of ArvinMeritor Common Stock for each quarter of fiscal years 2006 and 2005 were as follows:
Quarterly cash dividends in the amount of $0.10 per share were declared and paid in each quarter of the last two fiscal years.
See Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters for information on securities authorized for issuance under equity compensation plans.
On August 7, 2006, the company issued 11,400 shares of Common Stock to a retiring non-employee director in settlement of restricted share units that were awarded to him in 2004, 2005 and 2006 as annual grants under the 2004 Directors Stock Plan. The issuance of these securities was exempt from registration under the Securities Act of 1933, as a transaction not involving a public offering under Section 4(2).
Item 6.
Item 6. Selected Financial Data.
The following sets forth selected consolidated financial data. Prior period amounts have been restated for discontinued operations. The data should be read in conjunction with the information included under Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Conditions and Results of Operations.
Overview
ArvinMeritor, Inc. is a global supplier of a broad range of integrated systems, modules and components to the motor vehicle industry. The company serves light vehicle, commercial truck, trailer and specialty original equipment manufacturers and certain aftermarkets. Headquartered in Troy, Michigan, the company employs approximately 27,500 people at 112 manufacturing facilities in 26 countries. ArvinMeritor common stock is traded on the New York Stock Exchange under the ticker symbol ARM.
During fiscal year 2006, we completed the following transactions, which significantly improved our financial strength and liquidity position.
In fiscal year 2006, our light vehicle emissions technologies business continued to face significant challenges, including higher raw material costs, intense pricing pressures and increased competition. These factors were greater than previously anticipated and partially offset the expected benefits from our fiscal year 2005 restructuring actions. In addition, higher stainless steel prices and recent downturns in production at certain North American manufacturers are expected to further negatively impact the financial performance of this business in fiscal year 2007. These combined factors resulted in a decline in the fair value of the light vehicle emissions technologies business in fiscal year 2006, and accordingly, we recorded a $310 million non-cash goodwill impairment charge in the fourth quarter of fiscal year 2006. In response to these challenges we continue to rationalize and restructure this business. We are merging our light and commercial vehicle emissions businesses into a combined Emissions Technologies (ET) business and beginning in fiscal year 2007, ET will be a separate reportable segment. We have also identified restructuring plans to downsize certain facilities and realign our manufacturing footprint to utilize assets more efficiently, improve operations and lower costs. The total estimated cost of these actions is $50 million, of which approximately $40 million is expected to be cash costs. This restructuring program will be executed over the next 12 to 36 months. No amounts have been recorded for this restructuring program at September 30, 2006.
Our financial results for fiscal year 2006 were favorably impacted by strong volumes in the principal markets served by our Commercial Vehicle Systems (CVS) business. These results were negatively impacted by a labor disruption and work stoppage at our commercial vehicle brakes facility in Tilbury, Ontario, Canada in the third quarter of fiscal year 2006. In June 2006, a tentative collective bargaining agreement with the Canadian Auto Workers (“CAW”) could not be reached and, as a result, operations at the facility were suspended. An agreement with the CAW was eventually reached and operations resumed. This labor disruption negatively impacted operating income during fiscal year 2006 by $45 million. Included in this amount are premium labor costs, expedited freight and logistical costs and other costs associated with production disruptions at certain customers’ facilities.
A summary of our results for the fiscal year ended September 30, 2006 is as follows:
We continue to execute our restructuring plans announced in early fiscal year 2005 and recorded $37 million of restructuring costs, primarily in our LVS business segment, in fiscal year 2006. To date, we have downsized, consolidated, closed or sold 11 facilities, primarily in the LVS business segment.
Higher raw material costs and intense competition, coupled with global excess capacity most notably in the light vehicle industry, have created pressure from customers to reduce our prices. We continuously work to address these competitive challenges and offset price decreases by reducing costs, improving productivity and restructuring operations. The company’s cost reduction and productivity programs, including savings from our restructuring actions, more than offset the impact of lower selling prices to our customers in fiscal year 2006.
Also impacting our industry is the rising cost of pension and other post-retirement benefits. To partially address this issue we approved amendments to certain retiree medical plans in fiscal years 2002 and 2004. The cumulative effect of these amendments was a reduction in the accumulated postretirement benefit obligation (APBO) of $293 million, which was being amortized as a reduction of retiree medical expense over the average remaining service period of approximately 12 years. These plan amendments have been challenged in three separate class action lawsuits filed in the United States District Court for the Eastern District of Michigan (District Court). The lawsuits allege that the changes breach the terms of various collective bargaining agreements entered into with the United Auto Workers (the UAW lawsuit) and the United Steel Workers (the USW lawsuit) at facilities that have either been closed or sold. Plaintiffs in the UAW lawsuit sought injunctive relief requiring the company to provide lifetime retiree health care benefits under the applicable collective bargaining agreements. On December 22, 2005, the District Court issued an order granting a motion by the UAW for a preliminary injunction. The order enjoined the company from implementing the changes to retiree health benefits that had been scheduled to become effective on January 1, 2006, and ordered the company to reinstate and resume paying the full cost of health benefits for the UAW retirees at the levels existing prior to the changes approved in 2002 and 2004. On August 17, 2006, the District Court denied a motion by the company and the other defendants for summary judgment; granted a motion by the UAW for summary judgment; and granted the UAW’s request to make the terms of the preliminary injunction permanent (the injunction). Due to the uncertainty related to the ongoing lawsuits and because the injunction has the impact of at least temporarily changing the benefits provided under the existing postretirement medical plans, we have accounted for the injunction as a rescission of the 2002 and 2004 plan amendments that modified UAW retiree healthcare benefits. In addition, the injunction ordered the defendants to reimburse the plaintiffs for out-of-pocket expenses incurred since the date of the earlier benefit modifications. We recorded a $5 million reserve at September 30, 2006 as the best estimate of our liability for these retroactive benefits. Including the estimated liability for retroactive benefits, the accounting for the injunction increased retiree medical expense by approximately $17 million in fiscal year 2006. We continue to believe we have meritorious defenses to these actions and have appealed the District Court’s order to the U.S. Court of Appeals for the Sixth Circuit. The ultimate outcome of the UAW lawsuit may result in future plan amendments. The impact of any future plan amendments cannot be currently estimated. Based on management’s assessment of the USW lawsuit, the 2002 and 2004 plan amendments are still in effect for USW retirees. The ultimate outcome of the USW lawsuit may result in future plan amendments. The impact of any future plan amendments cannot be currently estimated.
We previously announced our intention to divest our Light Vehicle Aftermarket (LVA) businesses and therefore these businesses are reported as discontinued operations for all periods presented. As previously mentioned, we sold our LVA North American filters, exhaust and motion control businesses, our Gabriel South Africa ride control business and our 39 percent interest in our Purolator India joint venture during fiscal year 2006, generating cash proceeds of approximately $220 million. These businesses represented a significant portion of our combined LVA business and we expect to complete the divestiture of our remaining LVA businesses in fiscal year 2007.
In December 2005, we sold our light vehicle ride control business located in Asti, Italy. This sale, along with the previous divestiture of our 75-percent interest in AP Amortiguadores, S.A. (APA) in the second quarter of fiscal year 2004, substantially
completed our plan to exit the LVS ride control business. Therefore, the results of operations of this business are included in discontinued operations for all periods presented.
Cash provided by operating activities for the fiscal year ended September 30, 2006 was $440 million, compared to $32 million of cash used by operating activities in the prior year. The increase in cash flow was largely driven by a reduction in working capital, including non-recourse sales of accounts receivable, and lower pension and retiree medical contributions of $50 million.
MARKET OUTLOOK
Historically, the company has experienced periodic fluctuations in demand for light, commercial and specialty vehicles and certain aftermarkets, most notably in our commercial vehicle markets in North America. Vehicle production in our principal markets for the last five fiscal years is shown below:
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Source: Automotive industry publications and management estimates.
We anticipate the North American heavy-duty truck market to decrease approximately 33% in fiscal year 2007, with production at an estimated 235,000 units. In Western Europe, we expect production of heavy- and medium-duty trucks to be approximately 419,000 units. Our most recent outlook shows North American and Western European light vehicle production during fiscal year 2007 to be about the same as fiscal year 2006.
COMPANY OUTLOOK
Our business continues to address a number of challenging industry-wide issues, including:
•
Excess capacity;
•
High commodity prices, particularly steel and oil prices;
•
Weakened financial strength of some of the original equipment (OE) manufacturers;
•
Employee labor relations;
•
Reduced production volumes and changes in product mix in North America;
•
Higher energy and transportation costs;
•
OE pricing pressures; and
•
Currency exchange rate volatility.
We believe the price of steel will continue to challenge our industry during fiscal year 2007. While we generally do not expect this issue to significantly impact our results of operations when compared to the prior year, rising stainless steel prices are expected to negatively impact earnings. We have taken actions to help mitigate this issue, including finding new global steel sources, identifying alternative materials, finding ways to re-engineer our products to be less dependent on steel, working with our suppliers to reduce material costs, consolidating and selling scrap from many of our facilities and negotiating with our customers to recover some of the higher steel costs. We continue to further consolidate and restructure our LVS business to address competitive challenges in the automotive supplier industry. Anticipated restructuring actions include those actions previously discussed.
Significant factors that could affect our results in fiscal year 2007 include:
•
Higher than planned price reductions to our customers;
•
Additional restructuring actions and the timing and recognition of restructuring charges;
•
Our ability to recover steel price increases from our customers;
•
The financial strength of our suppliers and customers, including potential bankruptcies;
•
Any unplanned extended shutdowns or production interruptions;
•
Our ability to implement planned productivity and cost reduction initiatives;
•
The impact of any acquisitions or divestitures;
•
Significant gains or losses of existing business;
•
The ultimate outcome of the three class action lawsuits concerning our retiree medical plans;
•
The impact of currency fluctuations on sales and operating income;
•
The emergence from bankruptcy of certain competitors;
•
Higher than planned warranty expenses;
•
Any adjustments to the contingent liability associated with the Tilbury labor disruption;
•
Our ability to continue to access our bank revolving credit facilities and capital markets;
•
A significant reduction of business activity in the key markets of our customers;
•
The expected 2007 Class 8 downturn in North America or Europe is more severe than currently planned;
•
Lower volume of orders from key customers;
•
Ability to implement enterprise resource planning systems at our location successfully; and
•
The impact of any new accounting rules.
Results of Operations
The following is a summary of our financial results for the last three fiscal years. Prior period amounts have been restated for discontinued operations.
2006 Compared to 2005
Sales
The following table reflects geographical business segment sales for fiscal years 2006 and 2005. The reconciliation is intended to reflect the trend in business segment sales and to illustrate the impact changes in foreign currency exchange rates and acquisitions and divestitures had on sales (in millions).
Continuing Operations
Sales for fiscal year 2006 were $9,195 million, up $322 million, or 4 percent, from fiscal year 2005. The increase in sales was attributable to strong commercial vehicle truck and trailer volumes in our CVS business segment and higher pass-through sales in our LVS business segment. These increases were partially offset by foreign currency translation, primarily due to the stronger euro in relation to the U.S. dollar, which reduced sales by $72 million, and lower volumes in our North American LVS businesses. Divestitures of certain LVS businesses in previous periods and the sale of certain assets of CVS’ off-highway brake business reduced sales in fiscal year 2006 by $81 million.
Business Segments
Light Vehicle Systems (LVS) sales increased to $4,905 million in fiscal year 2006, up $86 million, or 2 percent, from $4,819 million in fiscal year 2005. The effect of foreign currency translation decreased sales by $40 million. Pass-through sales were approximately $1,600 million in fiscal year 2006 compared to approximately $1,300 million in fiscal year 2005. The higher pass-through sales were partially offset by lower value added sales, lower selling prices to our customers and the loss of sales associated with previously announced divestitures. Pass-through sales are products sold to our customers where we acquire certain components and assemble them into the final product. These pass-through sales carry minimal margins, as we have little engineering or manufacturing responsibility.
Commercial Vehicle Systems (CVS) sales were $4,290 million, up $236 million, or 6 percent, from fiscal year 2005. The increase in sales was primarily attributable to strong commercial vehicle truck and trailer volumes. Compared to fiscal year 2005, production volumes in North America for commercial vehicle heavy-duty trucks (Class 8) increased 8 percent and medium duty trucks increased 4 percent. Western Europe heavy and medium duty truck volumes increased 4 percent. These increases were partially offset by the loss of sales associated with the divestiture of certain assets of the off-highway brakes business of approximately $57 million and foreign currency translation which reduced sales by $32 million.
Operating Income (Loss) and Operating Margins
The following table reflects operating income and operating margins for fiscal years 2006 and 2005 (dollars in millions).
Operating loss for fiscal year 2006 was $119 million, compared to operating income of $184 million in fiscal year 2005. Operating loss was significantly impacted by a $310 million non-cash goodwill impairment charge recorded in our light vehicle emissions technologies business in the fourth quarter of fiscal year 2006. A labor disruption and work stoppage at our commercial vehicle brakes operation in Tilbury, Ontario unfavorably impacted operating income by $45 million. Operating loss for fiscal year 2006 also includes a $23 million gain on the sale of certain assets of CVS’ off-highway brakes business.
We recorded restructuring costs during fiscal years 2006 and 2005 as follows (in millions):
(1) The fiscal year 2005 program relates to the restructuring actions announced in May 2005.
The benefit of higher sales levels in our CVS business and cost savings from our restructuring actions of $29 million were largely offset by the loss of income associated with certain of our previous divestitures of approximately $20 million and higher pension and retiree medical costs of $32 million when compared to the same period last year. Impacting operating income in fiscal year 2005 were $14 million of charges associated with certain customer bankruptcies; $7 million of environmental remediation costs, primarily associated with a former Rockwell facility; and a $4 million gain on the sale of an automotive stamping and components manufacturing operation in the first quarter of fiscal year 2005.
Selling, general and administrative expenses as a percentage of sales were 4.1 percent in fiscal year 2006, compared to 4.2 percent in the prior year.
Business Segments
LVS operating loss was $291 million, compared to operating income of $1 million in fiscal year 2005. The primary driver for the decrease in operating income is the $310 million non-cash goodwill impairment charge recorded in the fourth quarter of fiscal year 2006.
LVS recorded restructuring costs of $31 million in fiscal year 2006. These restructuring costs are net of reversals of costs recorded in previous periods of $12 million and include $39 million of employee termination benefits, $3 million of asset impairment charges and $1 million of other costs associated with the closure of certain facilities. In the prior year, LVS recorded restructuring costs of $67 million. These charges included $51 million of costs associated with the actions announced in the second quarter of fiscal year 2005 and $16 million associated with the closure of the Sheffield, England stabilizer bar facility, the consolidation of two facilities in Brazil and a reduction in workforce in LVS’ operations in Spain. The $16 million relates to employee termination benefits and other costs of $11 million and asset impairments of $5 million.
In fiscal year 2006, LVS was able to more than offset lower customer pricing with productivity and cost reduction actions and restructuring savings. Also impacting operating income in fiscal year 2006 were approximately $20 million of liabilities recorded for certain warranty and other commercial matters and $9 million of higher pension and retiree medical costs. LVS also recorded a $5 million gain on the liquidation of Meritor Suspension Systems Holding (UK) Ltd., a joint venture, in fiscal year 2006. This gain primarily related to the extinguishment of debt owed to the minority partner. Operating income in fiscal year 2005 included $11 million of charges associated with certain customer bankruptcies, a $4 million net charge associated with a product warranty matter and a $4 million gain on the sale of LVS’ Columbus, Indiana stamping and manufacturing components business in the first quarter of fiscal year 2005.
CVS operating income was $185 million in fiscal year 2006, down from $193 million in fiscal year 2005. Operating margin declined to 4.3 percent, from 4.8 percent in fiscal year 2005. The benefits of higher sales volumes were more than offset by the labor disruption and work stoppage at our brakes facility in Tilbury, which unfavorably impacted operating income by $45 million, approximately $24 million of liabilities for certain warranty and other commercial matters and $23 million of higher pension and retiree medical costs. Favorably impacting operating income was a $23 million gain on the sale of certain assets of the off-highway brake business, productivity and cost reduction actions and restructuring savings. CVS recorded restructuring costs of $6 million in fiscal year 2006, primarily related to employee severance benefits, compared to restructuring costs of $19 million in the prior year. Impacting fiscal year 2005 operating income was a $3 million charge associated with the bankruptcy of a European trailer customer.
Other Income Statement Items
Equity in earnings of affiliates was $36 million in fiscal year 2006, compared to $28 million in fiscal year 2005. The increase was primarily related to improved performance and higher earnings of our commercial vehicle affiliates.
Interest expense, net and other was $133 million in fiscal year 2006 compared to $127 million in fiscal year 2005. Included in interest expense, net and other in fiscal year 2006 were $9 million of costs associated with the extinguishment of $600 million of notes we repurchased in the second quarter of fiscal year 2006. These costs include transaction expenses, including legal and other professional fees, unamortized debt issuance costs, and premiums paid to repurchase the notes. Included in interest expense, net and other in fiscal year 2005 was a $4 million loss on debt extinguishment associated with the debt exchange completed in the fourth quarter of fiscal year 2005. The loss on debt extinguishment primarily consisted of the premium paid to note holders to exchange their notes. See “Liquidity and Contractual Obligations” for further details concerning these debt extinguishments. The favorable impact of reduced fixed rate debt was partially offset by higher levels of short term borrowings and higher interest rates on our variable rate debt compared with the prior year.
Income tax benefit from continuing operations in fiscal year 2006 was $56 million compared to income tax expense of $16 million in the prior year. In fiscal year 2006, we recorded a $23 million tax benefit related to the expiration of certain statutes of limitations and the completion of various worldwide tax audits of certain of the company’s income tax returns. We also repatriated approximately $152 million in dividends in the fourth quarter of fiscal year as part of the American Jobs Creation Act of 2004. The dividends are subject to the elective 85 percent dividend received deduction and accordingly we recorded a corresponding tax benefit of $37 million related to the reversal of previously provided U.S. deferred tax liability on these unremitted foreign subsidiary earnings.
Minority interest expense was $14 million in fiscal year 2006 compared to $6 million in fiscal year 2005. Minority interests represent our minority partners’ share of income or loss associated with our less than 100-percent owned consolidated joint ventures. The increase in minority interest expense in fiscal year 2006 was primarily due to improved earnings in our commercial vehicle affiliates and the closure of the Sheffield, England, stabilizer bar facility in our MSSH joint venture in fiscal year 2005.
Loss from continuing operations for fiscal year 2006 was $174 million, or $2.51 per diluted share, compared to income from continuing operations of $63 million, or $0.90 per diluted share in fiscal year 2005. The decrease is primarily attributable to the $310 million goodwill impairment charge recorded in the fourth quarter of fiscal year 2006, partially offset by the income tax benefits previously mentioned.
Loss from discontinued operations was $1 million in fiscal year 2006 compared to $51 million in fiscal year 2005.
In fiscal year 2006, we completed the sale of our LVA North American filters, exhaust and motion control businesses, our Gabriel South Africa ride control business and our 39 percent interest in our Purolator India joint venture. Cash proceeds from these divestitures were approximately $220 million, resulting in a net pre-tax gain of $28 million ($18 million after-tax). We also recorded non-cash impairment charges of $22 million ($14 million after-tax) during fiscal year 2006 in certain of our LVA businesses. A non-cash impairment charge of $43 million ($28 million after-tax) related to our LVA businesses was recorded in fiscal year 2005. A $2 million after-tax gain on the sale of our coil coating business is included in income from discontinued operations in fiscal year 2005. Also impacting fiscal year 2005 were $6 million of after-tax changeover costs in LVA associated with a new supply agreement with a significant customer.
Loss from discontinued operations in fiscal years 2006 and 2005 includes after-tax restructuring costs of $4 million and $1 million, respectively, related to our LVA businesses.
Also included in loss from discontinued operations in fiscal year 2006 is an after-tax loss of $2 million on the sale of our LVS ride control business located in Asti, Italy and a reversal of approximately $7 million of after-tax employee severance benefits that were recorded in the prior year as part of our fiscal year 2005 restructuring actions. As a result of the sale of the ride control operations in Asti, Italy, these employee termination benefits will no longer be paid. Loss from discontinued operations in the prior year includes approximately $20 million of after-tax restructuring costs related to the previously expected closure of our light vehicle ride control operations.
2005 Compared to 2004
Sales
The following table reflects geographical business segment sales for fiscal years 2005 and 2004. The reconciliation is intended to reflect the trend in business segment sales and to illustrate the impact changes in foreign currency exchange rates and acquisitions and divestitures had on sales (in millions).
Continuing Operations
Sales for fiscal year 2005 were $8,873 million, up $986 million, or 13 percent, over fiscal year 2004. The increase in sales was attributable to stronger commercial vehicle truck and trailer volumes in our CVS business segment; new business awards, principally associated with suspension modules in our LVS business; and foreign currency translation, primarily due to the stronger euro in relation to the U.S. dollar. These increases were partially offset by lower volumes in certain of our European LVS businesses. Acquisitions, primarily our two new consolidated joint ventures with AB Volvo, added sales of $235 million; divestitures of certain LVS businesses in fiscal years 2005 and 2004 reduced sales in fiscal year 2005 by $120 million.
Business Segments
LVS sales increased to $4,819 million in fiscal year 2005, up $147 million, or 3 percent, from fiscal year 2004. The effect of foreign currency translation, primarily as a result of the stronger euro when compared to the US dollar, increased sales by $202 million. Divestitures, primarily the sale an automotive stamping and components manufacturing operation in the first quarter of fiscal year 2005, reduced sales by $120 million. Excluding the impact of foreign currency translation and divestitures, sales were up $65 million. Higher pass-through sales of approximately $300 million, principally associated with our new suspension module business, were partially offset by lower OE demand particularly in certain of our European businesses. Pass-through sales increased to approximately $1,300 million in fiscal year 2005 from approximately $1,000 million in fiscal year 2004.
CVS sales were $4,054 million, up $839 million, or 26 percent, from fiscal year 2004. The increase in sales was primarily attributable to stronger commercial vehicle truck and trailer volumes. Compared to fiscal year 2004, production volumes in North America for commercial vehicle heavy-duty trucks (Class 8) increased approximately 38 percent, medium duty trucks increased 21 percent and trailer volumes increased 15 percent. South American truck volumes increased 17 percent. Acquisitions, primarily the formation of two joint ventures with AB Volvo in the first quarter of fiscal 2005, added sales of $235 million.
Operating Income and Operating Margins
The following table reflects operating income and operating margins for fiscal years 2005 and 2004 (dollars in millions).
Operating income in fiscal year 2005 was $184 million, a decrease of $71 million, compared to fiscal year 2004, reflecting an operating margin of 2.1 percent, down from 3.2 percent. We recorded restructuring costs of $86 million during fiscal year 2005 as follows (in millions):
(1) The fiscal year 2005 program relates to the restructuring actions announced in May 2005
In addition to the fiscal year 2005 program, we recorded restructuring charges of $16 million in fiscal year 2005. These costs were primarily for severance and other employee termination costs, related to a reduction of approximately 20 salaried and 355 hourly employees, and asset impairments. These costs relate to the closure of the Sheffield, England, stabilizer bar facility, the consolidation of two facilities in Brazil and a reduction in workforce in our operations in Spain.
We recorded restructuring charges of $15 million in fiscal year 2004. These costs included severance and other employee termination costs of $10 million related to a reduction of approximately 50 salaried employees and 575 hourly employees in our LVS business, and $5 million associated with certain administrative and managerial employee termination costs.
Despite the higher sales levels, operating income in fiscal year 2005 was negatively impacted by the restructuring costs noted above and steel costs, which, net of recoveries, were approximately $90 million higher than in fiscal year 2004. Also impacting operating income in fiscal year 2005 were $14 million of charges associated with certain customer bankruptcies; $7 million of environmental remediation costs, primarily associated with a former Rockwell facility; and a $4 million gain on the sale of an automotive stamping and components manufacturing operation in the first quarter of fiscal year 2005. Retiree medical and pension costs were $16 million lower than fiscal year 2004. This is a result of amending certain retiree medical plans in fiscal year 2004, which reduced retiree medical expense by $22 million compared to fiscal year 2004.
Operating income in fiscal year 2004 includes the costs associated with the withdrawn tender offer for the outstanding shares of Dana Corporation (Dana) of $16 million (before a non-operating gain of $7 million on the sale of Dana stock owned by the company), and environmental remediation costs of $11 million (associated with a different Rockwell facility).
Selling, general and administrative expenses as a percentage of sales decreased to 4.2 percent in fiscal year 2005 from 4.8 percent in fiscal year 2004 due to reduced headcount resulting from the restructuring actions and our continued efforts to reduce selling, general and administrative spending.
Business Segments
LVS operating income was $1 million, a decrease of $117 million from operating income of $118 million in fiscal year 2004. The decrease in operating income is primarily due to the previously mentioned restructuring actions and higher steel costs in fiscal year 2005. LVS continued its restructuring efforts in fiscal year 2005 and recorded $67 million of restructuring charges
associated with facility closures and consolidations and workforce reductions compared to $10 million in the prior year. These fiscal year 2005 costs include $40 million of employee termination costs and $11 million of asset impairments related to the restructuring actions announced in May 2005. Additionally, LVS recorded $16 million of restructuring costs associated with the closure of its Sheffield, England, stabilizer bar facility, the consolidation of two facilities in Brazil and a reduction in workforce in its operations in Spain. The $16 million relates to employee termination benefits and other costs of $11 million and asset impairments of $5 million. Total headcount reductions associated with all of these actions were approximately 2,250, of which 500 were salaried employees and 1,750 were hourly employees.
LVS continued to experience narrowing margins in fiscal year 2005 due primarily to higher steel costs. LVS incurred higher net steel costs of approximately $40 million in fiscal year 2005. Also impacting operating income in fiscal year 2005, were lower value added sales volumes (non pass-through sales), $11 million of charges associated with certain customer bankruptcies and a $4 million net charge associated with a product warranty matter. LVS operating income improved by $13 million from fiscal year 2004 due to a reduction in foreign exchange loss attributable to the impact of hedging foreign exchange transactions in fiscal year 2005 that were not hedged in fiscal year 2004. LVS also recorded a $4 million gain on the sale of an automotive stamping and components manufacturing operation in the first quarter of fiscal year 2005.
CVS operating income was $193 million, an increase of $29 million from fiscal year 2004. Operating margin declined to 4.8 percent, from 5.1 percent in fiscal year 2004. The increase in operating income was largely attributable to higher sales volumes. The benefits of the higher sales volumes were partially offset by higher net steel costs of $50 million, and $19 million of restructuring costs principally associated with the reduction of approximately 225 salaried employees and 200 hourly employees. Also negatively impacting operating income was a $3 million charge associated with the bankruptcy of a European trailer customer. Retiree medical and pension costs were $18 million lower than the previous year, as a result of the amendment to certain retiree medical plans in fiscal year 2004. Fiscal year 2004 operating income included a $4 million charge in the fourth quarter associated with the settlement of a warranty matter.
Other Income Statement Items
Equity in earnings of affiliates was $28 million in fiscal year 2005, compared to $19 million in fiscal year 2004. The increase was primarily related to improved performance and higher earnings of our commercial vehicle affiliates. The increase was also partially driven by the reduction in losses associated with the dissolution of our CVS transmission joint venture with ZF Friedrichshafen in the second quarter of fiscal year 2004. We recorded equity losses of $4 million in fiscal year 2004 related to this joint venture.
Interest expense, net and other was $127 million in fiscal year 2005 compared to $107 million in fiscal year 2004. The increase in interest expense was primarily attributable to higher interest rates on our variable rate debt compared with fiscal year 2004. Also included in interest expense, net and other in fiscal year 2005 was a $4 million loss on debt extinguishment associated with the debt exchange completed in the fourth quarter of fiscal year 2005. The loss on debt extinguishment primarily consisted of the premium paid to note holders to exchange their notes. See “Liquidity and Contractual Obligations” for further details concerning the debt extinguishment.
Provision for income taxes was $16 million in fiscal year 2005, resulting in an effective rate of 19 percent. The effective tax rate was 27 percent in fiscal year 2004. The decline in the tax rate is principally associated with lower income levels relative to our structural tax position.
Minority interest expense was $6 million in fiscal year 2005 compared to $11 million in fiscal year 2004. Minority interests represent our minority partners’ share of income or loss associated with our less than 100-percent owned consolidated joint ventures. The decrease in minority interest expense in fiscal year 2005 is primarily related to our minority partners’ share of $9 million of restructuring costs associated with the closure of the Sheffield, England, stabilizer bar facility in our MSSC joint venture.
Income from continuing operations for fiscal year 2005 was $63 million, compared to $117 million in fiscal year 2004. The decrease was primarily attributable to the $86 million of restructuring costs and higher net steel costs of approximately $90 million, offset partially by the higher CVS sales volumes.
Loss from discontinued operations was $51 million in fiscal 2005 compared to a loss from discontinued operations of $159 million in fiscal 2004. In the fourth quarter of fiscal 2005, management concluded that it is more likely that LVA’s North American businesses will be sold individually. As a result, the company evaluated fair value on an individual business basis rather than LVA North America as a whole. This resulted in a non-cash impairment charge of $43 million ($28 million after-tax) to record certain LVA North American businesses at fair value. Also impacting fiscal year 2005, were $6 million of after-tax changeover costs in LVA, associated with a new supply agreement with a significant customer, which were more than offset by
lower depreciation expense. In accordance with accounting principles generally accepted in the United States, our LVA business segment discontinued depreciating fixed assets as of September 30, 2004. Depreciation expense in fiscal year 2004 was approximately $14 million after-tax.
The fiscal year 2004 results included a non-cash goodwill impairment charge of $190 million in our LVA business and a $20 million gain on the sale of an interest in a ride control joint venture. For more information on the impairment charge see Note 3 of the Notes to Consolidated Financial Statements.
In an effort to lower fixed costs and improve profitability resulting from weakening demand in the aftermarket business, LVA recorded after-tax restructuring costs totaling $1 million and $2 million during fiscal years 2005 and 2004, respectively. We also recorded after-tax restructuring costs of $19 million related to our LVS ride control business in fiscal year 2005. These costs included $10 million of employee termination benefits and $9 million of asset impairment charges.
Also impacting loss from discontinued operations in fiscal year 2005 was the loss of approximately $6 million of income from our coil coating business as a result of the sale of this business in November 2004. This loss of net income was offset partially by a $2 million gain on the sale of this business.
The effective tax rate for discontinued operations was 30 percent in fiscal year 2005, up from a negative 9 percent in fiscal year 2004. The negative tax rate in fiscal year 2004 was primarily due to the $190 million non-cash goodwill impairment charge, for which no tax benefit was provided.
Non-Consolidated Joint Ventures
At September 30, 2006, our continuing operations had investments in 10 significant joint ventures that were not majority-owned or controlled and were accounted for under the equity method of accounting. Our investments in non-consolidated joint ventures was $133 million and $114 million at September 30, 2006 and 2005, respectively.
These strategic alliances provide for sales, product design, development and manufacturing in certain product and geographic areas. Aggregate sales of our non-consolidated joint ventures were $1,795 million, $1,488 million and $1,100 million in fiscal years 2006, 2005 and 2004, respectively.
We received cash dividends from our affiliates of $23 million, $18 million and $15 million in fiscal years 2006, 2005 and 2004, respectively.
For more information about our non-consolidated joint ventures, see Note 13 of the Notes to Consolidated Financial Statements.
Financial Condition
Capitalization
We remain committed to strong cash flow generation, the reduction of debt and regaining an investment grade credit rating. In March 2006, we issued $300 million of 4.625 percent convertible senior unsecured notes due 2026. Net proceeds from the offering, along with proceeds from the sale of certain of our LVA businesses and borrowings under our accounts receivable securitization programs, were used to purchase and extinguish $672 million of notes with maturities between 2007 and 2012. Our total debt to capitalization ratio was 55 percent at September 30, 2006, compared to 63 percent at September 30, 2005.
For fiscal year 2006, our primary source of liquidity was cash from operating activities and proceeds from the divestitures of certain businesses, supplemented by our accounts receivables securitization and factoring programs and, as required, borrowings on our revolving credit facility.
Cash Flows
Cash provided by operating activities was $440 million in fiscal year 2006, compared to cash used by operating activities of $32 million in fiscal year 2005. The increase in cash flow was largely driven by a reduction in working capital, including non-recourse sales of accounts receivable, and lower pension and retiree medical contributions of $50 million, partially offset by higher cash restructuring costs. In addition, in fiscal year 2005, we used approximately $110 million of cash for working capital requirements at our new joint ventures with AB Volvo and to support higher CVS volumes. In fiscal year 2005, we partially terminated certain interest rate swaps and received proceeds from these terminations, including interest received, of $22 million.
Cash used for discontinued operations was $24 million in fiscal year 2006 compared to $141 million a year ago. Lower working capital levels contributed to this decline. In addition, in fiscal year 2005, LVA ceased participating in our accounts receivable securitization program. This increased LVA’s outstanding receivables by approximately $80 million during fiscal year 2005.
In fiscal year 2004, cash provided by operating activities was $219 million. Cash flow in fiscal year 2004 was favorably impacted by our fiscal calendar, which included 53 weeks in fiscal year 2004, compared to 52 weeks in fiscal year 2005. We used cash from operations and cash generated from the disposition of property, businesses and marketable securities to reduce our balances outstanding under our accounts receivable securitization and factoring programs by $187 million and our revolving credit facility by $53 million in fiscal year 2004.
Cash provided by investing activities was $110 million in fiscal year 2006, compared to $25 million in fiscal year 2005 and cash used by investing activities of $120 million in fiscal year 2004. During fiscal year 2006, we received proceeds of $39 million from the disposition of certain assets of our off-highway brakes business. We also received $26 million from the sale of various properties and machinery and equipment. These assets primarily related to closed facilities. In the third quarter of fiscal year 2006, we purchased $12 million of U.S. government securities and placed those securities into an irrevocable trust, for the sole purpose of funding payments of principal and interest through the stated maturity on $5 million principal amount of outstanding 6-3/4 percent notes due 2008 and the $6 million principal amount of outstanding 7-1/8 percent notes due 2009, in order to defease certain covenants under the associated indenture.
During fiscal year 2005, we used $31 million of cash for the acquisition of businesses, primarily the formation of two joint ventures with AB Volvo, and we received proceeds of $49 million from the disposition of certain property and businesses principally associated with the sale of our Columbus, Indiana automotive stamping and components manufacturing business.
Capital expenditures increased to $150 million in fiscal year 2006 from $144 million in fiscal year 2005. We continue to manage our capital expenditures and leverage our global supply base and the assets of our affiliate partners. As a result, capital expenditures as a percentage of sales were 1.6 percent in fiscal year 2006, flat compared to fiscal year 2005 and down from 1.9 percent in fiscal year 2004.
During fiscal year 2004, we received proceeds from the disposition of certain property and businesses of $37 million, principally from the sale of our trailer beam fabrication facility. We also received $18 million in cash from the sale of Dana stock.
Discontinued operations provided cash flows from investing activities of $218 million in fiscal year 2006, primarily related to the cash received from the sales of certain of our LVA businesses and our 39-percent equity ownership interest in Purolator India, a light vehicle aftermarket joint venture. In fiscal year 2005, discontinued operations provided investing cash flows of $151 million, primarily related to the proceeds from the sale of our coil coating business. Discontinued operations used cash of $6 million for capital expenditures in fiscal year 2006 compared to $12 million in fiscal year 2005.
In fiscal year 2004, cash used by discontinued operations was $23 million which included $54 million related to the buy-out of a lease associated with our coil coating business and capital expenditures, partially offset by $48 million of proceeds received from the sale of our interest in a joint venture.
Cash used for financing activities was $391 million in fiscal year 2006 compared to cash provided by financing activities of $54 million in fiscal year 2005. In the third quarter of fiscal year 2006, we replaced our $900 million revolving credit facility that was to expire in 2008 with two new senior secured credit facilities totaling $1.15 billion. The new credit facilities include a six year $170 million term loan and $980 revolving credit facility which expires in 2011. In March 2006, we issued $300 million of 4.625 percent convertible senior unsecured notes due in 2026. Net proceeds from the offering, along with proceeds from the sales of our LVA North American filters and exhaust businesses and borrowings under our accounts receivable securitization programs were used to purchase and extinguish $600 million of certain outstanding near-term debt maturities. We incurred $28 million of costs related to these transactions. Additionally, in fiscal year 2006, we purchased, at a discount, $72 million of certain of our other fixed rate debt securities on the open market. The reduction in amounts outstanding under lines of credit and other of $62 million in fiscal year 2006 is primarily due to the payment of $35 million to extinguish a capital lease obligation.
In September 2005, we entered into a new U.S. accounts receivable securitization arrangement. Amounts outstanding under this new arrangement are reported as short-term debt in the consolidated balance sheet and related borrowings are reported as cash flows from financing activities in the consolidated statement of cash flows. At September 30, 2006 and 2005, $40 million and $112 million was outstanding under this facility, respectively.
In fiscal year 2005, we purchased, at a discount, $20 million and $1 million of our 8-3/4 percent notes and 6.8 percent notes, respectively, on the open market. In September 2005, we paid $10 million of debt issuance costs to complete an offer to exchange a new series of debt securities for $194 million of our $499 million 6.8 percent notes due in 2009, and $59 million of our $150 million 7-1/8 percent notes also due in 2009. During fiscal year 2004, we decreased amounts outstanding under our revolving credit facility by $53 million.
We paid dividends of $28 million in each of fiscal years 2006, 2005 and 2004. In each of fiscal years 2005 and 2004, proceeds of $6 million were received from the exercise of stock options.
Liquidity and Contractual Obligations
We are contractually obligated to make payments as follows (in millions):
(1) Excludes fair value adjustment of notes of $8 million and unamortized debt discount of $1 million.
(2) Includes the estimated impact of our interest rate swaps.
In addition to the obligations above, in connection with the sale of our LVA North American filters business in fiscal year 2006, we agreed to indemnify the purchaser against liabilities from litigation and commercial losses in connection with specific intellectual property claims, with the maximum potential indemnity capped at $4 million for commercial losses.
We also sponsor defined benefit pension plans that cover most of our U.S. employees and certain non-U.S. employees. Our funding practice provides that annual contributions to the pension trusts will be at least equal to the minimum amounts required by ERISA in the U.S. and the actuarial recommendations or statutory requirements in other countries. Management expects funding for our retirement pension plans of approximately $134 million in fiscal year 2007.
We also sponsor retirement medical plans that cover the majority of our U.S. and certain non-U.S. employees and provide for medical payments to eligible employees and dependents upon retirement. Management expects retiree medical plan benefit payments of approximately $54 million in fiscal year 2007; $53 million in fiscal year 2008; $52 million in fiscal year 2009; $51 million in fiscal year 2010; and $50 million in fiscal year 2011.
Revolving and Other Debt - In June 2006, we replaced our $900 million revolving credit facility that was to expire in 2008 with two new senior secured credit facilities totaling $1.15 billion (the new credit facilities). The new credit facilities include a $980 million revolving credit facility and a $170 million term loan maturing in 2011 and 2012, respectively. Borrowings under the new revolving credit facility are subject to interest based on quoted LIBOR rates plus a margin, and a commitment fee on undrawn amounts, both of which are based upon the company’s current credit rating for the senior secured facilities. At September 30, 2006, the margin over the LIBOR rate was 150 basis points, and the commitment fee was 30 basis points. Similar to the prior revolving credit facility, the new revolving credit facility includes a $150 million limit on the issuance of letters of credit. At September 30, 2006 and 2005, approximately $25 million and $23 million of letters of credit, respectively, were issued.
The term loan is payable in quarterly installments of $0.25 million, with the remaining balance due at maturity. Borrowings under the term loan are subject to interest based on quoted LIBOR rates plus a margin. At September 30, 2006, the margin over the LIBOR rate was 175 basis points.
Borrowings under the revolving credit facility and term loan are collateralized by approximately $1.1 billion of the company’s assets, primarily consisting of eligible domestic U.S. accounts receivable, inventory, plant, property, and equipment, intellectual property and the company’s investment in all or a portion of certain of its wholly-owned subsidiaries.
Certain of the company’s subsidiaries, as defined in the credit agreement, irrevocably and unconditionally guarantee amounts outstanding under the new credit facilities. The new credit facility requires us to maintain a total net debt to earnings before interest, taxes, depreciation and amortization (“EBITDA”) ratio no greater than 4.25x and a minimum fixed charge coverage ratio (EBITDA less capital expenditures to interest expense) no less than 1.50x. At September 30, 2006, we were in compliance with all covenants.
We also have an arrangement with a non-consolidated joint venture that allows us to borrow funds from time to time, at LIBOR plus 50 basis points. No amounts were outstanding under this arrangement at September 30, 2006 and 2005.
Debt Securities - In fiscal year 2006, we purchased, at a discount, $69 million of our $380 million outstanding 8-3/4 percent notes and $3 million of our outstanding 6.8 percent notes on the open market.
In March 2006, we completed an offer to repurchase $600 million aggregate principal amount of our previously outstanding notes in the following amounts: $195 million of our outstanding $200 million 6.625 percent notes due in 2007; $95 million of our outstanding $100 million 6.75 percent notes due in 2008; $225 million of our outstanding $302 million 6.8 percent notes due in 2009; and $85 million of our outstanding $91 million 7.125 percent notes also due in 2009.
In the third quarter of fiscal year 2006, the company purchased $12 million of U.S. government securities and placed those securities into an irrevocable trust, for the sole purpose of funding payments of principal and interest through the stated maturity on the $5 million outstanding 6-3/4% notes due 2008 and the $6 million outstanding 7.125% notes due 2009, in order to defease certain covenants under the associated indenture.
In September 2005, we completed an offer to exchange $194 million of our previously outstanding $499 million 6.8 percent notes due in 2009, and $59 million of our previously outstanding $150 million 7-1/8 percent notes also due in 2009 for $253 million of new 8-1/8 percent notes due in 2015. Also in fiscal year 2005, we purchased, at a discount, $20 million and $1 million of our 8-3/4 percent notes and 6.8 percent notes, respectively, on the open market.
We have $150 million of debt securities remaining unissued under the shelf registration filed with the SEC in April 2001 (see Note 16 of the Notes to Consolidated Financial Statements).
Convertible Notes - In March 2006, the company issued $300 million of 4.625 percent convertible senior unsecured notes due 2026 (the “convertible notes”). The convertible notes were sold by the company to qualified institutional buyers in a private placement exempt from the registration requirements of the Securities Act of 1933. These convertible notes were registered with the Securities and Exhange Commission under the Securities Act of 1993 on May 23, 2006. Net proceeds received by the company, after issuance costs, were $289 million. Cash interest at a rate of 4.625 percent per annum from the date of issuance through March 1, 2016 is payable semi-annually in arrears on March 1 and September 1 of each year. After March 1, 2016, the principal amount of the convertible notes will be subject to accretion at a rate that provides holders with an aggregate annual yield to maturity of 4.625 percent.
The notes are convertible into shares of the company’s common stock at an initial conversion rate, subject to adjustment, equivalent to 47.6667 shares of common stock per $1,000 initial principal amount of notes, which represents an initial conversion price of approximately $20.98 per share. If converted, the accreted principal amount will be settled in cash and the remainder of the company’s conversion obligation, if any, in excess of such accreted principal amount will be settled in cash, shares of common stock, or a combination thereof, at the company’s election.
Holders may convert their notes at any time on or after March 1, 2024. Prior to March 1, 2024, holders may convert their notes only under the following circumstances:
•
during any calendar quarter, after the calendar quarter ending June 30, 2006, if the closing price of our common stock for 20 or more trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter exceeds 120 percent of the applicable conversion price;
•
during the five business day period after any five consecutive trading day period in which the average trading price per $1,000 initial principal amount of notes is equal to or less than 97 percent of the average conversion value of the notes during such five consecutive trading day period;
•
upon the occurrence of specified corporate transactions; or
•
if the notes are called by us for redemption.
On or after March 1, 2016, we may redeem the convertible notes, in whole or in part, for cash at a redemption price equal to 100 percent of the accreted principal amount plus any accrued and unpaid interest. On each of March 1, 2016, 2018, 2020, 2022, and 2024, or upon certain fundamental changes, holders may require the company to purchase all or a portion of their convertible notes at a purchase price in cash equal to 100 percent of the accreted principal amount plus any accrued and unpaid interest.
Accounts Receivable Securitization and Factoring - In March 2006, we entered into a new European arrangement to sell trade receivables through one of our European subsidiaries. Under the new arrangement, we can sell up to, at any point in time, 100 million ($127 million) of eligible trade receivables. The receivables under this program are sold at face value and excluded from the consolidated balance sheet. We had utilized 48 million ($61 million) of this accounts receivable securitization facility as of September 30, 2006.
In September 2005, we entered into a new $250 million U.S. accounts receivable securitization arrangement to improve financial flexibility and lower interest costs. Under the new arrangement, the company sells substantially all of the trade receivables of certain U.S. subsidiaries to ArvinMeritor Receivables Corporation (ARC), a wholly owned, consolidated special purpose subsidiary, which funds these purchases with borrowings under a loan agreement with a bank. Amounts outstanding under this agreement are collateralized by eligible receivables of ARC and are reported as short-term debt in the consolidated balance sheet. As of September 30, 2006 and 2005, we had utilized $40 million and $112 million of this accounts receivable securitization facility, respectively. If certain receivables performance-based covenants were not met, it would constitute a termination event, which, at the option of the banks, could result in termination of the accounts receivable securitization arrangement. At September 30, 2006, we were in compliance with all covenants.
In addition, several of our European subsidiaries factor eligible accounts receivable with financial institutions. The amount of factored receivables was $84 million and $23 million at September 30, 2006 and 2005, respectively. There can be no assurance that these factoring arrangements will be used or available to us in the future.
Off-Balance Sheet Arrangements
Guarantees - In December 2005, we guaranteed a third party’s obligation to reimburse another party (the other party) for payment of health and prescription drug benefits to a group of retired employees. The retirees were former employees of a wholly-owned subsidiary of the company prior to it being acquired by the company. To date, the third party has met its obligations to reimburse the other party. The APBO associated with these retiree medical benefits is considered the maximum potential exposure under this guarantee, and is estimated to be approximately $25 million. No amount has been recorded for this guarantee based on the probability of our having to perform under the guarantee. Due to the nature of this guarantee it is difficult to estimate its approximate term.
We have guaranteed certain trade payable balances of one of its non-consolidated joint ventures. In the event of a default by the joint venture, we would be required to pay the guaranteed party. The maximum exposure under the guarantee is $4 million and can be terminated by the company at any time on thirty days written notice. The estimated fair value of this guarantee is not significant, and therefore, no liability is recorded.
In addition to these guarantees we have other off-balance sheet arrangements, primarily related to our European accounts receivable securitization program and letters of credit under our senior secured credit facilities. See “Revolving and Other Debt” and “Accounts Receivable Securitization and Factoring.”
Tender Offer
In the first quarter of fiscal year 2004, as a result of the company’s decision to withdraw its all cash tender offer to acquire all of the outstanding shares of Dana Corporation, the company recorded a net charge of $9 million ($6 million after-tax, or $0.09 per diluted share). The pre-tax charge included $16 million in direct incremental acquisition costs, less a gain on the sale of Dana stock of $7 million.
Critical Accounting Policies
Critical accounting policies are those that are most important to the portrayal of the company’s financial condition and results of operations. These policies require management’s most difficult, subjective or complex judgments in the preparation of the financial statements and accompanying notes. Management makes estimates and assumptions about the effect of matters that are inherently uncertain, relating to the reporting of assets, liabilities, revenues, expenses and the disclosure of contingent assets and liabilities. Our most critical accounting policies are discussed below.
Pensions - Our pension obligations are determined on an actuarial basis annually and are measured as of June 30. The U.S. plans include a qualified and non-qualified pension plan. Significant non-U.S. plans are located in the United Kingdom, Canada and Germany. The following are the significant assumptions used in the measurement of the projected benefit obligation (PBO) and net periodic pension expense:
The discount rate is used to calculate the present value of the PBO. The rate is determined based on high-quality fixed income investments that match the duration of expected benefit payments. The company uses a portfolio of long-term corporate AA/Aa bonds that match the duration of the expected benefit payments to establish the discount rate for this assumption.
The assumed return on plan assets is used to determine net periodic pension expense. The rate of return assumptions are based on projected long-term market returns for the various asset classes in which the plans are invested, weighted by the target asset allocations. An incremental amount for active management, where appropriate, is included in the rate of return assumption. The return assumption is reviewed annually.
The rate of compensation increase represents the long-term assumption for expected increases to salaries for pay-related plans.
These assumptions reflect our historical experience and our best judgments regarding future expectations. The effects of the indicated increase and decrease in selected assumptions, assuming no changes in benefit levels and no amortization of gains or losses for the plans in 2006, are shown below (in millions):
NA - Not Applicable
Accounting guidance applicable to pensions does not require immediate recognition of the effects of a deviation between actual and assumed experience and the revision of an estimate. This approach allows the favorable and unfavorable effects that fall within an acceptable range to be netted and disclosed as an unrecognized gain or loss in the footnotes. Based on the June 30, 2006
and 2005 measurement date, we had an unrecognized loss of $587 million and $866 million, respectively, at September 30, 2006 and 2005. A portion of this loss will be recognized into earnings in fiscal year 2007. The effect on fiscal years after 2007 will depend on the actual experience of the plans.
In recognition of the long-term nature of the liabilities of the pension plans, we have targeted an asset allocation strategy designed to promote asset growth while maintaining an acceptable level of risk over the long term. Asset-liability studies are performed periodically to validate the continued appropriateness of these asset allocation targets. The asset allocation for the U.S. plan is targeted at 50-70 percent equity securities, 25-35 percent debt securities, and 5-15 percent alternative investments. The target asset allocation ranges for the non-U.S. plans are 65-75 percent equity securities, 20-35 percent debt securities, and 0-5 percent real estate and alternative investments. The asset class mix and the percentage of securities in any asset class or market may vary as the risk/return characteristics of either individual market or asset classes vary over time.
The investment strategies for the pension plans are designed to achieve an appropriate diversification of investments as well as safety and security of the principal invested. Assets invested are allocated to certain global sub-asset categories within prescribed ranges in order to promote international diversification across security type, issuer type, investment style, industry group, and economic sector. Assets of the plans are both actively and passively managed. Policy limits are placed on the percentage of plan assets that can be invested in a security of any single issuer and minimum credit quality standards are established for debt securities. ArvinMeritor securities comprised less than one-half percent of the value of our worldwide pension assets as of September 30, 2006.
The fiscal year 2007 pension expense is estimated to be $76 million. This may vary depending upon the accuracy of our original and future assumptions.
Retiree Medical - We have retirement medical plans that cover the majority of our U.S. and certain non-U.S. employees and provide for medical payments to eligible employees and dependents upon retirement. Our retiree medical obligations are measured as of June 30.
The following are the significant assumptions used in the measurement of the accumulated postretirement benefit obligation (APBO):
The discount rate is the rate used to calculate the present value of the APBO. The rate is determined based on high-quality fixed income investments that match the duration of expected benefit payments. We have typically used the corporate AA/Aa bond rate for this assumption.
The health care cost trend rate represents the company’s expected annual rates of change in the cost of health care benefits. The trend rate noted above represents a forward projection of health care costs as of the measurement date. Our projection for fiscal year 2007 is an increase in health care costs of 8.0 percent. For measurement purposes, the annual increase in health care costs was assumed to decrease gradually to 5.0 percent by fiscal year 2011 and remain at that level thereafter.
A one-percentage point change in the assumed health care cost trend rate for all years to, and including, the ultimate rate would have the following effects (in millions):
Fiscal year 2007 retiree medical expense is estimated to be approximately $57 million. This may vary depending upon the accuracy of our original and future assumptions.
Product Warranties - Our CVS segment records product warranty costs at the time of shipment of products to customers. Liabilities for product recall campaigns are recorded at the time the company’s obligation is known and can be reasonably estimated. Product warranties, including recall campaigns, not expected to be paid within one year are recorded as a non-current liability.
Our LVS segment records product warranty liabilities based on its individual customer or warranty-sharing agreements. Product warranties are recorded for known warranty issues when amounts can be reasonably estimated.
Significant factors and information used by management when estimating product warranty liabilities include:
• Past claims experience;
• Sales history;
• Product manufacturing and industry developments; and
• Recoveries from third parties.
Asbestos - Maremont Corporation (“Maremont”) - Maremont, a subsidiary of ArvinMeritor, manufactured friction products containing asbestos from 1953 through 1977, when it sold its friction product business. Arvin acquired Maremont in 1986. Maremont and many other companies are defendants in suits brought by individuals claiming personal injuries as a result of exposure to asbestos-containing products. Although Maremont has been named in these cases, very few cases allege actual injury and, in the cases where actual injury has been alleged, very few claimants have established that a Maremont product caused their injuries. Plaintiffs’ lawyers often sue dozens or even hundreds of defendants in individual lawsuits on behalf of hundreds or thousands of claimants, seeking damages against all named defendants irrespective of the disease or injury and irrespective of any causal connection with a particular product. For these reasons, Maremont does not consider the number of claims filed or the damages alleged to be a meaningful factor in determining its asbestos-related liability.
Prior to February 2001, Maremont participated in the Center for Claims Resolution (“CCR”) and shared with other CCR members in the payment of defense and indemnity costs for asbestos-related claims. The CCR handled the resolution and processing of asbestos claims on behalf of its members until February 2001, when it was reorganized and discontinued negotiating shared settlements. Since that time, Maremont has handled asbestos-related claims through its own defense counsel and has taken a more aggressive defensive approach that involves examining the merits of each asbestos-related claim.
At the end of fiscal year 2004 and through the third quarter of fiscal year 2005, Maremont established reserves for pending asbestos-related claims that reflected internal estimates of its defense and indemnity costs. These estimates were based on the history and nature of filed claims to date and Maremont’s experience with historical indemnity and litigation costs, using data from actual CCR settlements, experience in resolving claims since dissolution of the CCR, and Maremont’s assessment of the nature of the claims. Maremont did not accrue reserves for its potential liability for asbestos-related claims that may be asserted against it in the future, because it did not have sufficient information to make a reasonable estimate of these unknown claims.
In the fourth quarter of fiscal year 2005, Maremont worked with Bates White LLC (Bates White), a consulting firm with extensive experience estimating costs associated with asbestos litigation, to assist with determining whether it would be possible to estimate the cost of resolving pending and future asbestos-related claims that have been, and could reasonably be expected to be, filed against Maremont, as well as the cost of Maremont’s share of committed but unpaid settlements entered into by the CCR. Although it is not possible to estimate the full range of costs because of various uncertainties, Bates White advised Maremont that it would be possible to determine an estimate of a reasonable forecast of the cost of resolving pending and future asbestos-related claims, based on historical data and certain assumptions with respect to events that occur in the future. We engaged Bates White to update the study as of September 30, 2006.
Bates White provided an estimate of the reasonably possible range of Maremont’s obligation for asbestos personal injury claims over the next three to four years of $31 million to $44 million. After consultation with Bates White, Maremont determined that as of September 30, 2006 the most likely and probable liability for pending and future claims over the next four years is $41 million. The ultimate cost of resolving pending and future claims is estimated based on the history of claims and expenses for plaintiffs represented by law firms in jurisdictions with an established history with Maremont.
The following assumptions were made by Maremont after consultation with Bates White and are included in their study:
• Pending and future claims were estimated for a four year period ending in fiscal year 2010. Maremont believes that the litigation environment will change significantly in several years, and that the reliability of estimates of future probable
expenditures in connection with asbestos-related personal injury claims declines for each year further in the future. As a result, estimating a probable liability beyond four years is difficult and uncertain;
• The ultimate cost of resolving pending and future claims filed in Madison County, Illinois, a jurisdiction where a substantial amount of Maremont’s claims are filed, will decline to reflect average outcomes throughout the United States;
• Defense and processing costs for pending and future claims filed outside of Madison County, Illinois will be at the level consistent with Maremont’s prior experience; and
• The ultimate cost of resolving nonmalignant claims with plaintiffs’ law firms in jurisdictions without an established history with Maremont cannot be reasonably estimated. Recent changes in tort law and insufficient settlement history make estimating a liability for these nonmalignant claims difficult and uncertain.
Maremont has insurance that reimburses a substantial portion of the costs incurred defending against asbestos-related claims. The coverage also reimburses Maremont for any indemnity paid on those claims. The coverage is provided by several insurance carriers based on insurance agreements in place. Maremont has recorded a $31 million asbestos-related insurance receivable as of September 30, 2006. Certain insurance policies have been settled in cash prior to the ultimate settlement of related asbestos liabilities. Amounts received from insurance settlements generally reduce recorded insurance receivables. Receivables for policies in dispute are not recorded.
The amounts recorded for the asbestos-related reserves and recoveries from insurance companies are based upon assumptions and estimates derived from currently known facts. All such estimates of liabilities and recoveries for asbestos-related claims are subject to considerable uncertainty because such liabilities and recoveries are influenced by variables that are difficult to predict. The future litigation environment for Maremont could change significantly from its past experience, due, for example, to changes in the mix of claims filed against Maremont in terms of plaintiffs’ law firm, jurisdiction and disease; legislative or regulatory developments; Maremont’s approach to defending claims; or payments to plaintiffs from other defendants. Estimated recoveries are influenced by coverage issues among insurers, and the continuing solvency of various insurance companies. If the assumptions with respect to the nature of pending claims, the cost to resolve claims and the amount of available insurance prove to be incorrect, the actual amount of liability for Maremont’s asbestos-related claims, and the effect on the company, could differ materially from current estimates and, therefore, could have a material impact on our financial position and results of operations.
Asbestos - Rockwell - ArvinMeritor, along with many other companies, has also been named as a defendant in lawsuits alleging personal injury as a result of exposure to asbestos used in certain components of Rockwell products many years ago. Liability for these claims was transferred to the company at the time of the spin-off of the automotive business to Meritor from Rockwell in 1997. Currently there are thousands of claimants in lawsuits that name us, together with many other companies, as defendants. However, we do not consider the number of claims filed or the damages alleged to be a meaningful factor in determining asbestos-related liabilities. A significant portion of the claims do not identify any of Rockwell’s products or specify which of the claimants, if any, were exposed to asbestos attributable to Rockwell’s products, and past experience has shown that the vast majority of the claimants will never identify any of Rockwell’s products. For those claimants who do show that they worked with Rockwell’s products, we nevertheless believe we have meritorious defenses, in substantial part due to the integrity of the products involved, the encapsulated nature of any asbestos-containing components, and the lack of any impairing medical condition on the part of many claimants. We defend these cases vigorously. Historically, ArvinMeritor has been dismissed from the vast majority of these claims with no payment to claimants.
In the fourth quarter of fiscal year 2006, the company engaged Bates White to assist with determining whether it would be possible to estimate the cost of resolving pending and future Rockwell legacy asbestos-related claims that have been, and could reasonably be expected to be, filed against the company. Although it is not possible to estimate the full range of costs because of various uncertainties, Bates White advised the company that it would be able to determine an estimate of probable defense costs which could be incurred to resolve pending and future Rockwell legacy asbestos-related claims. Accordingly, the company recorded a $7 million liability for defense costs associated with these claims. This estimate was based on historical data and certain assumptions with respect to events that occur in the future. Bates White was unable to determine an estimate of indemnity costs for pending or future Rockwell legacy asbestos-related claims. Bates White and management cannot reasonably estimate the ultimate liabilities for these costs, primarily because the company does not have a sufficient history of claims settlement from which to develop reliable assumptions. The uncertainties of asbestos claim litigation and resolution of the litigation with the insurance companies make it difficult to predict accurately the ultimate resolution of asbestos claims. That uncertainty is increased by the possibility of adverse rulings or new legislation affecting asbestos claim litigation or the settlement process. Subject to these uncertainties and based on the company’s experience defending these asbestos claims, the company does not believe these lawsuits will have a material adverse effect on its financial condition. Rockwell was not a member of the CCR and handled its asbestos-related claims using its own litigation counsel. As a result, the company does not have any additional potential liabilities for committed CCR settlements in connection with the Rockwell-legacy cases.
Rockwell maintained insurance coverage that management believes covers indemnity and defense costs, over and above self-insurance retentions, for most of these claims. The company has initiated claims against these carriers to enforce the insurance policies. Although the status of one carrier as a financially viable entity is in question, the company expects to recover the majority of defense and indemnity costs it has incurred to date, over and above self-insured retentions, and a substantial portion of the costs for defending asbestos claims going forward. Accordingly, the company has recorded an insurance receivable related to Rockwell legacy asbestos-related liabilities of $7 million at September 30, 2006.
Environmental - We record liabilities for environmental issues in the accounting period in which our responsibility and remediation plans are established and the cost can be reasonably estimated. At environmental sites in which more than one potentially responsible party has been identified, we record a liability for our allocable share of costs related to our involvement with the site, as well as an allocable share of costs related to insolvent parties or unidentified shares. At environmental sites in which we are the only potentially responsible party, a liability is recorded for the total estimated costs of remediation before consideration of recovery from insurers or other third parties. The ultimate cost with respect to our environmental obligations could significantly exceed the costs we have recorded as liabilities. Significant factors considered by management when estimating environmental reserves include:
• Evaluations of current law and existing technologies;
• The outcome of discussions with regulatory agencies;
• Physical and scientific data at the site;
• Government regulations and legal standards; and
• Proposed remedies and technologies.
Goodwill - Goodwill is reviewed for impairment annually or more frequently if certain indicators arise. If business conditions or other factors cause the profitability and cash flows of a reporting unit to decline, we may be required to record impairment charges for goodwill at that time. The goodwill impairment review is a two-step process. Step one consists of a comparison of the fair value of a reporting unit with its carrying amount. An impairment loss may be recognized if the review indicates that the carrying value of a reporting unit exceeds its fair value. Estimates of fair value are primarily determined by using discounted cash flows and market multiples on earnings. If the carrying amount of a reporting unit exceeds its fair value, step two requires the fair value of the reporting unit to be allocated to the underlying assets and liabilities of that reporting unit, resulting in an implied fair value of goodwill. If the carrying amount of the goodwill of the reporting unit exceeds the implied fair value, an impairment charge is recorded equal to the excess.
The impairment review is highly judgmental and involves the use of significant estimates and assumption. These estimates and assumptions have a significant impact on the amount of any impairment charge recorded. Discounted cash flow methods are dependent upon assumption of future sales trends, market conditions and cash flows of each reporting unit over several years. Actual cash flows in the future may differ significantly from those previously forecasted. Other significant assumptions include growth rates and the discount rate applicable to future cash flows.
Impairment of Long-Lived Assets - Long-lived assets, excluding goodwill, to be held and used are reviewed for impairment whenever adverse events or changes in circumstances indicate a possible impairment. An impairment loss is recognized when the long-lived assets’ carrying value exceeds the fair value. If business conditions or other factors cause the profitability and cash flows to decline, we may be required to record impairment charges at that time. Long-lived assets held for sale are recorded at the lower of their carrying amount or fair value less cost to sell. Significant judgments and estimates used by management when evaluating long-lived assets for impairment include:
• An assessment as to whether an adverse event or circumstance has triggered the need for an impairment review; and
• Undiscounted future cash flows generated by the asset.
Income Taxes - Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. If it is more likely than not that the deferred tax asset will be realized, no valuation allowance is recorded. Management judgment is required in determining the company’s provision for income taxes, deferred tax assets and liabilities and the valuation allowance recorded against the company’s net deferred tax assets. The valuation allowance would need to be adjusted in the event future taxable income is materially different than amounts estimated. Significant judgments, estimates and factors considered by management in its determination of the probability of the realization of deferred tax assets include:
• Historical operating results;
• Expectations of future earnings;
• Tax planning strategies; and
• The extended period of time over which retirement medical and pension liabilities will be paid.
As of September 30, 2006, the company had approximately $457 million in U.S. net deferred tax assets. These deferred tax assets include net operating loss carryovers that can be used to offset taxable income in future periods and reduce income taxes payable in those future periods. However, many of these deferred taxes will expire if they are not utilized within certain time periods. It is possible that some or all of these deferred tax assets could ultimately expire unused. Risk factors include (a) a more severe than expected downturn in the fiscal year 2007 outlook for the company’s CVS segment, which has significant U.S. operations, (b) higher than planned volume or price reductions from the company’s key customers and (c) higher than planned material cost increases.
These risk factors are offset by the following strategic initiatives: (a) the company has undertaken numerous restructuring initiatives in 2006 which are expected to result in significant savings in future periods, (b) the commercial vehicle market in the United States is expected to recover in 2008 and 2009 significantly benefiting the company and (c) the company has announced that it is embarking on a major cost redcution and value creation program that is expected to generate significant improvements in earnings in future periods.
The expiration periods for $556 million of deferred tax assets related to net operating losses and tax credit carryforwards are as follows: $30 million between fiscal years 2007 and 2011; $53 million between fiscal years 2012 and 2021; $242 million between fiscal years 2022 and 2026; and $231 million can be carriedfoward indefinitely. The company has provided valuation allowances on these deferred tax assets of approximately $22 million, $30 million, $8 million and $123 million, respectively.
New Accounting Pronouncements
New accounting standards to be implemented:
In July 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes” which prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. Additionally, FIN 48 provides criteria for subsequently recognizing, derecognizing and measuring changes in uncertain tax positions and requires expanded disclosures with respect to the uncertainty of income taxes. The accounting provisions of FIN 48 will be effective for the company beginning October 1, 2007 with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. We are in the process of determining the effect the adoption of FIN 48 will have on our consolidated financial statements.
In September 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 157 (SFAS 157), “Fair Value Measurements” which provides a definition of fair value establishes a framework for measuring fair value and requires expanded disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those years. The provisions of SFAS 157 will be applied prospectively.
In September 2006, the FASB issued SFAS No. 158 (SFAS 158), “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R)”. This statement requires an entity to recognize the funded status of its defined benefit pension plans and other postretirement benefit plans, such as a retiree health care plan, on the balance sheet and to recognize changes in the funded status, that arise during the period but are not recognized as components of net periodic benefit cost, within other comprehensive income, net of income taxes. SFAS 158 also requires measurement of the funded status of the plans as of the balance sheet date. SFAS 158 is effective for recognition of the funded status of the plans for fiscal years ending after December 15, 2006 and is effective for the measurement date provisions for fiscal years ending after December 15, 2008. The impact of this statement will be dependent upon our June 30, 2007 actuarial valuation and changes in assumptions compared to the current year’s valuation. However, if this standard had been effective for the year ended September 30, 2006, the impact would have been a reduction to shareowners’ equity, net of tax, of approximately $300 million.
In September 2006, the SEC issued Staff Accounting Bulletin (SAB) No. 108, “Quantifying Financial Misstatements”, which expresses the Staff’s views regarding the process of quantifying financial statement misstatements. Registrants are required to quantify the impact of correcting all misstatements, including both the carryover and reversing effects of prior year misstatements, on the current year financial statements. The financial statements would require adjustment when either approach results in quantifying a misstatement that is material, after considering all relevant quantitative and qualitative factors. SAB 108 is effective for financial
statements covering the first fiscal year ending after November 15, 2006. We are in the process of determining the effect, if any, SAB No. 108 will have on our consolidated financial statements.
New accounting standards implemented:
In March 2005, the FASB issued Interpretation No. 47 (FIN 47), “Accounting for Conditional Asset Retirement Obligations,” an interpretation of SFAS No. 143, “Accounting for Asset Retirement Obligations.” FIN 47 clarifies the term “conditional asset retirement obligation” as used in SFAS No. 143 and provides clarification with respect to the timing of liability recognition for such obligations. Conditional asset retirement obligations represent a legal obligation to perform asset retirement activities in which the timing and/or method of settlement are conditional on a future event. FIN 47 requires an entity to recognize a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. We adopted FIN 47 in the fourth quarter of fiscal year 2006. The adoption of FIN 47 did not have a material impact on the company’s results of operations or financial position.
In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment,” which requires compensation costs related to share-based payment transactions to be recognized in the financial statements. This statement also establishes fair value as the measurement objective for share-based payment transactions with employees. The company began expensing the fair value of stock options in fiscal year 2002. The company adopted the provisions of SFAS No. 123(R) in the first quarter of fiscal year 2006, which resulted primarily in changing the company’s method of accounting for retirement eligible employees and estimating forfeitures for unvested stock based compensation awards. Subsequent to adoption, the company began recognizing compensation expense associated with stock grants to retirement eligible employees during the year granted. Prior to adoption, the company expensed stock compensation granted to retirement eligible employees ratably over the respective vesting period. Also upon adoption the company reclassified amounts recorded in unearned compensation (a contra-equity account) to additional paid-in-capital in the consolidated balance sheet. The adoption of SFAS No. 123(R) did not have a material impact on the company’s results of operations or financial position.
In December 2004, the FASB issued Staff Position (FSP) FAS 109-2, “Accounting and Disclosure Guidance for the Foreign Repatriation Provision within the American Jobs Creation Act of 2004.” The American Jobs Creation Act of 2004 (the Act) creates a temporary incentive for U.S. corporations to repatriate foreign subsidiary earnings by providing an elective 85 percent dividends received deductions for certain dividends from controlled foreign corporations. The FSP addresses whether a company should be allowed additional time beyond the financial reporting period in which the Act was enacted, to evaluate the effects of the Act on the company’s plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS No. 109. Prior to the fourth quarter of the fiscal year ended September 30, 2006, the company was evaluating the repatriation provisions of the Act and could not reasonably estimate a range of the income tax effects of such repatriation. There were numerous factors that were not controllable by the company that made it difficult for us to determine whether to take advantage of the Act and if so determined, to estimate the range of the income tax effects prior to the fourth quarter of fiscal year 2006. These factors included approvals by government bodies and employee groups. In the fourth quarter of fiscal year 2006 we repatriated approximately $152 million in dividends subject to the elective 85 percent dividend received deduction and recorded a corresponding tax benefit of $37 million related to the reversal of previously provided U.S. deferred tax liability on these unremitted foreign subsidiary earnings. The dividend was paid in September 2006.
International Operations
Approximately 48 percent of the company’s total assets, excluding assets of discontinued operations, as of September 30, 2006, and 50 percent of fiscal 2006 sales from continuing operations were outside North America. Management believes that international operations have significantly benefited the financial performance of the company. However, our international operations are subject to a number of risks inherent in operating abroad. There can be no assurance that these risks will not have a material adverse impact on our ability to increase or maintain our foreign sales or on our financial condition or results of operations.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk.
We are exposed to global market risks, including foreign currency exchange rate risk related to our transactions denominated in currencies other than the U.S. dollar and interest rate risk associated with our debt.
We use foreign currency forward contracts to manage the exposures arising from foreign currency exchange risk. Gains and losses on the underlying foreign currency exposures are partially offset with gains and losses on the foreign currency forward contracts. Under this program, we have designated the foreign currency contracts (the contracts) as cash flow hedges of underlying foreign currency forecasted purchases and sales. The effective portion of changes in the fair value of the contracts is recorded in Accumulated Other Comprehensive Income (AOCI) in the statement of shareowners’ equity and is recognized in operating income when the underlying forecasted transaction impacts earnings. The contracts generally mature within 12 months. Prior to this program, we used foreign exchange contracts to offset the effect of exchange rate fluctuations on foreign currency denominated payables and receivables but did not designate these contracts as hedges for accounting purposes. These contracts were generally of short duration (less than three months). It is difficult to predict the impact the euro and other currencies will have on our sales and operating income.
We also use interest rate swaps to manage the proportion of variable rate debt to fixed rate debt. It is our policy not to enter into derivative instruments for speculative purposes, and therefore, we hold no derivative instruments for trading purposes.
Sensitivity Analysis: We use sensitivity models to calculate the fair value and cash flow impact that a hypothetical change in market currency rates and interest rates would have on derivative and debt instruments. Actual gains or losses in the future may differ significantly from that analysis, however, based on changes in the timing and amount of interest rate and foreign currency exchange rate movements and the company’s actual exposures.
The results of the sensitivity analysis are as follows (in millions):
(1) Includes only the risk related to the derivative instruments that serve as hedges and does not include the risk related to the underlying hedged item or on other operating transactions. The analyses assume overall derivative instruments and debt levels remain unchanged for each hypothetical scenario.
Item 8.
Item 8. Financial Statements and Supplementary Data.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareowners of ArvinMeritor, Inc.
Troy, Michigan
We have audited the accompanying consolidated balance sheets of ArvinMeritor, Inc. (the “Company”) as of September 30, 2006 and 2005, and the related consolidated statements of operations, cash flows and shareowners’ equity for each of the three years in the period ended September 30, 2006. Our audits also included the financial statement schedule listed in the Index at Item 15(a)(2). These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of ArvinMeritor, Inc. as of September 30, 2006 and 2005, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 2006, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company's internal control over financial reporting as of September 30, 2006, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated November 17, 2006 expressed an unqualified opinion on management's assessment of the effectiveness of the Company's internal control over financial reporting and an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.
/s/ DELOITTE & TOUCHE LLP
DELOITTE & TOUCHE LLP
Detroit, Michigan
November 17, 2006
ARVINMERITOR, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(In millions, except per share amounts)
See Notes to Consolidated Financial Statements. Fiscal year 2005 and 2004 amounts have been restated for discontinued operations.
ARVINMERITOR, INC.
CONSOLIDATED BALANCE SHEET
(In millions)
See Notes to Consolidated Financial Statements. Fiscal year 2005 amounts have been restated for discontinued operations.
ARVINMERITOR, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(In millions)
See Notes to Consolidated Financial Statements. Fiscal year 2005 and 2004 amounts have been restated for discontinued operations.
ARVINMERITOR, INC.
CONSOLIDATED STATEMENT OF SHAREOWNERS’ EQUITY
(In millions, except per share amounts)
See Notes to Consolidated Financial Statements.
ARVINMERITOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1.
BASIS OF PRESENTATION
ArvinMeritor, Inc. (the company or ArvinMeritor) is a global supplier of a broad range of integrated systems, modules and components serving light vehicle, commercial truck, trailer and specialty original equipment manufacturers (OEM) and certain aftermarkets. The consolidated financial statements are those of the company and its consolidated subsidiaries.
The company’s Light Vehicle Aftermarket (LVA) businesses, Light Vehicle Systems (LVS) ride control business and coil coating business are presented as discontinued operations in the consolidated statement of operations and related notes. The company sold its LVA North American filters, exhaust and motion control businesses, its Gabriel South Africa LVA ride control business and its 39 percent interest in its Purolator India joint venture during fiscal year 2006. The company sold its coil coating business during the first quarter of fiscal year 2005. Results of operations related to these businesses are presented as discontinued operations in the consolidated statement of operations for the period through the date of sale. The assets and liabilities of LVA are classified as held for sale and included in assets and liabilities of discontinued operations in the consolidated balance sheet. In the fourth quarter of fiscal year 2006, the company decided to retain its 51 percent interest in its Gabriel de Venezuela light vehicle aftermarket joint venture. As a result, the results of operations, assets and liabilities and cash flows of this business are presented in continuing operations in the consolidated financial statements and prior periods have been restated to reflect this presentation (see Note 3).
The company’s fiscal quarters end on the Sundays nearest December 31, March 31 and June 30 and its fiscal year ends on the Sunday nearest September 30. The 2006, 2005 and 2004 fiscal years ended on October 1, 2006, October 2, 2005 and October 3, 2004, respectively. Fiscal years 2006 and 2005 include 52 weeks compared to 53 weeks in fiscal year 2004. All year and quarter references relate to the company’s fiscal year and fiscal quarters, unless otherwise stated. For ease of presentation, September 30 is used consistently throughout this report to represent the fiscal year end.
2.
SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America (U.S.) (GAAP) requires the use of estimates and assumptions related to the reporting of assets, liabilities, revenues, expenses and related disclosures. Actual results could differ from these estimates. Significant estimates and assumptions were used to value goodwill and other long-lived assets, including impairment charges (see Notes 3 and 4), costs associated with the company’s restructuring actions (see Note 5), product warranty liabilities (see Note 14), long-term incentive compensation plan obligations (see Note 19), retiree medical and pension obligations (see Notes 20 and 21), income taxes (see Note 22), and contingencies including asbestos and environmental matters (see Note 23).
Consolidation and Joint Ventures
The consolidated financial statements include the accounts of the company and those majority-owned subsidiaries in which the company has control. All significant intercompany balances and transactions are eliminated in consolidation. The balance sheet and results of operations of controlled subsidiaries where ownership is greater than 50 percent, but less than 100 percent, are included in the consolidated financial statements and are offset by a related minority interest expense and liability recorded for the minority interest ownership. Investments in affiliates that are not controlled or majority-owned are reported using the equity method of accounting (see Note 13).
Foreign Currency
Local currencies are generally considered the functional currencies for operations outside the U.S. For operations reporting in local currencies, assets and liabilities are translated at year-end exchange rates with cumulative currency translation adjustments included as a component of Accumulated Other Comprehensive Loss in the consolidated balance sheet. Income and expense items are translated at average rates of exchange during the year.
ARVINMERITOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Impairment of Long-Lived Assets
Long-lived assets, excluding goodwill, to be held and used are reviewed for impairment whenever adverse events or changes in circumstances indicate a possible impairment. An impairment loss is recognized when a long-lived asset’s carrying value exceeds the fair value. If business conditions or other factors cause the profitability and cash flows to decline, the company may be required to record impairment charges at that time. During fiscal year 2006 and 2005, the company recorded $3 million and $31 million of asset impairment charges, respectively, associated with various restructuring actions (see Note 5). Included in this amount are $15 million of asset impairment charges included in discontinued operations associated with the company’s LVS ride control business (see Note 3). Long-lived assets held for sale are recorded at the lower of their carrying amount or fair value less cost to sell. During fiscal year 2006 and 2005, the company recognized non-cash impairment charges of $22 million and $43 million, respectively, to record certain LVA businesses at fair value, less cost to sell (see Note 3).
Discontinued Operations
A business component that either has been disposed of or is classified as held for sale is reported as discontinued operations if the cash flows of the component have been or will be eliminated from the ongoing operations of the company and the company will no longer have any significant continuing involvement in the business component. The results of operations of discontinued operations are aggregated and presented separately in the consolidated statement of operations and consolidated statement of cash flows. Assets and liabilities of the discontinued operations, if included in the disposal group, are aggregated and reported separately as assets and liabilities of discontinued operations in the consolidated balance sheet (see Note 3).
Revenue Recognition
Revenues are recognized upon shipment of product and transfer of ownership to the customer. Provisions for customer sales allowances and incentives are recorded as a reduction of sales at the time of product shipment. The company recognizes “pass-through” sales for certain of its OEM customers. These pass-through sales occur when, at the direction of the OEM customers, the company purchases components from suppliers, uses them in the company’s manufacturing process, and sells them as part of a completed system.
Allowance for Doubtful Accounts
An allowance for uncollectible trade receivables is recorded based on consideration of write-off history, aging analysis, and any specific, known troubled accounts.
Earnings per Share
Basic earnings per share is calculated using the weighted average number of shares outstanding during each year. The diluted earnings per share calculation includes the impact of dilutive common stock options, restricted stock and performance share awards.
A reconciliation of basic average common shares outstanding to diluted average common shares outstanding is as follows (in millions):
The potential effects of restricted stock and stock options were excluded from the diluted earnings per share calculation for the fiscal year ended September 30, 2006 because their inclusion in a net loss period would reduce the net loss per share. At September 30, 2006 options to purchase 4.5 million shares of common stock were not included in the computation of diluted earnings per share. At September 30, 2005 and 2004, options to purchase 3.8 million and 1.7 million shares of common stock, respectively, were not included in the computation of diluted earnings per share because their exercise price exceeded the average market price for the period and thus their inclusion would be anti-dilutive.
ARVINMERITOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The company issued $300 million of convertible senior unsecured notes in the second quarter of fiscal year 2006 (see Note 16). Since the company’s stock price during the quarter is less than the conversion price, these convertible notes are not included in the computation of diluted earnings per share because their inclusion would be anti-dilutive.
Other
Other significant accounting policies are included in the related notes, specifically, inventories (Note 9), customer reimbursable tooling and engineering (Note 10), property and depreciation (Note 11), capitalized software (Note 12), product warranties (Note 14), financial instruments (Note 17), stock based compensation (Note 19), retirement medical plans (Note 20), retirement pension plans (Note 21), income taxes (Note 22) and environmental and asbestos-related liabilities (Note 23).
New Accounting Standards
New accounting standards to be implemented:
In July 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes” which prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. Additionally, FIN 48 provides criteria for subsequently recognizing, derecognizing and measuring changes in uncertain tax positions and requires expanded disclosures with respect to the uncertainty of income taxes. The accounting provisions of FIN 48 will be effective for the company beginning October 1, 2007 with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The company is in the process of determining the effect the adoption of FIN 48 will have on its consolidated financial statements.
In September 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements” which provides a definition of fair value, establishes a framework for measuring fair value and requires expanded disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those years. The provisions of SFAS 157 will be applied prospectively.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R)”. This statement requires an entity to recognize the funded status of its defined benefit pension plans and other postretirement benefit plans, such as a retiree health care plan, on the balance sheet and to recognize changes in the funded status that arise during the period but are not recognized as components of net periodic benefit cost, within other comprehensive income, net of income taxes. SFAS 158 also requires measurement of the funded status of the plans as of the balance sheet date. SFAS 158 is effective for recognition of the funded status of the plans for fiscal years ending after December 15, 2006 and is effective for the measurement date provisions for fiscal years ending after December 15, 2008. The impact of this statement will be dependent upon the company’s June 30, 2007 actuarial valuation of these liabilities and related changes in assumptions compared to the current year’s valuation. However, if this standard had been effective for the year ended September 30, 2006, the impact would have been a reduction to shareowners’ equity, net of tax, of approximately $300 million.
In September 2006, the SEC issued Staff Accounting Bulletin (SAB) No. 108, “Quantifying Financial Misstatements”, which expresses the Staff’s views regarding the process of quantifying financial statement misstatements. Registrants are required to quantify the impact of correcting all misstatements, including both the carryover and reversing effects of prior year misstatements, on the current year financial statements. The financial statements would require adjustment when either approach results in quantifying a misstatement that is material, after considering all relevant quantitative and qualitative factors. SAB 108 is effective for financial statements covering the first fiscal year ending after November 15, 2006. The company is in the process of determining the effect, if any, the SAB No. 108 will have on its consolidated financial statements.
New accounting standards implemented:
In March 2005, the FASB issued Interpretation No. 47 (FIN 47), “Accounting for Conditional Asset Retirement Obligations,” an interpretation of SFAS No. 143, “Accounting for Asset Retirement Obligations.” FIN 47 clarifies the term “conditional asset retirement obligation” as used in SFAS No. 143 and provides clarification with respect to the timing of liability recognition for such obligations. Conditional asset retirement obligations represent a legal obligation to perform asset retirement activities in which the timing and/or method of settlement are conditional on a future event. FIN 47 requires an entity to recognize a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. The company adopted FIN 47 in the fourth quarter of fiscal year 2006. The adoption of FIN 47 did not have a material impact on the company’s results of operations or financial position.
ARVINMERITOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment,” which requires compensation costs related to share-based payment transactions to be recognized in the financial statements. This statement also establishes fair value as the measurement objective for share-based payment transactions with employees. The company began expensing the fair value of stock options in fiscal year 2002. The company adopted the provisions of SFAS No. 123(R) in the first quarter of fiscal year 2006, which resulted primarily in changing the company’s method of accounting for retirement eligible employees and estimating forfeitures for unvested stock based compensation awards. Subsequent to adoption, the company began recognizing compensation expense associated with stock grants to retirement eligible employees during the year granted. Prior to adoption, the company expensed stock compensation granted to retirement eligible employees ratably over the respective vesting period. Also upon adoption the company reclassified amounts recorded in unearned compensation (a contra-equity account) to additional paid-in-capital in the consolidated balance sheet. The adoption of SFAS No. 123(R) did not have a material impact on the company’s results of operations or financial position.
In December 2004, the FASB issued Staff Position (FSP) FAS 109-2, “Accounting and Disclosure Guidance for the Foreign Repatriation Provision within the American Jobs Creation Act of 2004.” The American Jobs Creation Act of 2004 (the Act) creates a temporary incentive for U.S. corporations to repatriate foreign subsidiary earnings by providing an elective 85 percent dividends received deductions for certain dividends from controlled foreign corporations. The FSP addresses whether a company should be allowed additional time beyond the financial reporting period in which the Act was enacted, to evaluate the effects of the Act on the company’s plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS No. 109. Prior to the fourth quarter of the fiscal year ended September 30, 2006, the company was evaluating the repatriation provisions of the Act and could not reasonably estimate a range of the income tax effects of such repatriation. There were numerous factors that were not controllable by the company that made it difficult for us to determine whether to take advantage of the Act and if so determined, to estimate the range of the income tax effects prior to the fourth quarter of fiscal year 2006. These factors included approvals by government bodies and employee groups. In the fourth quarter of fiscal year 2006, the company repatriated approximately $152 million in dividends subject to the elective 85 percent dividend received deduction and recorded a corresponding tax benefit of $37 million related to the reversal of previously provided U.S. deferred tax liability on these unremitted foreign subsidiary earnings. The dividend was paid in September 2006.
3.
DISCONTINUED OPERATIONS
Light Vehicle Aftermarket
In October 2004, the company announced plans to divest its LVA businesses. This plan is part of the company’s long-term strategy to focus on core competencies and support its global light vehicle systems OEM customers and its commercial vehicle systems OEM and aftermarket customers. LVA supplied exhaust, ride control, motion control and filter products, as well as other automotive parts to the passenger car, light truck and sport utility vehicle aftermarket. LVA is reported as discontinued operations in the consolidated statement of operations. The assets and liabilities of LVA were held for sale and included in assets and liabilities of discontinued operations in the consolidated balance sheet. Accordingly, net property and amortizable intangible assets are no longer being depreciated or amortized. In the fourth quarter of fiscal year 2006, the company decided to retain its 51 percent interest in its Gabriel de Venezuela light vehicle aftermarket joint venture. As a result, the results of operations, assets and liabilities and cash flows of this business are presented in continuing operations in the consolidated financial statements and prior periods have been restated to reflect this presentation. The inclusion of this consolidated joint venture in continuing operations favorably impacted income from continuing operations by $4 million, $5 million and $2 million in fiscal years 2006, 2005 and 2004, respectively. In September 2006, the company recorded a cumulative $3 million adjustment for depreciation expense related to this business not recorded in fiscal years 2006 and 2005.
The company sold its LVA North American filters, exhaust and motion control businesses; its Gabriel South Africa ride control business; and its 39-percent equity ownership interest in its light vehicle aftermarket joint venture, Purolator India during fiscal year 2006. Cash proceeds from these divestitures were $222 million, resulting in a net pre-tax gain on sale of $28 million ($18 million after-tax), which is recorded in loss from discontinued operations. These businesses represented a significant portion of our combined LVA business and the company expects to complete the divestiture of its remaining LVA businesses in fiscal year 2007.
Also during fiscal year 2006, the company recognized non-cash impairment charges of $22 million ($14 million after-tax) to record certain LVA businesses at fair value. The impairment charges are recorded in loss from discontinued operations in the consolidated statement of operations. In the fourth quarter of fiscal year 2005, management concluded that it was more likely that LVA’s North American businesses would be sold individually rather than as a whole. Although management believed that this strategy would not have a material impact on the aggregate value expected to be realized from the divestiture of LVA, this change in strategy required the company, for accounting purposes, to evaluate fair value on an individual business basis rather than LVA North America as a whole. This resulted in a non-cash impairment charge of $43 million ($28 million after-tax) to record certain LVA North American businesses at fair value. The company’s previous strategy was to sell the North American LVA business as a whole.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Accordingly, the company’s previous analysis of impairment was on the total North American business. This analysis indicated that the aggregate fair value of the North LVA American business, when taken as a whole, exceeded its carrying value.
In order to reduce costs and improve profitability, LVA recorded restructuring costs of $6 million, $2 million and $3 million in fiscal years 2006, 2005 and 2004, respectively. The costs recorded during fiscal year 2006 relate to employee severance benefits for the reduction of approximately 75 employees. At September 30, 2006 and 2005, $4 million and $2 million, respectively, of restructuring reserves primarily related to unpaid employee termination benefits are included in liabilities of discontinued operations.
In fiscal year 2005, LVA entered into a five-year exclusive supply agreement with a significant customer to supply certain exhaust and ride control products. As part of the supply agreement, LVA incurred certain costs to changeover the customer to LVA products. LVA recognizes these costs, known as changeover costs, as selling expenses in the period the changeover occurs. LVA recognized approximately $6 million of after-tax changeover costs as expense in fiscal year 2005.
The company’s fiscal year 2004 annual goodwill impairment review indicated the carrying value of the LVA reporting unit exceeded its fair value. Increased competition, difficult market conditions, particularly in the exhaust market, and higher raw material costs resulted in a decline in fair value in fiscal year 2004. As a result, in the fourth quarter of fiscal year 2004, the company recognized a goodwill impairment charge of $190 million ($190 million after-tax) in its LVA reporting unit. The fair value of LVA was estimated using earnings multiples based on precedent transactions of comparable companies and the expected present value of future cash flows.
Light Vehicle Ride Control
In December 2005, the company sold its light vehicle ride control business located in Asti, Italy and recorded an after-tax loss on the sale of $2 million. This sale, along with the previous divestiture of the company’s 75-percent shareholdings in AP Amortiguadores, S.A. (APA) in the second quarter of fiscal year 2004, substantially completed the company’s plan to exit its LVS ride control business (ride control). Therefore, ride control is presented as discontinued operations in the consolidated statement of operations and consolidated statement of cash flows for all periods presented. Ride control provides shock absorbers, struts, ministruts, and corner modules to the light vehicle industry. Net proceeds from the sale of APA were $48 million, resulting in a pre-tax gain of $20 million, which is recorded in discontinued operations in the consolidated statement of operations. The company previously expected to close the ride control business in Asti, Italy during fiscal year 2006 and recorded approximately $31 million of restructuring costs in fiscal year 2005 related to the expected closure. These costs included $16 million of employee termination benefits and $15 million of asset impairment charges. As a result of the sale of the Asti, Italy ride control operations, the company reversed during fiscal year 2006, $11 million of restructuring costs related to employee termination benefits that will no longer be paid by the company. These restructuring costs, including the subsequent reversal, are recorded in discontinued operations in the consolidated statement of operations.
Coil Coating
In November 2004, the company completed the sale of its coil coating business, Roll Coater, Inc., a wholly owned subsidiary which supplied coil coating services and other value-added metal processing services to the transportation, appliance, heating and cooling, construction, doors and other industries. Cash proceeds from the sale were $163 million, resulting in a $2 million after-tax gain, which is recorded in income from discontinued operations.
Results of the discontinued operations are summarized as follows (in millions):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Assets and liabilities of the discontinued operations are summarized as follows (in millions):
Goodwill is reviewed for impairment annually or more frequently if certain indicators arise. If business conditions or other factors cause the profitability and cash flows of the reporting unit to decline, the company may be required to record impairment charges for goodwill at that time. The goodwill impairment review is a two-step process. Step one consists of a comparison of the fair value of a reporting unit with its carrying amount. An impairment loss may be recognized if the review indicates that the carrying value of a reporting unit exceeds its fair value. Estimates of fair value are primarily determined by using discounted cash flows and market multiples on earnings. If the carrying amount of a reporting unit exceeds its fair value, step two requires the fair value of the reporting unit to be allocated to the underlying assets and liabilities of that reporting unit, resulting in an implied fair value of goodwill. If the carrying amount of the goodwill of the reporting unit exceeds the implied fair value, an impairment charge is recorded equal to the excess.
The impairment review is highly judgmental and involves the use of significant estimates and assumption. These estimates and assumptions have a significant impact on the amount of any impairment charge recorded. Discounted cash flow methods are dependent upon assumption of future sales trends, market conditions and cash flows of each reporting unit over several years. Actual cash flows in the future may differ significantly from those previously forecasted. Other significant assumptions include growth rates and the discount rate applicable to future cash flows.
In fiscal year 2006, our light vehicle emissions technologies reporting unit continued to face significant challenges, including higher raw material costs, intense pricing pressures and increased competition. These factors were greater than previously anticipated and partially offset the expected benefits from the company’s fiscal year 2005 restructuring actions. In addition, higher stainless steel prices and recent downturns in production at certain North American manufacturers are expected to further negatively impact the financial performance of this reporting unit in fiscal year 2007. These combined factors resulted in a decline in the fair value of the light vehicle emissions technologies reporting unit in fiscal year 2006.
Step one of the company’s fiscal 2006 annual goodwill impairment review indicated the carrying value of its LVS emissions technology reporting unit exceeded its fair value. The fair value of this reporting unit was estimated using a probability weighted average cash flow analysis. This analysis considered multiple cash flow scenarios, including earnings multiples and the expected present value of future cash flows. The company is currently in the process of completing the step two analysis and expects to have this completed in the first quarter of fiscal year 2007. However, the company recorded a $310 million non-cash goodwill impairment charge in the fourth quarter of fiscal year 2006 as its best estimate of the impairment loss. This estimate could change upon completion of the step two analysis in fiscal year 2007.
In response to the challenges LVS emissions technologies continues to face, the company has identified restructuring plans to downsize certain underperforming facilities and realign its emissions technoligies manufacturing footprint to utilize assets more efficiently, improve operations and lower costs. The total estimated cost of these actions is $50 million, of which approximately $40
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
approximately $40 million is expected to be cash costs. This restructuring program will be executed over the next 12 to 36 months. No amounts have been recorded for this restructuring program at September 30, 2006.
A summary of the changes in the carrying value of goodwill, by segment, is as follows (in millions):
The company recorded net restructuring charges of $37 million, $86 million and $15 million during the fiscal years ended September 30, 2006, 2005, and 2004, respectively. At September 30, 2006 and 2005, there was $40 million and $56 million, respectively, of restructuring reserves primarily related to unpaid employee termination benefits in the consolidated balance sheet.
Fiscal year 2005 program: In the second quarter of fiscal year 2005, the company announced the elimination of approximately 400 to 500 salaried positions and approved plans to consolidate, downsize, close or sell certain underperforming businesses or facilities. During fiscal year 2006, the company identified approximately 550 additional salaried and hourly headcount reductions in its LVS business segment. Including these additional headcount reductions, the fiscal year 2005 actions resulted in the reduction of approximately 900 salaried and 1,900 hourly employees and the sale, closure or consolidation of 11 global facilities, primarily in the LVS business segment. These actions were intended to align capacity with industry conditions, utilize assets more efficiently, and improve operations. The total estimated cost of these actions was approximately $135 million, of which approximately $105 million was estimated to be cash costs. Estimated costs include employee severance and other exit costs, as well as asset impairments. Asset impairment charges relate to manufacturing facilities that will be closed or sold and machinery and equipment that have become idle and obsolete as a result of the facility closures.
During fiscal year 2006, the company recorded $37 million of restructuring costs associated with the fiscal year 2005 program. The restructuring costs were primarily in the company’s LVS business segment and included the additional salaried and hourly actions identified during fiscal year 2006. These restructuring costs are net of reversals of costs recorded in previous periods of $13 million and include $44 million related to employee severance benefits, $3 million of asset impairment charges and $3 million of other closure costs. The $13 million of reversals primarily relate to employee severance costs that will no longer be paid or were lower than previously expected. The company sold the operations of a facility it previously expected to close. As a result, the company no longer had to pay severance costs to the related employees.
Cumulative restructuring costs recorded for the fiscal year 2005 program, including amounts recorded in discontinued operations, are $127 million as of September 30, 2006. These costs include $92 million of employee termination benefits, $29 million of asset impairment charges and $6 million of other closure costs. Also included in these costs is a $24 million reversal of restructuring costs during fiscal year 2006, of which $11 million is related to the sale of the company’s ride control business in Asti, Italy. This $11 million reversal is recorded in discontinued operations in the consolidated statement of operations (see Note 3). The company expects to complete the remaining fiscal year 2005 restructuring actions in fiscal year 2007.
Other restructuring actions: During fiscal year 2005, Meritor Suspensions Systems Holdings (UK) Ltd (MSSH), a 57-percent owned consolidated joint venture of the company, closed its Sheffield, England stabilizer bar facility. The LVS business segment recorded restructuring and other exit costs of approximately $9 million related to this action during fiscal year 2005. These costs included employee termination and other exit costs of approximately $4 million and asset impairment charges of $5 million. The employee termination benefits related to a reduction of approximately 10 salaried and 125 hourly employees.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The LVS business segment also recorded during fiscal year 2005, restructuring costs of $7 million for previously approved employee terminations and other expenses. These costs related to a reduction in workforce of approximately 10 salaried and 230 hourly employees and the consolidation of two plants in Brazil.
Also in fiscal year 2005, the company recorded restructuring costs of $4 million that were incurred as a result of the integration of the two consolidated joint ventures with AB Volvo into the Commercial Vehicle Systems (CVS) business. These costs relate to severance and other termination benefits, associated with approximately 20 employees, and other restructuring costs of the joint ventures. The formation of the joint ventures were accounted for using the purchase method of accounting and these restructuring costs were reflected in the purchase price allocation. In fiscal year 2006, the company reversed approximately $2 million of these costs as part of the final purchase price allocation. The reversal of these costs were recorded as a reduction of goodwill recorded in the purchase price allocation (see Note 6).
Fiscal year 2004 actions: The company recorded restructuring costs of $10 million during fiscal year 2004 related to workforce reductions and facility consolidations in its LVS business segment. These actions follow the management realignment of the company’s LVS business and were also intended to address the competitive challenges in the automotive supplier industry. These costs included severance and other employee termination costs related to a reduction of approximately 50 salaried and 575 hourly employees. The company also recorded in fiscal year 2004, restructuring charges totaling $5 million associated with certain administrative and managerial employee termination costs.
In addition, the company recorded $1 million of restructuring costs relating to the integration of Zeuna Stärker GmbH & Co. KG (Zeuna Stärker) in fiscal year 2004 as part of the final purchase price allocation (see Note 6).
A summary of the changes in the restructuring reserves is as follows (in millions):
(1) Restructuring charges related to ride control are included in discontinued operations in the consolidated statement of operations.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
6.
ACQUISITIONS AND DIVESTITURES
In fiscal year 2006, the company acquired the remaining 20 percent interest in Zeuna Starker Produzione Italia SpA (ZSPI) from the minority partner for 5 million ($6 million). As a result, ZSPI is a wholly-owned subsidiary of the company at September 30, 2006. This acquisition was accounted for as a business combination and accordingly $1 million of the purchase price was allocated to goodwill in the consolidated balance sheet. Concurrent with this transaction, ZSPI sold its land and building to a related party of the minority partner for 5 million ($6 million). These transactions had no impact on the company’s results of operations for the fiscal year ended September 30, 2006.
In October 2005, the company completed the sale of certain assets of its commercial vehicle off-highway brake business for cash proceeds of approximately $39 million and recognized a pre-tax gain on the sale of $23 million. The sale includes equipment and certain assets from manufacturing facilities in York, South Carolina and Cwmbran, U.K. The divestiture of the off-highway brakes operation is aligned with the company’s strategy to focus on its core products. These operations had sales of approximately $60 million in fiscal year 2005.
In December 2004, the company completed the divestiture of its LVS Columbus, Indiana automotive stamping and components manufacturing business and recognized a pre-tax gain on the sale of $4 million. This divestiture is part of the company’s plan to rationalize its operations and focus on its core automotive businesses. This manufacturing operation had sales of $83 million in fiscal year 2004.
On October 4, 2004, the company formed two joint ventures in France with AB Volvo to manufacture and distribute axles. The company acquired its 51-percent interest for a purchase price of 19 million ($25 million). Accordingly, beginning in the first quarter of fiscal year 2005, the results of operations and financial position of these joint ventures are consolidated by the company. The company has an option to purchase and AB Volvo has an option to require the company to purchase the remaining 49-percent interest in one of the joint ventures beginning in the first quarter of fiscal year 2008 for 16 million ($20 million) plus interest at EURIBOR rates, plus a margin. This option to purchase the minority interest is essentially a financing arrangement as the minority shareholder does not participate in any profits or losses of the joint venture. Therefore, this is recorded as a long-term obligation of the company which is included in other liabilities (see Note 15). Accordingly, no minority interest is recognized for the 49-percent interest in this joint venture. The company recorded $4 million of goodwill associated with the purchase price allocation during fiscal 2005. In fiscal year 2006, the company reversed approximately $2 million of restructuring costs recorded as part of the final purchase price allocation. The reversal of these costs were recorded as a reduction of goodwill recorded in the purchase price allocation. In September 2005, as part of the purchase agreement, the company purchased approximately $5 million of additional machinery and equipment from AB Volvo.
As part of the company’s continuing strategy to divest non-core businesses, in the third quarter of fiscal 2004, the company completed the sale of its CVS trailer beam fabrication facility in Kenton, OH. The divestiture of this facility is in line with the company’s strategy to be less vertically integrated and more focused on its core processes for the design and assembly of complete systems. This divestiture did not have a material impact on sales or net income. Net proceeds from this divestiture were approximately $14 million.
7.
ACCOUNTS RECEIVABLE SECURITIZATION AND FACTORING
In March 2006, the company entered into a new European arrangement to sell trade receivables through one of its European subsidiaries. Under the new arrangement, the company can sell up to, at any point in time, 100 million ($127 million) of eligible trade receivables. The receivables under this program are sold at face value and excluded from the company’s consolidated balance sheet. The company continues to perform collection and administrative functions related to these receivables. Costs associated with this securitization arrangement were $1 million in fiscal year 2006 and are included in operating income in the consolidated statement of operations. The gross amount of proceeds received from the sale of receivables under this arrangement was $216 million for fiscal year 2006. The company’s retained interest in receivables sold is $6 million at September 30, 2006. The company had utilized 48 million ($61 million) of this accounts receivable securitization facility as of September 30, 2006.
The company also participates in a U.S. accounts receivable securitization program to enhance financial flexibility and lower interest costs. Under this $250 million program, which was established in September 2005, and amended in fiscal year 2006, the company sells substantially all of the trade receivables of certain U.S. subsidiaries to ArvinMeritor Receivables Corporation (ARC), a wholly-owned, special purpose subsidiary. ARC funds these purchases with borrowings under a loan agreement with a bank. Amounts outstanding under this agreement are collateralized by eligible receivables purchased by ARC and are reported as short-term debt in the consolidated balance sheet (see Note 16). As of September 30, 2006 and 2005, the company had utilized $40 million and $112 million, respectively, of this accounts receivable securitization facility. Borrowings under this arrangement are collateralized by approximately $384 million of receivables held at ARC at September 30, 2006. If certain receivables performance-based covenants are not met, it would constitute a termination event, which, at the option of the banks, could result in termination of the accounts receivable securitization arrangement. At September 30, 2006, the company was in compliance with all covenants.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Prior to September 2005, the company participated in an accounts receivable securitization program wherein ARC entered into an agreement to sell an undivided interest in up to $250 million of eligible receivables to a bank conduit that funded its purchases through the issuance of commercial paper. The receivables under this program were sold at fair market value and were excluded from the consolidated balance sheet. A discount on the sale, included in interest expense, net and other, of $4 million was recorded in fiscal year 2005 and $5 million was recorded in fiscal year 2004. The company did not have a retained interest in the receivables sold, but did perform collection and administrative functions. The gross amount of proceeds received from the sale of receivables under these programs was $1,308 million and $2,387 million for fiscal years 2005 and 2004, respectively.
In addition, several of the company’s European subsidiaries factor eligible accounts receivable with financial institutions. Certain receivables are factored without recourse to the company and are excluded from accounts receivable. The amount of factored receivables excluded from accounts receivable was $84 million and $23 million at September 30, 2006 and 2005, respectively.
8. OTHER INCOME (EXPENSE)
Other income (expense) is comprised of the following (in millions):
In fiscal year 2005, the company closed its stabilizer bar facility located in Sheffield, England and sold land and buildings (see Note 5). This facility was the primary operations of MSSH. During fiscal year 2006, the company substantially completed the liquidation of MSSH and recorded a $5 million gain, primarily related to the extinguishment of debt owed to the minority partner.
In the first quarter of fiscal year 2004, as a result of the company’s decision to withdraw its all cash tender offer to acquire all of the outstanding shares of Dana Corporation, the company recorded a net charge of $9 million ($6 million after-tax). The pre-tax charge includes $16 million in direct incremental acquisition costs less a gain on the sale of Dana stock of $7 million.
Inventories are stated at the lower of cost (using FIFO or average methods) or market (determined on the basis of estimated realizable values) and are summarized as follows (in millions):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Other current assets are summarized as follows (in millions):
Costs incurred for tooling and engineering, principally for light vehicle products, for which customer reimbursement is contractually guaranteed, are classified as customer reimbursable tooling and engineering. These costs are billed to the customer based on the terms of the contract. Provisions for losses are provided at the time management expects costs to exceed anticipated customer reimbursements.
The company holds certain assets as held for sale. These assets primarily relate to land and buildings that have been previously closed through restructuring and other rationalization actions. At September 30, 2005, assets held for sale also included assets related to CVS’ off-highway brake business, which was sold in October 2005 (see Note 6).
Property is stated at cost. Depreciation of property is based on estimated useful lives, generally using the straight-line method. Estimated useful lives for buildings and improvements range from 10 to 50 years and estimated useful lives for machinery and equipment range from 3 to 20 years. Significant betterments are capitalized, and disposed or replaced property is written off. Maintenance and repairs are charged to expense. Company-owned tooling is classified as property and depreciated over the shorter of its expected life or the life of the related vehicle platform, generally not to exceed three years.
Net Property is summarized as follows (in millions):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Other assets are summarized as follows (in millions):
In accordance with Statement of Position (SOP) 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use,” costs relating to internally developed or purchased software in the preliminary project stage and the post-implementation stage are expensed as incurred. Costs in the application development stage that meet the criteria for capitalization are capitalized and amortized using the straight-line basis over the estimated economic useful life of the software.
Patents, licenses and other intangible assets include trademarks and other indefinite lived intangibles of $8 million, an intangible asset associated with the retirement pension plans of $9 million and other amortizable intangible assets of $3 million. The company’s trademarks, which were determined to have an indefinite life, and pension intangible asset are not amortized. Patents, licenses and other intangible assets are amortized over their contractual or estimated useful lives, as appropriate. The company anticipates amortization expense for patents, licenses and other intangible assets of approximately $1 million for fiscal year 2007 and $2 million total thereafter.
13.
INVESTMENTS IN NON-CONSOLIDATED JOINT VENTURES
The company’s significant non-consolidated joint ventures and related ownership interest at September 30, 2006 are as follows:
The company’s investments in non-consolidated joint ventures was as follows (in millions):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The company’s equity in earnings of non-consolidated joint ventures were as follows (in millions):
The summarized financial information presented below represents the combined accounts of the company’s non-consolidated joint ventures (in millions):
Dividends received from the company’s non-consolidated joint ventures were $23 million in fiscal year 2006, $18 million in fiscal year 2005 and $15 million in fiscal year 2004.
The company had sales to its non-consolidated joint ventures of approximately $30 million, $15 million and $29 million in fiscal years 2006, 2005 and 2004, respectively. The company had purchases from its non-consolidated joint ventures of approximately $334 million, $63 million and $45 million in fiscal years 2006, 2005, and 2004, respectively. Additionally, the company leases space and provides certain administrative and technical services to various non-consolidated joint ventures. The company collected $2 million for such leases and services during fiscal year 2006. The amount collected by the company for such leases and services was not material to its results of operations or financial condition during fiscal year 2005.
Amounts due from the company’s non-consolidated joint ventures were $30 million and $19 million at September 30, 2006 and 2005, respectively. Amounts due to the company’s non-consolidated joint ventures were $46 million and $10 million at September 30, 2006 and 2005, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Other current liabilities are summarized as follows (in millions):
The company’s CVS segment records product warranty costs at the time of shipment of products to customers. Warranty reserves are primarily based on factors that include past claims experience, sales history, product manufacturing and engineering changes and industry developments. Liabilities for product recall campaigns are recorded at the time the company’s obligation is known and can be reasonably estimated. Product warranties, including recall campaigns, not expected to be paid within one year are recorded as a non-current liability.
The company’s LVS segment records product warranty liabilities based on individual customer or warranty-sharing agreements. Product warranties are recorded for known warranty issues when amounts can be reasonably estimated.
A summary of the changes in product warranties is as follows (in millions):
In fiscal year 2004, the company, as a result of receiving the wrong grade of steel from one of its steel suppliers, manufactured and shipped certain products that were out of specification with various customers’ orders. The company was notified by a customer in fiscal year 2005 that it was initiating a field service campaign covering approximately 35,000 vehicles that were manufactured by the customer during the relevant time frame, prior to the aforementioned steel issue being identified, and would expect the company to reimburse it for the cost of the campaign. Associated with this matter, in fiscal year 2005, the company recorded a warranty charge of $4 million, net of probable recoveries from the supplier, which are recorded in receivables. In the first quarter of fiscal year 2006, the company reached a settlement with the supplier regarding the field service campaign. This settlement resulted in a $1 million reduction in the company’s recorded liability, net of recoveries. Additionally, in fiscal year 2005 another customer notified the company that it had initiated a field service campaign to replace an affected part in approximately 8,300 vehicles. Although this field service campaign is associated with the same steel issue and the same supplier, it relates to a different part on the vehicle. Based on the currently available facts and circumstances, the company does not believe it has a probable liability, net of recoveries, related to this matter.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Other liabilities are summarized as follows (in millions):
As discussed in Note 6, the company recorded a long-term obligation of 16 million ($20 million) plus interest to purchase the remaining 49-percent interest in one of the joint ventures formed with AB Volvo.
Long-Term Debt, net of discounts where applicable, is summarized as follows (in millions):
(1) These convertible notes contain a put and call feature, which allows for earlier redemption beginning in 2016 (see Convertible Securities below).
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Debt Securities
In March 2006, the company completed the repurchase of $600 million aggregate principal amount of its previously outstanding notes in the following amounts: $195 million of its outstanding $200 million 6-5/8 percent notes due in 2007; $95 million of its outstanding $100 million 6-3/4 percent notes due in 2008; $225 million of its outstanding $302 million 6.8 percent notes due in 2009; and $85 million of its outstanding $91 million 7-1/8 percent notes also due in 2009. The repurchase was accounted for as an extinguishment of debt and, accordingly, $9 million was recognized as a loss on debt extinguishment and is included in interest expense, net and other in the consolidated statement of operations. The loss primarily consists of debt reacquisition costs associated with the note repurchase, unamortized debt issuance costs and debt discount, and the premium paid to repurchase the notes.
The company also purchased, at a discount, $69 million of its $380 million outstanding 8-3/4 percent notes on the open market during fiscal year 2006. The purchase of these debt securities was accounted for as an extinguishment of debt and, accordingly, $3 million was recognized as a gain on debt extinguishment and is included in interest expense, net and other in the consolidated statement of operations. In the first quarter of fiscal year 2006, the company purchased $3 million of the outstanding 6.8 percent notes on the open market at a discount.
In September 2005, the company completed an offer to exchange $194 million of its previously outstanding $499 million 6.8 percent notes, due in 2009, and $59 million of its previously outstanding $150 million 7-1/8 percent notes, also due in 2009 for $253 million of new 8-1/8 percent notes due in 2015. The exchange of the $194 million of 6.8 percent notes was accounted for as an extinguishment of debt and, accordingly, $4 million was recognized in fiscal year 2005 as a loss on debt extinguishment and included in interest expense, net and other in the consolidated statement of operations. The loss on debt extinguishment primarily consisted of the premium paid to note holders to exchange their notes. The exchange of the $59 million of 7-1/8 percent notes was accounted for as a debt exchange, and accordingly, the $3 million premium paid to exchange these notes was recorded as a discount and included as a reduction in the carrying value of the new notes.
In addition, during fiscal year 2005, the company terminated a portion of its outstanding interest rate swaps (see Interest Rate Swaps below) and used the proceeds to purchase, at a discount, $20 million and $1 million of the 8-3/4 percent notes and 6.8 percent notes, respectively, on the open market. In connection with the purchase of these notes, the company recognized approximately $1 million of the fair value adjustment of notes as a reduction of interest expense in fiscal year 2005.
The company previously filed a shelf registration statement with the Securities and Exchange Commission registering $750 million aggregate principal amount of debt securities to be offered in one or more series on terms determined at the time of sale. At September 30, 2006 the company had $150 million of debt securities available for issuance under this shelf registration.
Investment in Debt Defeasance Trust
During fiscal year 2006, the company purchased $12 million of U.S. government securities and placed those securities into an irrevocable trust, for the sole purpose of funding payments of principal and interest through the stated maturity on the $5 million of outstanding 6-3/4 percent notes due 2008 and the $6 million of outstanding 7-1/8 percent notes due 2009, in order to defease certain covenants under the associated indenture. As these securities are restricted and can only be withdrawn and used for payments of the principal and interest on the aforementioned notes, the assets of the trust are primarily recorded in Other Assets (see Note 12) in the consolidated balance sheet.
Convertible Securities
In March 2006, the company issued $300 million of 4.625 percent convertible senior unsecured notes due 2026 (convertible notes). The convertible notes were sold by the company to qualified institutional buyers in a private placement exempt from the registration requirements of the Securities Act of 1933. These convertible notes were registered with the Securities and Exchange Commission under the Securities Act of 1933 on May 23, 2006. Net proceeds received by the company, after issuance costs, were $289 million. The related debt issuance costs are being amortized over a ten-year term, which represents the earliest date that the company can redeem the convertible notes. The company used the net proceeds from this offering, together with proceeds from the sales of its LVA North American filters and exhaust businesses and other sources to fund the repurchase of $600 million aggregate principal amount of previously outstanding notes (see Debt Securities above).
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Cash interest at a rate of 4.625 percent per annum from the date of issuance through March 1, 2016 is payable semi-annually in arrears on March 1 and September 1 of each year. After March 1, 2016, the principal amount of the convertible notes will be subject to accretion at a rate that provides holders with an aggregate annual yield to maturity of 4.625 percent.
The notes are convertible into shares of the company’s common stock at an initial conversion rate, subject to adjustment, equivalent to 47.6667 shares of common stock per $1,000 initial principal amount of notes, which represents an initial conversion price of approximately $20.98 per share. If converted, the accreted principal amount will be settled in cash and the remainder of the company’s conversion obligation, if any, in excess of such accreted principal amount will be settled in cash, shares of common stock, or a combination thereof, at the company’s election.
Holders may convert their notes at any time on or after March 1, 2024. Prior to March 1, 2024, holders may convert their notes only under the following circumstances:
•
during any calendar quarter, after the calendar quarter ending June 30, 2006, if the closing price of the company’s common stock for 20 or more trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter exceeds 120 percent of the applicable conversion price;
•
during the five business day period after any five consecutive trading day period in which the average trading price per $1,000 initial principal amount of notes is equal to or less than 97 percent of the average conversion value of the notes during such five consecutive trading day period;
•
upon the occurrence of specified corporate transactions; or
•
if the notes are called by us for redemption.
On or after March 1, 2016, the company may redeem the convertible notes, in whole or in part, for cash at a redemption price equal to 100 percent of the accreted principal amount plus any accrued and unpaid interest. On each of March 1, 2016, 2018, 2020, 2022, and 2024, or upon certain fundamental changes, holders may require the company to purchase all or a portion of their convertible notes at a purchase price in cash equal to 100 percent of the accreted principal amount plus any accrued and unpaid interest.
The convertible notes are fully and unconditionally guaranteed by certain subsidiaries of the company that currently guarantee the company’s obligations under its senior secured credit facilities and other publicly-held notes (see Senior Secured Credit Facilities below).
Subordinated Debentures
The company, through Arvin Capital I (the trust), a wholly-owned finance subsidiary trust, issued $39 million of 9.5 percent Company-Obligated Mandatorily Redeemable Preferred Capital Securities of a Subsidiary Trust (preferred capital securities), due February 1, 2027, and callable in February 2007 at a premium and in February 2017 at par. The proceeds from the capital securities are invested entirely in 9.5 percent junior subordinated debentures of the company, which are the sole assets of the trust. The company fully and unconditionally guarantees the trust’s obligation to the holders of the preferred capital securities.
Under the provisions of FASB Interpretation No. 46, it was determined that the trust is a variable interest entity in which the company does not have a variable interest and therefore is not the primary beneficiary and accordingly has included in long-term debt $39 million of junior subordinated debentures due to the trust.
Senior Secured Credit Facilities
In June 2006, the company replaced its $900 million revolving credit facility that was to expire in 2008 with two new senior secured credit facilities totaling $1.15 billion (the new credit facilities). The new credit facilities include a $980 million revolving credit facility and a $170 million term loan maturing in 2011 and 2012, respectively. Debt issuance costs associated with the new credit facilities of $10 million are being amortized over the five year term of the revolving credit facility. Borrowings under the new revolving credit facility are subject to interest based on quoted LIBOR rates plus a margin, and a commitment fee on undrawn amounts, both of which are based upon the company’s current credit rating for the senior secured facilities. At September 30, 2006, the margin over the LIBOR rate was 150 basis points, and the commitment fee was 30 basis points. Similar to the prior revolving credit facility, the new revolving credit facility includes a $150 million limit on the issuance of letters of credit. At September 30, 2006 and 2005, approximately $25 million and $23 million letters of credit, respectively, were issued.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The term loan is payable in quarterly installments of $0.25 million with the remaining balance due at maturity. Borrowings under the term loan are subject to interest based on quoted LIBOR rates plus a margin. At September 30, 2006, the margin over the LIBOR rate was 175 basis points.
Borrowings under the revolving credit facility and term loan are collateralized by approximately $1.1 billion of the company’s assets, primarily consisting of eligible domestic U.S. accounts receivable, inventory, plant, property, and equipment, intellectual property and the company’s investment in all or a portion of certain of its wholly-owned subsidiaries.
The new credit facilities require the company to maintain a total net debt to earnings before interest, taxes, depreciation and amortization (EBITDA) ratio no greater than 4.25x and a minimum fixed charge coverage ratio (EBITDA less capital expenditures to interest expense) no less than 1.50x. At September 30, 2006, the company was in compliance with all covenants.
Certain of the company’s subsidiaries, as defined in the credit agreement, irrevocably and unconditionally guarantee amounts outstanding under the new credit facilities. Similar subsidiary guarantees are provided for the benefit of the holders of the publicly-held notes outstanding under the company’s indentures (see Note 27).
Accounts Receivable Securitization
In September 2005, the company entered into a new $250 million accounts receivable securitization arrangement. As discussed in Note 7, the company’s previous accounts receivable securitization facility expired in September 2005. Under the new arrangement, the company sells substantially all of the trade receivables of certain U.S. subsidiaries to ARC. ARC funds these purchases with borrowings under a loan agreement with a bank. The weighted average interest rate on borrowings under this arrangement was approximately 4.80 percent during fiscal 2006. Amounts outstanding under this agreement are reported as short-term debt in the consolidated balance sheet and are collateralized by $384 million of eligible receivables purchased and held by ARC at September 30, 2006. If certain receivables performance-based covenants are not met, it would constitute a termination event, which, at the option of the banks, could result in termination of the accounts receivable securitization arrangement. At September 30, 2006, the company was in compliance with all covenants.
Related Parties
A 57-percent owned consolidated joint venture of the company has a $6 million, 6.5-percent loan with its minority partner. The maturity date of this loan was extended in November 2005 to fiscal year 2009. This loan is included in long-term debt in the consolidated balance sheet.
The company also has an arrangement with a non-consolidated joint venture that allows the company to borrow funds from time to time, at LIBOR plus 50 basis points. No amounts were outstanding under this arrangement at September 30, 2006 and 2005.
Interest Rate Swap Agreements
In September 2006, the company executed a new swap agreement that effectively converts $25 million notional amount of 8-1/8 percent notes to variable rates. In March 2006, concurrent with the repurchase of $225 million of the company’s outstanding $302 million 6.8 percent notes, the company terminated $30 million notional amount of its 6.8 percent interest rate swaps.
In May 2005, the company terminated $262 million of its $300 million notional amount 8.75 percent interest rate swap and $22 million of its $100 million notional amount 6.8 percent interest rate swap. Proceeds from these terminations, including interest received, were $22 million. The fair value adjustment to the notes associated with these partially terminated swaps was $20 million, and is amortized to earnings as a reduction of interest expense over the remaining life of the debt. The fair value adjustment of the notes is classified in Long-Term Debt in the consolidated balance sheet. Simultaneously, the company executed new swap agreements that effectively convert $183 million notional amount of 8-3/4 percent notes and $15 million notional amount of 6.8 percent notes to variable interest rates. The new swap agreements had the same terms as the original agreements, and the fixed spread is approximately 140 basis points higher than in the original swap agreements.
As of September 30, 2006, the company had interest rate swap agreements that effectively convert $221 million of the company’s 8-3/4 percent notes and $63 million of the 6.8 percent notes to variable interest rates. These are in addition to the $25 million notional amount interest rate swap executed in September 2006, As of September 30, 2006, the fair value of the 8-3/4 percent swaps was a liability of $ 6 million and is included in Other Liabilities and the fair value of the 6.8 percent swaps was not significant. As of September 30, 2005, the fair value of the swaps was not material. The terms of the interest rate swap agreements require the company to place cash on deposit as collateral if the fair value of the interest rate swaps declines below zero. Accordingly, the company has placed $6 million on deposit with the counterparty as collateral and recorded such deposit as a reduction in the carrying value of the associated interest rate swap. The swaps have been designated as fair value hedges and the
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
impact of the changes in their fair values is offset by an equal and opposite change in the carrying value of the related notes. Under the terms of the swap agreements, the company receives a fixed rate of interest of 8.75 percent, 6.8 percent and 8.125 percent on notional amounts of $221 million, $63 million and $25 million, respectively, and pays variable rates based on three-month LIBOR plus a weighted-average spread of 3.41 percent. The payments under the agreements coincide with the interest payment dates on the hedged debt instruments, and the difference between the amounts paid and received is included in interest expense, net and other. Included in the fair value adjustment of notes is $12 million related to previously terminated interest rate swaps, which is being amortized to earnings as a reduction of interest expense over the remaining life of the related debt.
The company classifies the cash flows associated with its interest rate swaps in cash flows from operating activities in its consolidated statement of cash flows. This is consistent with the classification of the cash flows associated with the underlying hedged item.
Leases
The company had entered into an agreement to lease certain manufacturing and administrative assets. Under the agreement, the assets were held by a variable interest entity in which the company had a variable interest in the form of a $30 million residual value guarantee that obligates the company to absorb a majority of the variable interest entity’s losses. Accordingly the assets and liabilities of this variable interest entity were included in the company’s consolidated balance sheet. In July 2006, the company purchased the assets and extinguished the liability for $35 million.
The company has various other operating leasing arrangements. Future minimum lease payments under these operating leases are $23 million in 2007, $17 million in 2008, $14 million in 2009, $10 million in 2010, $8 million in 2011 and $11 million thereafter.
Covenants
The senior secured revolving credit facility requires the company to maintain a total net debt to earnings before interest, taxes, depreciation and amortization (EBITDA) ratio no greater than 4.25x and a minimum fixed charge coverage ratio (EBITDA less capital expenditures to interest expense) no less than 1.50x. At September 30, 2006, the company was in compliance with all covenants.
The company’s financial instruments include cash and cash equivalents, short-term debt, long-term debt, interest rate swaps, and foreign exchange forward contracts. The company uses derivatives for hedging and non-trading purposes in order to manage its interest rate and foreign exchange rate exposures. The company’s interest rate swap agreements are discussed in Note 16.
Foreign Exchange Contracts
The company’s operations are exposed to global market risks, including the effect of changes in foreign currency exchange rates. The company has a foreign currency cash flow hedging program to reduce the company’s exposure to changes in exchange rates. The company uses foreign currency forward contracts to manage the company’s exposures arising from foreign currency exchange risk. Gains and losses on the underlying foreign currency exposures are partially offset with gains and losses on the foreign currency forward contracts.
Under this program, the company has designated the foreign exchange contracts (the “contracts”) as cash flow hedges of underlying forecasted foreign currency purchases and sales. The effective portion of changes in the fair value of the contracts is recorded in Accumulated Other Comprehensive Income (AOCI) in the consolidated statement of shareowners’ equity and is recognized in operating income when the underlying forecasted transaction impacts earnings. The contracts generally mature within 12 months. The company recognized gains on the contracts of approximately $2 million and $14 million in the fiscal years ended September 30, 2006 and 2005, respectively. The contracts were not significant to results of operations in fiscal year 2004. The impact to operating income associated with hedge ineffectiveness was not significant in fiscal years 2006, 2005 and 2004.
At September 30, 2006, there was a $1 million loss recorded in AOCI. The company expects to reclassify this amount from AOCI to operating income during the next three months as the forecasted hedged transactions are recognized in earnings. At September 30, 2005, there was a $2 million gain recorded in AOCI.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The company classifies the cash flows associated with the contracts in cash flows from operating activities in the consolidated statement of cash flows. This is consistent with the classification of the cash flows associated with the underlying hedged item.
Fair Value
Fair values of financial instruments are summarized as follows (in millions):
Cash and cash equivalents - All highly liquid investments purchased with an original maturity of three months or less are considered to be cash equivalents. The carrying value approximates fair value because of the short maturity of these instruments.
Interest rate swaps and foreign exchange forward contracts - Fair values are estimated by obtaining quotes from external sources.
Short-term debt - The carrying value of short-term debt approximates fair value because of the short maturity of these borrowings.
Long-term debt - Fair values are based on interest rates that would be currently available to the company for issuance of similar types of debt instruments with similar terms and remaining maturities.
Common Stock
The company is authorized to issue 500 million shares of Common Stock, with a par value of $1 per share, and 30 million shares of Preferred Stock, without par value, of which two million shares are designated as Series A Junior Participating Preferred Stock (Junior Preferred Stock). Under the Company Rights Plan, a Preferred Share Purchase Right (Right) is attached to each share of Common Stock pursuant to which the holder may, in certain takeover-related circumstances, become entitled to purchase from the company 1/100th of a share of Junior Preferred Stock at a price of $100, subject to adjustment. Also, in certain takeover-related circumstances, each Right (other than those held by an acquiring person) will be exercisable for shares of Common Stock or stock of the acquiring person having a market value of twice the exercise price. In certain events, the company may exchange each Right for one share of Common Stock or 1/100th of a share of Junior Preferred Stock. The Rights will expire on July 7, 2010, unless earlier exchanged or redeemed at a redemption price of $0.01 per Right. Until a Right is exercised, the holder, as such, will have no voting, dividend or other rights as a shareowner of the company.
The company has reserved approximately 15.6 million shares of Common Stock in connection with its Long-Term Incentives Plan (LTIP), Directors Stock Plan, Incentive Compensation Plan, 1998 and 1988 Stock Benefit Plans, and Employee Stock Benefit Plan for grants of non-qualified stock options, incentive stock options, stock appreciation rights, restricted stock, performance shares, restricted share units and stock awards to key employees and directors. At September 30, 2006, there were 1.5 million shares available for future grants under these plans.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Treasury Stock
The company accounts for treasury stock at cost. There were no purchases of treasury stock in fiscal years 2006, 2005 or 2004. During fiscal years 2006 and 2005, approximately 0.5 million and 0.9 million shares of treasury stock were issued in connection with the exercise of stock options and issuance of restricted stock under the company’s incentive plans.
Accumulated Other Comprehensive Loss
The components of Accumulated Other Comprehensive Loss as reported in the Consolidated Balance Sheet and Statement of Shareowners’ Equity are as follows:
Stock Options
Under the company’s incentive plans, stock options are granted at prices equal to the fair value on the date of grant and have a maximum term of 10 years. Stock options vest over a three year period from the date of grant. No stock options were granted during fiscal years 2006 and 2005.
Information related to stock options is as follows (shares in thousands, exercise price and remaining contractual term represent weighted averages, and aggregate intrinsic values in millions):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table provides additional information about outstanding stock options at September 30, 2006 (shares in thousands, exercise price represents a weighted average):
Compensation expense is recognized for the non-vested portion of previously issued stock options. The company recorded compensation expense of $3 million, $6 million, and $7 million in fiscal years 2006, 2005, and 2004, respectively, associated with the expensing of stock options. The total intrinsic value of options exercised was less than $1 million in fiscal year 2006 and $2 million and $3 million in fiscal years 2005 and 2004, respectively.
The weighted average grant date fair value of options granted was $5.80 for fiscal 2004. The fair value was estimated on the date of grant using the Black-Scholes pricing model and the following assumptions:
Restricted Stock, Restricted Units, and Performance Share Units
The company grants shares of restricted stock and restricted and performance share units to certain employees and non-employee members of the Board of Directors in accordance with the Employee Stock Benefit Plan and the 2004 Directors Stock Plan, respectively. The company measures the grant price fair value of these stock based awards at the market price of the company’s common stock as of the date of the grant. These awards typically vest over three years and are subject to continued employment by the employee. Performance share units are also subject to satisfaction of certain conditions related to the company’s financial performance. Compensation cost associated with stock based awards is recognized ratably over the vesting period. Cash dividends on the restricted stock are reinvested in additional shares of common stock during the vesting period.
In fiscal years 2006, 2005, and 2004, the company granted 888,300, 851,975, and 738,100 shares of stock based awards, respectively. The grant date fair value of these shares was $13.69, $20.53, and $22.68 for shares granted in 2006, 2005 and 2004, respectively.
The company’s nonvested restricted shares and share units as of September 30, 2006, and the activity during fiscal year 2006 is summarized as follows (shares in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
As of September 30, 2006, there was $15 million of total unrecognized compensation costs related nonvested equity compensation arrangements. These costs are expected to be recognized over a weighted average period of 1.2 years. Total compensation expense recognized for restricted stock, restricted share units, and performance share units was $14 million in fiscal year 2006, $18 million in fiscal year 2005 and $9 million in fiscal year 2004.
Prior to the adoption of SFAS 123(R), total compensation expense related to the grants of restricted stock was recorded as unearned compensation and was shown as a separate reduction of shareowners’ equity. Unearned compensation was expensed over the vesting period. Upon the adoption of SFAS 123(R) in fiscal year 2006, compensation expense is recorded as incurred as a reduction of additional paid in capital in the consolidated statement of shareowners’ equity. In addition, the previously recorded balance in unearned compensation was reclassed to additional paid in capital.
The company has retirement medical plans that cover the majority of its U.S. and certain non-U.S. employees and provide for medical payments to eligible employees and dependents upon retirement. These plans are unfunded.
The company approved amendments to certain retiree medical plans in fiscal years 2002 and 2004. The cumulative effect of these amendments was a reduction in the accumulated postretirement benefit obligation (APBO) of $293 million, which was being amortized as a reduction of retiree medical expense over the average remaining service period of approximately 12 years. These plan amendments have been challenged in three separate class action lawsuits that have been filed in the United States District Court for the Eastern District of Michigan (District Court). The lawsuits allege that the changes breach the terms of various collective bargaining agreements entered into with the United Auto Workers (the UAW lawsuit) and the United Steel Workers (the USW lawsuit) at facilities that have either been closed or sold. The complaints also allege a companion claim under the Employee Retirement Income Security Act of 1974 (ERISA) essentially restating the alleged collective bargaining breach claims and seeking to bring them under ERISA. Plaintiffs sought injunctive relief requiring the company to provide lifetime retiree health care benefits under the applicable collective bargaining agreements.
On December 22, 2005, the District Court issued an order granting a motion by the UAW for a preliminary injunction. The order enjoined the company from implementing the changes to retiree health benefits that had been scheduled to become effective on January 1, 2006, and ordered the company to reinstate and resume paying the full cost of health benefits for the UAW retirees at the levels existing prior to the changes approved in 2002 and 2004. On August 17, 2006, the District Court denied a motion by the company and the other defendants for summary judgment; granted a motion by the UAW for summary judgment; and granted the UAW’s request to make the terms of the preliminary injunction permanent (the injunction). Due to the uncertainty related to the ongoing lawsuits and because the injunction has the impact of at least temporarily changing the benefits provided under the existing postretirement medical plans, the company has accounted for the injunction as a rescission of the 2002 and 2004 plan amendments that modified UAW retiree healthcare benefits. The company recalculated the APBO as of December 22, 2005, which resulted in an increase in the APBO of $168 million. The increase in APBO will offset the remaining unamortized negative prior service cost of the 2002 and 2004 plan amendments and will increase retiree medical expense over the average remaining service period associated with the original plan amendments of approximately 10 years. In addition, the increase in APBO resulted in higher interest cost, a component of retiree medical expense. The company began recording the impact of the injunction in March 2006, 90 days from the December 22, 2005 measurement date, which is consistent with the 90-day lag between the company’s normal plan measurement date of June 30 and its fiscal year-end. In addition, the injunction ordered the defendants to reimburse the plaintiffs for out-of-pocket expenses incurred since the date of the earlier benefit modifications. The company recorded a $5 million reserve at September 30, 2006 as the best estimate of its liability for these retroactive benefits. Including the estimated liability for retroactive benefits, the injunction increased retiree medical expense by approximately $17 million in fiscal year 2006. The company continues to believe it has meritorious defenses to these actions and has appealed the District Court’s order to the U.S. Court of Appeals for the Sixth Circuit. The ultimate outcome of the UAW lawsuit may result in future plan amendments. The impact of any future plan amendments cannot be currently estimated.
Based on management’s assessment of the USW lawsuit, the 2002 and 2004 plan amendments are still in effect for USW retirees. The ultimate outcome of the USW lawsuit may result in future plan amendments. The impact of any future plan amendments cannot be currently estimated.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The company’s retiree medical obligations are measured as of June 30. The following are the assumptions used in the measurement of the APBO and retiree medical expense:
Since the company measures its retiree medical obligations at June 30, the assumptions noted above are used to calculate the APBO as of June 30 of the current fiscal year and retiree medical expense for the subsequent fiscal year.
The discount rate is used to calculate the present value of the APBO. This rate is determined based on high-quality fixed income investments that match the duration of expected retiree medical benefits. The company has typically used the corporate AA/Aa bond rate for this assumption. The health care cost trend rate represents the company’s expected annual rates of change in the cost of health care benefits. The trend rate noted above represents a projection of health care costs as of the measurement date through 2011, at which time the health care trend rate is projected to be 5.0 percent. The company’s projection for fiscal year 2007 is an increase in health care costs of 8.0 percent.
The APBO as of the June 30 measurement date is summarized as follows (in millions):
The following reconciles the change in APBO and the amounts included in the consolidated balance sheet (in millions):
(1) The APBO at September 30, 2005 included $15 million of benefit payments made during the forth quarter of fiscal year 2005.
(2) The company recorded a $5 million reserve for retiree medical liabilities at September 30, 2006 as its best estimate for retroactive benefits related to the previously mentioned injunction.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Actuarial losses relate to changes in the discount rate and earlier than expected retirements due to certain plant closings and restructuring actions. In accordance with SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other than Pensions”, a portion of the actuarial losses is not subject to amortization. The actuarial losses that are subject to amortization are generally amortized over the average expected remaining service life, which is approximately 12 years. Union plan amendments are generally amortized over the contract period, or 3 years.
The Medicare Prescription Drug Improvement and Modernization Act of 2003 provides for a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit at least actuarially equivalent to the benefit established by the law. The company provides retiree medical benefits for certain plans that exceed the value of the benefits that are provided by the Medicare Part D plan. Therefore, management concluded that these plans are at least actuarially equivalent to the Medicare Part D plan and the company is eligible for the federal subsidy. The impact of the subsidy was reflected as a reduction in the 2006 and 2005 retiree medical expense of $4 million and $2 million, respectively. Additionally, the subsidy reduced the APBO at June 30, 2005 by $25 million.
The retiree medical liability is included in the consolidated balance sheet as follows (in millions):
The components of retiree medical expense are as follows (in millions):
(1) The company recognized a curtailment gain in fiscal year 2004 of $5 million related to the previously mentioned amendments to certain retiree medical plans in fiscal year 2004
(2) The company recorded a $5 million charge for retiree medical liabilities at September 30, 2006 as its best estimate for retroactive benefits related to the previously mentioned injunction.
A one-percentage point change in the assumed health care cost trend rate for all years to, and including, the ultimate rate would have the following effects (in millions):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The company expects future benefit payments as follows (in millions):
The company sponsors defined benefit pension plans that cover most of its U.S. employees and certain non-U.S. employees. Pension benefits for salaried employees are based on years of credited service and compensation. Pension benefits for hourly employees are based on years of service and specified benefit amounts. The company’s funding policy provides that annual contributions to the pension trusts will be at least equal to the minimum amounts required by ERISA in the U.S. and the actuarial recommendations or statutory requirements in other countries.
Certain of the company’s non-U.S. subsidiaries provide limited non-pension benefits to retirees in addition to government-sponsored programs. The cost of these programs is not significant to the company. Most retirees outside the U.S. are covered by government-sponsored and administered programs.
The company’s pension obligations are measured as of June 30. The U.S. plans include a qualified and non-qualified pension plan. The non-U.S. plans include plans primarily in the United Kingdom, Canada and Germany.
The following are the assumptions used in the measurement of the projected benefit obligation (PBO) and net periodic pension expense:
Since the company measures its pension obligations at June 30, the assumptions noted above are used to calculate the PBO as of June 30 of the current fiscal year and net periodic pension expense for the subsequent fiscal year.
The discount rate is used to calculate the present value of the PBO. The rate used reflects a rate of return on high-quality fixed income investments that match the duration of expected benefit payments. The company uses a portfolio of long-term corporate AA/Aa bonds that match the duration of the expected benefit payments to establish the discount rate for this assumption.
The assumed return on plan assets is used to determine net periodic pension expense. The rate of return assumptions are based on projected long-term market returns for the various asset classes in which the plans are invested, weighted by the target asset allocations. An incremental amount for active plan asset management, where appropriate, is included in the rate of return assumption. The return assumption is reviewed annually.
The rate of compensation increase represents the long-term assumption for expected increases to salaries for pay-related plans.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table reconciles the change in the PBO and the change in plan assets (in millions):
In fiscal 2006, the decrease to actuarial losses (see table below) relates primarily to the increase in the discount rate assumptions. In accordance with SFAS No. 87, “Employers’ Accounting for Pensions”, a portion of the actuarial losses is not subject to amortization. The actuarial losses that are subject to amortization are generally amortized over the expected remaining service life, which ranges from 12 to 18 years, depending on the plan. The increase in the discount rate was the primary reason for the decrease in the unfunded status of the U.S. plans at September 30, 2006. In accordance with SFAS No. 87, the company utilizes a market-related value of assets, which recognizes changes in the fair value of assets over a five-year period.
In recognition of the long-term nature of the liabilities of the pension plans, the company has targeted an asset allocation strategy that intends to promote asset growth while maintaining an acceptable level of risk over the long-term. Asset-liability studies are performed periodically to validate the continued appropriateness of these asset allocation targets. The target asset allocation ranges for the U.S. plan are 50-70 percent equity securities, 25-35 percent debt securities, and 5-15 percent alternative investments. The target asset allocation ranges for the non-U.S. plans are 65-75 percent equity securities, 20-35 percent debt securities, and 0-5 percent real estate and alternative investments. The asset class mix and the percentage of securities in any asset class or market may vary as the risk/return characteristics of either individual market or asset classes vary over time.
The investment strategies for the pension plans are designed to achieve an appropriate diversification of investments as well as safety and security of the principal invested. Assets invested are allocated to certain global sub-asset categories within prescribed ranges in order to promote international diversification across security type, issuer type, investment style, industry group, and economic sector. Assets of the plans are both actively and passively managed. Policy limits are placed on the percentage of plan assets that can be invested in a security of any single issuer and minimum credit quality standards are established for debt securities. ArvinMeritor securities comprised less than one half of one percent of the value of our worldwide pension assets during 2006 and 2005.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The weighted average asset allocation for the U.S. and non U.S. pension plans are as follows:
The following reconciles the funded status with the amount included in the consolidated balance sheet (in millions):
(1)
Funded status at September 30, 2005 included $6 million of contributions made during the forth quarter of fiscal year 2005.
SFAS No. 87 requires a company to record a minimum liability that is at least equal to the unfunded accumulated benefit obligation. The additional minimum pension liability, net of a deferred tax asset, is charged to accumulated other comprehensive loss. At September 30, 2006 and 2005, the company’s additional minimum pension liability reflected in accumulated other comprehensive loss was $257 million and $436 million, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Amounts included in the consolidated balance sheet at September 30 were comprised of the following (in millions):
The pension liability is included in Retirement Benefits in the consolidated balance sheet as follows (in millions):
In accordance with SFAS No. 132(R) “Employers’ Disclosures about Pensions and Other Postretirement Benefits”, the PBO, accumulated benefit obligation (ABO) and fair value of plan assets is required to be disclosed for all plans where the ABO is in excess of plan assets. The difference between the PBO and ABO is that the PBO includes projected compensation increases.
Additional information is as follows (in millions):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The components of net periodic pension expense are as follows (in millions):
In connection with the company’s sale of the CVS Kenton, OH facility (see Note 6), the company recognized a curtailment loss of $4 million in fiscal year 2004.
Information about the expected cash flows for the U.S. and non-U.S. pension plans is as follows (in millions):
The company also sponsors certain defined contribution savings plans for eligible employees. Expense related to these plans was $10 million, $12 million and $11 million for fiscal years 2006, 2005 and 2004, respectively.
The components of the benefit (provision) for Income Taxes are summarized as follows (in millions):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The deferred tax expense or benefit represents tax effects of current year deductions or items of income that will be recognized in future periods for tax purposes. The deferred tax benefit primarily represents the tax benefit of current year net operating losses and tax credits carried forward.
Net current and non-current deferred income tax assets included in the consolidated balance sheet consist of the tax effects of temporary differences related to the following (in millions):
Net current and non-current deferred income tax assets are included in the consolidated balance sheet as follows (in millions):
September 30,
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
As of September 30, 2006 the company had approximately $457 million in U.S. net deferred tax assets. These deferred tax assets include net operating loss carryovers that can be used to offset taxable income in future periods and reduce income taxes payable in those future periods. However, many of these deferred taxes will expire if they are not utilized within certain time periods. At this time, the company considers it more likely than not that it will have U.S. taxable income in the future that will allow it to realize these deferred tax assets. Significant factors considered by management in its determination of the probability of the realization of the deferred tax benefits include: (a) historical operating results, (b) expectations of future earnings, and (c) tax planning strategies.
It is possible that some or all of these deferred tax assets could ultimately expire unused. Risk factors include (a) a more severe than expected downturn in the fiscal year 2007 outlook for the company’s CVS segment, which has significant U.S. operations, (b) higher than planned volume or price reductions from the company’s key customers and (c) higher than planned material cost increases.
These risk factors are offset by the following strategic initiatives: (a) the company has undertaken numerous restructuring initiatives in 2006 which are expected to result in significant savings in future periods, (b) the commercial vehicle market in the United States is expected to recover in 2008 and 2009 significantly benefiting the company and (c) the company has announced that it is embarking on a major cost reduction and value creation program that is expected to generate significant improvements in earnings in future periods.
The expiration periods for $556 million of deferred tax assets related to net operating losses and tax credit carryforwards are as follows: $30 million between fiscal years 2007 and 2011; $53 million between fiscal years 2012 and 2021; $242 million between fiscal years 2022 and 2026; and $231 million can be carried foward indefinitely. The company has provided valuation allowances on these deferred tax assets of approximately $22 million, $30 million, $8 million and $123 million, respectively.
The company’s (benefit) provision for income taxes was different from the (benefit) provision for income taxes at the U.S. statutory rate for the reasons set forth below (in millions):
The company provides accruals for tax contingencies in accordance with SFAS No. 5, Accounitng for Contingencies. The company believes that positions taken on its returns are supportable; however, it has recorded a liability for its best estimate of a loss on certain of these positions. In fiscal year 2006, the company completed various worldwide tax audits of certain of the company’s income tax returns and certain statutes of limitations expired. As a result of these audit settlements and expiration of statutes of limitations, the company reduced it accrual for tax contingencies by $23 million.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The company also repatriated approximately $152 million in dividends in the fourth quarter of fiscal year as part of the American Jobs Creation Act of 2004. The dividends are subject to the elective 85 percent dividend received deduction and accordingly the company recorded a corresponding tax benefit of $37 million related to the reversal of previously provided U.S. deferred tax liability on these unremitted foreign subsidiary earnings.
For fiscal year 2006, the significant benefit for U.S. foreign tax credits relates to foreign taxes associated with dividends not covered under the Act. For fiscal year 2005, the significant benefit for recognition of basis differences was related to a deferred tax asset recognized for the excess of the tax basis over the amount for financial reporting of investments in several of the company’s United Kingdom subsidiaries. This asset is expected to reverse in the foreseeable future. For fiscal year 2004, the significant benefit for recognition of basis differences was related to the following items: (a) favorable book and tax basis differences on the sale of APA, (b) favorable impact of recently issued IRS regulations supporting recoverability of previously disallowed capital losses and (c) utilization of previously unrecognized capital losses associated with our Brazilian restructuring.
The income tax provisions were calculated based upon the following components of income (loss) before income taxes (in millions):
For fiscal 2006 and 2005, no provision has been made for U.S., state or additional foreign income taxes related to approximately $569 million and $488 million, respectively, of undistributed earnings of foreign subsidiaries that have been or are intended to be permanently reinvested. Quantification of the deferred tax liability, if any, associated with permanently reinvested earnings is not practicable.
Environmental
Federal, state and local requirements relating to the discharge of substances into the environment, the disposal of hazardous wastes and other activities affecting the environment have, and will continue to have, an impact on the manufacturing operations of the company. The process of estimating environmental liabilities is complex and dependent on physical and scientific data at the site, uncertainties as to remedies and technologies to be used and the outcome of discussions with regulatory agencies. The company records liabilities for environmental issues in the accounting period in which its responsibility and remediation plans are established and the cost can be reasonably estimated. At environmental sites in which more than one potentially responsible party has been identified, the company records a liability for its allocable share of costs related to its involvement with the site, as well as an allocable share of costs related to insolvent parties or unidentified shares. At environmental sites in which ArvinMeritor is the only potentially responsible party, the company records a liability for the total estimated costs of remediation before consideration of recovery from insurers or other third parties.
The company has been designated as a potentially responsible party at seven Superfund sites, excluding sites as to which the company’s records disclose no involvement or as to which the company’s potential liability has been finally determined. Management estimates the total reasonably possible costs the company could incur for the remediation of Superfund sites at September 30, 2006 to be approximately $25 million, of which $10 million is recorded as a liability. During fiscal years 2006 and 2005, the company recorded environmental remediation costs of $3 million and $6 million, respectively, resulting from a revised estimate to remediate a former Rockwell facility sold in 1990.
In addition to the Superfund sites, various other lawsuits, claims and proceedings have been asserted against the company, alleging violations of federal, state and local environmental protection requirements, or seeking remediation of alleged environmental impairments, principally at previously disposed-of properties. For these matters, management has estimated the total reasonably possible costs the company could incur at September 30, 2006 to be approximately $65 million, of which $17 million is recorded as a liability. During fiscal year 2006, the company recorded environmental remediation costs of $5 million, resulting from revised estimates to remediate these sites. During fiscal year 2004, the company recorded environmental remediation costs of $11 million resulting from an agreement with the Environmental Protection Agency to remediate a different former Rockwell facility that was sold in 1985.
Included in the company’s environmental liabilities are costs for on-going operating, maintenance and monitoring at environmental sites in which remediation has been put into place. This liability is discounted using a discount rate of 5-percent and is approximately $9 million at September 30, 2006. The undiscounted estimate of these costs is approximately $12 million.
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Following are the components of the Superfund and non-Superfund environmental reserves (in millions):
(1) Recorded $3 million of environmental remediation costs in income from discontinued operations in the consolidated statement of income for the fiscal year ended September 30, 2006.
Environmental reserves are included in Other Current Liabilities (see Note 14) and Other Liabilities (see Note 15).
The actual amount of costs or damages for which the company may be held responsible could materially exceed the foregoing estimates because of uncertainties, including the financial condition of other potentially responsible parties, the success of the remediation and other factors that make it difficult to predict actual costs accurately. However, based on management’s assessment, after consulting with outside advisors that specialize in environmental matters, and subject to the difficulties inherent in estimating these future costs, the company believes that its expenditures for environmental capital investment and remediation necessary to comply with present regulations governing environmental protection and other expenditures for the resolution of environmental claims will not have a material adverse effect on the company’s business, financial condition or results of operations. In addition, in future periods, new laws and regulations, changes in the remediation plan, advances in technology and additional information about the ultimate clean-up remedy could significantly change the company’s estimates. Management cannot assess the possible effect of compliance with future requirements.
Asset Retirement Obligations
The company has identified conditional asset retirement obligations for which a reasonable estimate of fair value could not be made since the potential settlement dates cannot be determined at this time. Due to the long term, productive nature of the company’s manufacturing operations, absent plans or expectation of plans to initiate asset retirement activities, the company was not able to reasonably estimate the settlement date for the related obligation. Therefore, the company has not recognized conditional asset retirement obligations when there are no plans or expectations of plans to retire the asset.
Asbestos
Maremont Corporation (“Maremont”), a subsidiary of ArvinMeritor, manufactured friction products containing asbestos from 1953 through 1977, when it sold its friction product business. Arvin acquired Maremont in 1986. Maremont and many other companies are defendants in suits brought by individuals claiming personal injuries as a result of exposure to asbestos-containing products. Maremont had approximately 51,895 and 61,700 pending asbestos-related claims at September 30, 2006 and 2005, respectively. Although Maremont has been named in these cases, in the cases where actual injury has been alleged very few claimants have established that a Maremont product caused their injuries. Plaintiffs’ lawyers often sue dozens or even hundreds of defendants in individual lawsuits on behalf of hundreds or thousands of claimants, seeking damages against all named defendants irrespective of the disease or injury and irrespective of any causal connection with a particular product. For these reasons, Maremont does not consider the number of claims filed or the damages alleged to be a meaningful factor in determining its asbestos-related liability.
Maremont’s asbestos-related reserves and corresponding asbestos-related recoveries are summarized as follows (in millions):
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A portion of the asbestos-related recoveries and reserves are included in Other Current Assets and Liabilities, with the majority of the amounts recorded in Other Assets and Liabilities (see Notes 10, 12, 14 and 15).
Prior to February 2001, Maremont participated in the Center for Claims Resolution (“CCR”) and shared with other CCR members in the payment of defense and indemnity costs for asbestos-related claims. The CCR handled the resolution and processing of asbestos claims on behalf of its members until February 2001, when it was reorganized and discontinued negotiating shared settlements. Upon dissolution of the CCR in February 2001, Maremont began handling asbestos-related claims through its own defense counsel and has taken a more aggressive defensive approach that involves examining the merits of each asbestos-related claim. Although the company expects legal defense costs to continue at higher levels than when it participated in the CCR, the company believes its litigation strategy has reduced the average indemnity cost per claim.
Pending and Future Claims: At the end of fiscal year 2004 and through the third quarter of fiscal year 2005, Maremont established reserves for pending asbestos-related claims that reflected internal estimates of its defense and indemnity costs. These estimates were based on the history and nature of filed claims to date and Maremont’s experience. Maremont developed experience factors for estimating indemnity and litigation costs using data on actual experience in resolving claims since dissolution of the CCR and its assessment of the nature of the claims. Maremont did not accrue reserves for its potential liability for asbestos-related claims that may be asserted against it in the future, because it did not have sufficient information to make a reasonable estimate of these unknown claims.
In the fourth quarter of fiscal year 2005, Maremont engaged Bates White LLC (Bates White), a consulting firm with extensive experience estimating costs associated with asbestos litigation, to assist with determining whether it would be possible to estimate the cost of resolving pending and future asbestos-related claims that have been, and could reasonably be expected to be, filed against Maremont, as well as the cost of Maremont’s share of committed but unpaid settlements entered into by the CCR. Although it is not possible to estimate the full range of costs because of various uncertainties, Bates White advised Maremont that it would be able to determine an estimate of probable costs to resolve pending and future asbestos-related claims, based on historical data and certain assumptions with respect to events that occur in the future. The company engaged Bates White to update the study as of September 30, 2006.
Bates White provided an estimate of the reasonably possible range of Maremont’s obligation for asbestos personal injury claims over the next three to four years of $31 million to $44 million. After consultation with Bates White, Maremont determined that as of September 30, 2006 the most likely and probable liability for pending and future claims over the next four years is $41 million. The ultimate cost of resolving pending and future claims is estimated based on the history of claims and expenses for plaintiffs represented by law firms in jurisdictions with an established history with Maremont.
The following assumptions were made by Maremont after consultation with Bates White and are included in their study:
• Pending and future claims were estimated for a four year period ending in fiscal year 2010. Maremont believes that the litigation environment will change significantly in several years, and that the reliability of estimates of future probable expenditures in connection with asbestos-related personal injury claims declines for each year further in the future. As a result, estimating a probable liability beyond four years is difficult and uncertain;
• The ultimate cost of resolving pending and future claims filed in Madison County, Illinois, a jurisdiction where a substantial amount of Maremont’s claims are filed, will decline to reflect average outcomes throughout the United States;
• Defense and processing costs for pending and future claims filed outside of Madison County, Illinois will be at the level consistent with Maremont’s prior experience; and
• The ultimate cost of resolving nonmalignant claims with plaintiffs’ law firms in jurisdictions without an established history with Maremont cannot be reasonably estimated. Recent changes in tort law and insufficient settlement history make estimating a liability for these nonmalignant claims difficult and uncertain.
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Shortfall and other: Several former members of the CCR have filed for bankruptcy protection, and these members have failed, or may fail, to pay certain financial obligations with respect to settlements that were reached while they were CCR members. Maremont is subject to claims for payment of a portion of these defaulted member shares (shortfall). In an effort to resolve the affected settlements, Maremont has entered into negotiations with plaintiffs’ attorneys, and an estimate of Maremont’s obligation for the shortfall is included in the total asbestos-related reserves. In addition, Maremont and its insurers are engaged in legal proceedings to determine whether existing insurance coverage should reimburse any potential liability related to this issue. Payments by the company related to shortfall and other were not significant in fiscal years 2006 or 2005.
Recoveries: Maremont has insurance that reimburses a substantial portion of the costs incurred defending against asbestos-related claims. The coverage also reimburses Maremont for any indemnity paid on those claims. The coverage is provided by several insurance carriers based on insurance agreements in place. Incorporating historical information with respect to buy-outs and settlements of coverage, and excluding any policies in dispute, the insurance receivable related to asbestos-related liabilities is $31 million. The difference between the estimated liability and insurance receivable is related to proceeds received from settled insurance policies and liabilities for shortfall and other. Certain insurance policies have been settled in cash prior to the ultimate settlement of related asbestos liabilities. Amounts received from insurance settlements generally reduce recorded insurance receivables. Receivables for policies in dispute are not recorded. In fiscal year 2005, the company received $12 million associated with the settlement of certain insurance policies. Billings to insurance companies for indemnity and defense costs of resolved cases were $6 million and $12 million in fiscal years 2006 and 2005, respectively.
The amounts recorded for the asbestos-related reserves and recoveries from insurance companies are based upon assumptions and estimates derived from currently known facts. All such estimates of liabilities and recoveries for asbestos-related claims are subject to considerable uncertainty because such liabilities and recoveries are influenced by variables that are difficult to predict. The future litigation environment for Maremont could change significantly from its past experience, due, for example, to changes in the mix of claims filed against Maremont in terms of plaintiffs’ law firm, jurisdiction and disease; legislative or regulatory developments; Maremont’s approach to defending claims; or payments to plaintiffs from other defendants. Estimated recoveries are influenced by coverage issues among insurers, and the continuing solvency of various insurance companies. If the assumptions with respect to the nature of pending claims, the cost to resolve claims and the amount of available insurance prove to be incorrect, the actual amount of liability for Maremont’s asbestos-related claims, and the effect on the company, could differ materially from current estimates and, therefore, could have a material impact on the company’s financial position and results of operations.
Rockwell - ArvinMeritor, along with many other companies, has also been named as a defendant in lawsuits alleging personal injury as a result of exposure to asbestos used in certain components of Rockwell products many years ago. Liability for these claims was transferred to the company at the time of the spin-off of the automotive business to Meritor from Rockwell in 1997. Currently there are thousands of claimants in lawsuits that name the company, together with many other companies, as defendants. However, the company does not consider the number of claims filed or the damages alleged to be a meaningful factor in determining asbestos-related liabilities. A significant portion of the claims do not identify any of Rockwell’s products or specify which of the claimants, if any, were exposed to asbestos attributable to Rockwell’s products, and past experience has shown that the vast majority of the claimants will never identify any of Rockwell’s products. For those claimants who do show that they worked with Rockwell’s products, management nevertheless believes it has meritorious defenses, in substantial part due to the integrity of the products involved, the encapsulated nature of any asbestos-containing components, and the lack of any impairing medical condition on the part of many claimants. The company defends these cases vigorously. Historically, ArvinMeritor has been dismissed from the vast majority of these claims with no payment to claimants.
In the fourth quarter of fiscal year 2006, the company engaged Bates White to assist with determining whether it would be possible to estimate the cost of resolving pending and future Rockwell legacy asbestos-related claims that have been, and could reasonably be expected to be, filed against the company. Although it is not possible to estimate the full range of costs because of various uncertainties, Bates White advised the company that it would be able to determine an estimate of probable defense costs which could be incurred to resolve pending and future Rockwell legacy asbestos-related claims. Accordingly, the company recorded a $7 million liability for defense costs associated with these claims. This estimate was based on historical data and certain assumptions with respect to events that occur in the future. Bates White was unable to determine an estimate of indemnity costs for pending or future Rockwell legacy asbestos-related claims. Bates White and management cannot reasonably estimate the ultimate liabilities for these costs, primarily because the company does not have a sufficient history of claims settlement from which to develop reliable assumptions. The uncertainties of asbestos claim litigation and resolution of the litigation with the insurance companies make it difficult to predict accurately the ultimate resolution of asbestos claims. That uncertainty is increased by the possibility of adverse rulings or new legislation affecting asbestos claim litigation or the settlement process. Subject to these uncertainties and based on the company’s experience defending these asbestos claims, the company does not believe these lawsuits will have a material adverse effect on its financial condition or results of operations. Rockwell was not a member of the CCR and handled its asbestos-related
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
claims using its own litigation counsel. As a result, the company does not have any additional potential liabilities for committed CCR settlements or shortfall (as described above) in connection with the Rockwell-legacy cases.
Rockwell maintained insurance coverage that management believes covers indemnity and defense costs, over and above self-insurance retentions, for most of these claims. The company has initiated claims against these carriers to enforce the insurance policies. Although the status of one carrier as a financially viable entity is in question, the company expects to recover the majority of defense and indemnity costs it has incurred to date, over and above self-insured retentions, and a substantial portion of the costs for defending asbestos claims going forward. Accordingly, the company has recorded an insurance receivable related to Rockwell legacy asbestos-related liabilities of $7 million at September 30, 2006.
Contingencies Related to Work Stoppage
The company’s collective bargaining agreement with the Canadian Auto Workers (“CAW”) at its CVS brakes facility in Tilbury, Ontario, Canada, expired on June 3, 2006. On June 4, 2006, the company announced that, after lengthy negotiations, a new tentative agreement with the CAW had not yet been reached and, as a result, the company had suspended operations at the facility. On June 12, 2006, the company reached a tentative agreement with the CAW, which was subsequently ratified on June 14, 2006, and resumed operations. As a result of this work stoppage, the company experienced temporary manufacturing inefficiencies and incurred certain costs in order to return to normal production. The company was temporarily unable to completely fulfill certain customer orders, resulting in temporary production interruptions at some customer manufacturing facilities. The impact of this labor disruption on operating income in fiscal year 2006 was $45 million. Included in this amount are premium labor costs, expedited freight and logistical costs and other costs associated with production disruptions at certain customers’ facilities. At September 30, 2006, $29 million is recorded as a contingent liability in the consolidated balance sheet. The ultimate settlement of this liability will be determinable over a period of time and may be negotiated, as a commercial matter, with the affected customers. The amount of this liability may change in future periods depending on our customers’ ability to schedule additional production to compensate for prior disruptions, the results of the negotiations with the affected customers and other factors. The company believes that any future adjustment to this liability will not have a material effect on the company’s results of operations and financial position.
Product Recall Campaign
Beginning in fiscal year 2002, the company recalled certain of its commercial vehicle axles equipped with TRW model 20-EDL tie rod ends because of potential safety-related defects in those ends. TRW, Inc. (TRW) manufactured the affected tie rod ends from June 1999 through June 2000 and supplied them to the company for incorporation into its axle products. The company estimated the cost of its recall of TRW model 20-EDL tie rod ends to be approximately $17 million and recorded a liability and offsetting receivable for the estimated cost. In the fourth quarter of fiscal 2004, in anticipation of a settlement of this matter with TRW, the company recorded a charge of $4 million as a reduction of the receivable due from TRW at September 30, 2004. In December 2004, the company reached an agreement with TRW settling this matter, resulting in no additional charges to the Company. See Note 14 for additional information related to the company’s product warranties.
Guarantees
In December 2005, the company guaranteed a third party’s obligation to reimburse another party (the other party) for payment of health and prescription drug benefits to a group of retired employees. The retirees were former employees of a wholly-owned subsidiary of the company prior to it being acquired by the company. To date, the third party has met its obligations to reimburse the other party. The APBO associated with these retiree medical benefits is considered the maximum potential exposure under this guarantee, and is estimated to be approximately $25 million. No amount has been recorded for this guarantee based on the probability of the company having to perform under the guarantee. Due to the nature of this guarantee it is difficult to estimate its approximate term.
The company has guaranteed certain trade payable balances of one of its non-consolidated joint ventures. In the event of a default by the joint venture, the company would be required to pay the guaranteed party. The maximum exposure under the guarantee is $4 million and can be terminated by the company at any time on thirty days written notice. The estimated fair value of this guarantee is not significant, and therefore, no liability is recorded.
Indemnifications
The company has provided indemnifications in conjunction with certain transactions, primarily divestitures. These indemnities address a variety of matters, which may include environmental, tax, asbestos, and employment-related matters, and the periods of indemnification vary in duration. The company’s maximum obligations under such indemnifications cannot be
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reasonably estimated. The company is not aware of any claims or other information that would give rise to material payments under such indemnifications.
In connection with the sale of the LVA North American filters business, the company agreed to indemnify the purchaser against liabilities from litigation and commercial losses in connection with specific intellectual property claims, with a maximum indemnity of $4 million for commercial losses, which is included in the consolidated balance sheet at September 30, 2006.
Other
Various other lawsuits, claims and proceedings have been or may be instituted or asserted against the company, relating to the conduct of the company’s business, including those pertaining to product liability, intellectual property, safety and health, and employment matters. Although the outcome of litigation cannot be predicted with certainty, and some lawsuits, claims or proceedings may be disposed of unfavorably to the company, management believes the disposition of matters that are pending will not have a material adverse effect on the company’s business, financial condition or results of operations.
The company defines its operating segments as components of its business where separate financial information is available and is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The company’s chief operating decision maker (CODM) is the Chief Executive Officer.
The company has two reportable operating segments: Light Vehicle Systems (LVS) and Commercial Vehicle Systems (CVS). LVS is a major supplier of air and emission systems, aperture systems (roof and door systems), and undercarriage systems (suspension system modules, and wheel products) for passenger cars, motorcycles and all-terrain vehicles, light trucks and sport utility vehicles to original equipment manufacturers (OEMs). CVS supplies drivetrain systems and components, including axles and drivelines, braking systems, suspension systems and exhaust and ride control products, for medium- and heavy-duty trucks, trailers and specialty vehicles to OEMs and the commercial vehicle aftermarket. The company’s previously reported LVA segment is reported in discontinued operations (see Note 3).
The company uses operating income as the primary basis for the CODM to evaluate the performance of each of the company’s reportable segments. The accounting policies of the segments are the same as those applied in the Consolidated Financial Statements. The company may allocate certain common costs, primarily corporate functions, between the segments differently than the company would for stand alone financial information prepared in accordance with GAAP. These allocated costs include expenses for shared services such as information technology, finance, communications, legal and human resources. The company does not allocate interest expense, equity in earnings of affiliates and certain legacy and other corporate costs not directly associated with the segments’ operating income.
Beginning in fiscal year 2007, the company changed its reportable operating segments to three: LVS, CVS and a newly created reportable segment for Emissions Technologies, which will include our combined light and commercial vehicle emissions businesses. The company established Emissions Technology as a separate segment in order to better support increasing demand for emissions systems. The company will begin to report under this new segment structure in the first quarter of fiscal year 2007 and all prior period segment amounts will be restated. In addition, the company will measure segment operating performance based on earnings before interest, taxes, depreciation and amortization (EBITDA).
Segment information is summarized as follows (in millions):
Sales:
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Earnings:
Depreciation and Amortization:
Capital Expenditures:
Segment Assets:
(1) Corporate assets consist primarily of cash, taxes and prepaid pension costs. For fiscal years 2006 and 2005, segment assets include $384 million and $432 million, respectively, of receivables sold to ARC under the accounts receivable securitization and factoring agreements (see Note 7).
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Sales by geographic area are based on the location of the selling unit. Information on the company’s geographic areas is summarized as follows (in millions):
Sales by Geographic Area:
Assets by Geographic Area (excludes assets of discontinued operations):
Sales to DaimlerChrysler AG (which owns Chrysler, Mercedes-Benz AG and Freightliner Corporation) represented 18 percent, 21 percent and 19 percent of the company’s sales in fiscal years 2006, 2005 and 2004, respectively. Sales to Volkswagen comprised 11 percent of the company’s sales in fiscal year 2006 and 10 percent in fiscal years 2005 and 2004. Sales to General Motors Corporation comprised 10 percent, 10 percent and 13 percent of the company’s sales in fiscal 2006, 2005 and 2004, respectively. Sales to Ford Motor Company comprised 10 percent of the company’s sales in fiscal year 2006 and 2004 and were below 10 percent in fiscal year 2005. The significant financial deterioration, including bankruptcy, of any one of these customers could have a material adverse effect on the company’s financial position and results of operation. No other customer comprised 10 percent or more of the company’s sales in any of the three fiscal years ended September 30, 2006.
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25.
QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following is a condensed summary of the company’s unaudited quarterly results of continuing operations for fiscal 2006 and 2005. Amounts related to prior quarters have been restated to reflect the company’s consolidated Gabriel de Venezuela joint venture in continuing operations (see Note 3). Per share amounts are based on the weighted average shares outstanding for that quarter. Earnings per share for the year may not equal the sum of the four fiscal quarters’ earnings per share due to changes in basic and diluted shares outstanding.
Fourth quarter loss from continuing operations included a pre-tax non-cash goodwill impairment charge of $310 million in the company’s LVS emissions technologies reporting unit, and pre-tax restructuring costs of $18 million. Fourth quarter net loss included an after-tax loss of $6 million on the sale of certain LVA businesses. The work stoppage at the company’s brake facility in Tilbury, Ontario, Canada unfavorably impacted third quarter income from continuing operations by $45 million pre-tax. Second quarter income from continuing operations included pre-tax restructuring costs of $17 million. Second quarter net income includes a net after-tax gain of $22 million on the sale of certain LVA businesses and an after-tax non-cash impairment charge of $12 million related to certain LVA businesses. First quarter income from continuing operations included a $23 million pre-tax gain on the sale of certain assets of CVS’ off-highway brake business.
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Fourth quarter income from continuing operations included pre-tax restructuring costs of $21 million, and a pre-tax loss from debt extinguishment of $4 million. Fourth quarter net loss included an impairment charge of $28 million after-tax in LVA. Third quarter income from continuing operations included pre-tax restructuring costs of $6 million. Second quarter loss from continuing operations included pre-tax restructuring costs of $49 million; a pre-tax charge of $9 million resulting from a customer bankruptcy, and pre-tax environmental remediation costs of $6 million associated with a former Rockwell facility. First quarter income from continuing operations included pre-tax restructuring costs of $10 million; a $4 million pre-tax gain on the divestiture of the Columbus, Indiana automotive stamping and components manufacturing business and a $5 million pre-tax charge associated with the bankruptcy of certain customers.
27.
SUPPLEMENTAL GUARANTOR CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
Certain of the company’s wholly-owned subsidiaries, as defined in the credit agreement (the Guarantors) irrevocably and unconditionally guarantee amounts outstanding under the senior credit facilities. Similar subsidiary guarantees were provided for the benefit of the holders of the publicly-held notes outstanding under the company’s indentures (see Note 16).
In lieu of providing separate audited financial statements for the Guarantor subsidiaries, the company has included the accompanying condensed consolidating financial statements. These condensed consolidating financial statements are presented on the equity method. Under this method, the investments in subsidiaries are recorded at cost and adjusted for the parent’s share of the subsidiary’s cumulative results of operations, capital contributions and distributions and other equity changes. The Guarantor subsidiaries are combined in the condensed consolidating financial statements.
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CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
(In millions)
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CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
(In millions)
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CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
(In millions)
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CONDENSED CONSOLIDATING BALANCE SHEET
(In millions)
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CONDENSED CONSOLIDATING BALANCE SHEET
(In millions)
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CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
(In millions)
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CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
(In millions)
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CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
(In millions)
In October 2006, the company implemented a new enterprise resource planning system at one of its European plants. This system change is part of the company's plan to integrate, consolidate, and standardize its information systems. During the implementation, the location experienced significant issues, causing temporary manufacturing ineffciencuies impacting the company's ability to completely fulfill certain customer orders. This resulted in production interruptions at some customer manufacturing facilities. As a result, the company began incurring costs to return to normal production as well as costs associated with production disruptions at certain customer facilities. The company does not believe this event will have a material impact on its fiscal year 2007 operating results.
.
Item 9A.
Item 9A. Controls and Procedures.
Disclosure Controls and Procedures
As required by Rule 13a-15 under the Securities Exchange Act of 1934 (“Exchange Act”), under the supervision and with the participation of the management of ArvinMeritor, Inc., including the chief executive officer and chief financial officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2006. Based upon that evaluation, the chief executive officer and the chief financial officer have concluded that, as of September 30, 2006, our disclosure controls and procedures were effective in providing reasonable assurance that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.
Management Report on Internal Control over Financial Reporting
ArvinMeritor’s management is responsible for establishing and maintaining adequate internal control over financial reporting for the company, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. ArvinMeritor’s internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes, in accordance with accounting principles generally accepted in the United States of America.
All internal control systems, no matter how well designed, have inherent limitations and may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
ArvinMeritor’s management, including the chief executive officer and chief financial officer, assessed the effectiveness of its internal control over financial reporting as of September 30, 2006. In making this assessment, management used the criteria set forth in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on management’s assessment and the criteria set forth by COSO, ArvinMeritor’s management concluded that the internal control over financial reporting maintained by the company, as of September 30, 2006, was effective.
Deloitte & Touche LLP, ArvinMeritor’s independent registered public accounting firm, has issued an attestation report on management’s assessment of its internal control over financial reporting, which follows.
November 15, 2006
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareowners of ArvinMeritor, Inc.
Troy, Michigan
We have audited management's assessment, included in the accompanying Management Report on Internal Control over Financial Reporting, that ArvinMeritor, Inc. (the “Company”) maintained effective internal control over financial reporting as of September 30, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that the Company maintained effective internal control over financial reporting as of September 30, 2006, is fairly stated, in all material respects, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2006, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet and the related consolidated statements of operations, cash flows and shareowners’ equity of the Company and financial statement schedule listed in the Index at Item 15(a)(2) as of and for the year ended September 30, 2006. Our report dated November 17, 2006 expressed an unqualified opinion on those financial statements and financial statement schedule.
/s/ DELOITTE & TOUCHE LLP
DELOITTE & TOUCHE LLP
Detroit, Michigan
November 17, 2006
Changes in Internal Control Over Financial Reporting
Under the supervision and with the participation of our management, including the chief executive officer and chief financial officer, we have evaluated any change in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ended September 30, 2006, and found no change that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.
Item 9B.
Item 9B.
Other Information.
PART III
Item 10.
Item 10.
Directors and Executive Officers of the Registrant.
See the information under the captions Election of Directors, Information as to Nominees for Directors and Continuing Directors, Involvement in Certain Legal Proceedings and Section 16(a) Beneficial Ownership Reporting Compliance in the 2007 Proxy Statement. See also the information with respect to executive officers of ArvinMeritor under Item 4A of Part I. No director or nominee for director was selected pursuant to any arrangement or understanding between that individual and any person other than ArvinMeritor pursuant to which such person is or was to be selected as a director or nominee. There are no family relationships, as defined in Item 401 of Regulation S-K, between any of the directors or nominees for director and any other director, executive officer or person nominated to become a director or executive officer.
ArvinMeritor has a separately designated standing audit committee established in accordance with Section 3(a)(58)(A) of the Exchange Act. The current members of the Audit Committee are William D. George, Jr. (chairman), David W. Devonshire, Ivor J. Evans, Victoria B. Jackson and Steven G. Rothmeier. The Board of Directors has determined that ArvinMeritor has at least one “audit committee financial expert” (as defined in Item 401(h) of Regulation S-K), David W. Devonshire, serving on the Audit Committee. Mr. Devonshire is “independent,” as defined in the listing standards of the NYSE.
The charters of the Audit Committee, the Compensation and Management Development Committee, the Corporate Governance and Nominating Committee and the Environmental and Social Responsibility Committee of the Board of Directors are posted on our website, www.arvinmeritor.com, in the section headed “Investors - Corporate Governance.”
All ArvinMeritor employees, including our chief executive officer, chief financial officer, controller and other executive officers, are required to comply with our corporate policies regarding Standards of Business Conduct and Conflicts of Interest. ArvinMeritor’s ethics manual, including the text of the policies on Standards of Business Conduct and Conflicts of Interest, is posted on our website (www.arvinmeritor.com), in the section headed “Investors - Corporate Governance.” We will also post on our website any amendment to, or waiver from, a provision of our policies that applies to our chief executive officer, chief financial officer or controller, and that relates to any of the following elements of these policies: honest and ethical conduct; disclosure in reports or documents filed by the company with the SEC and in other public communications; compliance with applicable laws, rules and regulations; prompt internal reporting of code violations; and accountability for adherence to the policies.
ArvinMeritor’s chief executive officer and chief financial officer have filed certifications, as required by the Sarbanes-Oxley Act of 2002 and Rule 13a-14(a) and (b) under the Exchange Act, as exhibits to each Quarterly Report on Form 10-Q filed with the SEC during fiscal year 2006 and to this Annual Report on Form 10-K. The company’s chief executive officer also filed with the NYSE in February 2006 a certification that he was not aware of any violation by the company of the NYSE listing standards.
See the information under the captions Compensation of Directors, Executive Compensation, Agreements with Named Executive Officers and Retirement Benefits in the 2007 Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Security Ownership of Certain Beneficial Owners and Management
See the information under the captions Voting Securities and Ownership by Management of Equity Securities in the 2007 Proxy Statement.
Securities Authorized for Issuance under Equity Compensation Plans
See the information under the caption Securities Authorized for Issuance under Other Equity Compensation Plans in the 2007 Proxy Statement.
Item 13.
Item 13.
Certain Relationships and Related Transactions.
If any reportable relationships and related transactions exist, they will be reported in the 2007 Proxy Statement.
Item 14.
Item 14.
Principal Accountant Fees and Services.
See the information under the caption Independent Accountants’ Fees in the 2007 Proxy Statement.
PART IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules.
(a)
Financial Statements, Financial Statement Schedules and Exhibits.
(1) Financial Statements (all financial statements listed below are those of the company and its consolidated subsidiaries):
Consolidated Statement of Operations, years ended September 30, 2006, 2005 and 2004.
Consolidated Balance Sheet, September 30, 2006 and 2005.
Consolidated Statement of Cash Flows, years ended September 30, 2006, 2005 and 2004.
Consolidated Statement of Shareowners' Equity, years ended September 30, 2006, 2005 and 2004.
Notes to Consolidated Financial Statements.
Report of Independent Registered Public Accounting Firm.
(2) Financial Statement Schedule for the years ended September 30, 2006, 2005 and 2004.
Schedule II - Valuation and Qualifying Accounts ............
S-1
Schedules not filed with this Annual Report on Form 10-K are omitted because of the absence of conditions under which they are required or because the information called for is shown in the financial statements or related notes.
(3) Exhibits
3-a
Restated Articles of Incorporation of ArvinMeritor, filed as Exhibit 4.01 to ArvinMeritor’s Registration Statement on Form
S-4, as amended (Registration Statement No. 333-36448) ("Form S-4"), is incorporated by reference.
3-b
By-laws of ArvinMeritor, filed as Exhibit 3 to ArvinMeritor's Quarterly Report on Form 10-Q for the quarterly period ended
June 29, 2003 (File No. 1-15983), is incorporated by reference.
Company, N.A.), as rights agent, filed as Exhibit 4.03 to the Form S-4, is incorporated by reference.
Manhattan Bank), as trustee, filed as Exhibit 4 to Meritor's Registration Statement on Form S-3 (Registration No. 333-49777), is incorporated by reference.
BNY Midwest Trust Company (successor to The Chase Manhattan Bank), as trustee, filed as Exhibit 4-b-1 to ArvinMeritor's Annual Report on Form 10-K for the fiscal year ended September 30, 2000 (File No. 1-15983) (“2000 Form 10-K”), is incorporated by reference.
and BNY Midwest Trust Company (successor to The Chase Manhattan Bank), as trustee (including Subsidiary Guaranty dated as of June 23, 2006), filed as Exhibit 4.2 to ArvinMeritor’s Current Report on Form 8-K, dated June 23, 2006 and filed on June 27, 2006 (File No. 1-15983)(“June 23, 2006 Form 8-K”), is incorporated by reference.
ArvinMeritor and BNY Midwest Trust Company (successor to Harris Trust and Savings Bank), as trustee, filed as Exhibit 4-4 to Arvin's Registration Statement on Form S-3 (Registration No. 33-53087), is incorporated by reference.
and BNY Midwest Trust Company (successor to Harris Trust and Savings Bank), as trustee, filed as Exhibit 4-c-1 to
the 2000 Form 10-K, is incorporated by reference.
and BNY Midwest Trust Company (successor to Harris Trust and Savings Bank), as trustee (including Subsidiary Guaranty dated as of June 23, 2006), filed as Exhibit 4.3 to the June 23, 2006 Form 8-K, is incorporated by reference.
4.4 to Arvin's Registration Statement on Form S-3 (Registration No. 333-18521), is incorporated by reference.
ArvinMeritor and Wilmington Trust Company, as trustee, filed as Exhibit 4.5 to Arvin's Current Report on Form 8-K, dated January 28, 1997 and filed on February 10, 1997 (File No. 1-302), is incorporated by reference.
ArvinMeritor and Wilmington Trust Company, filed as Exhibit 4-d-2 to the 2000 Form 10-K, is incorporated by reference.
4.1 to ArvinMeritor’s Current Report on Form 8-K, dated March 7, 2006 and filed on March 9, 2006 (File No. 1-15983), is incorporated by reference.
and BNY Midwest Trust Company, as trustee (including Subsidiary Guaranty dated as of June 23, 2006), filed as Exhibit 4.1 to the June 23, 2006 Form 8-K, is incorporated herein by reference.
from time to time parties thereto as lenders, JP Morgan Chase Bank, National Association, as Administrative Agent, Citicorp North America, Inc. and UBS Securities LLC, as Syndication Agents, ABN AMRO Bank N.V., BNP Paribas and Lehman Commercial Paper Inc., as Documentation Agents, and J.P. Morgan Securities Inc. and Citigroup Global Markets, as Joint Lead Arrangers and Joint Book Runners, filed as Exhibit 10.1 to the June 23, 2006 Form 8-K, is incorporated by reference.
National Association, as Administrative Agent, for the benefit of itself, the lenders and other holders of guaranteed obligations, filed as Exhibit 10.2 to the June 23, 2006 Form 8-K, is incorporated herein by reference.
JPMorgan Chase Bank, National Association, as Administrative Agent, filed as Exhibit 10.3 to the June 23, 2006 Form 8-K, is incorporated by reference.
*10-b-1 1997 Long-Term Incentives Plan, as amended and restated, filed as Exhibit 10 to ArvinMeritor’s Current Report on Form 8-K
dated and filed on April 20, 2005 (File No. 1-15983), is incorporated by reference.
*10-b-2 Form of Restricted Stock Agreement under the 1997 Long-Term Incentives Plan, filed as Exhibit 10-a-2 to Meritor’s Annual
Report on Form 10-K for the fiscal year ended September 30, 1997 (File No. 1-13093), is incorporated by reference.
*10-b-3 Form of Option Agreement under the 1997 Long-Term Incentives Plan, filed as Exhibit 10(a) to Meritor's Quarterly Report
on Form 10-Q for the quarterly period ended March 31, 1998 (File No. 1-13093), is incorporated by reference.
*10-b-4 Form of Performance Share Agreement under the 1997 Long-Term Incentives Plan, filed as Exhibit 10-b to ArvinMeritor’s
Current Report on Form 8-K, dated December 7, 2004 and filed on December 9, 2004 (File No. 1-15983), is incorporated by reference.
*10-b-5 Description of Performance Goals Established in connection with 2005-2007 Cash Performance Plan under the 1997 Long-
Term Incentives Plan, filed as Exhibit 10-c to ArvinMeritor’s Current Report on Form 8-K, dated February 16, 2005 and filed on February 17, 2005 (File No. 1-15983), is incorporated by reference.
*10-b-6 Description of Performance Goals Established in connection with 2006-2008 Cash Performance Plan under the 1997 Long-
Term Incentives Plan, filed as Exhibit 10-b-6 to ArvinMeritor’s Form 10-K for the fiscal year ended October 2, 2005 (File No. 1-15983), is incorporated by reference.
Term Incentives Plan.
*10-c
Description of Compensation of Non-Employee Directors.
ended March 28, 2004 (File No. 1-15983), is incorporated by reference.
*10-d-2 Form of Restricted Share Unit Agreement under the 2004 Directors Stock Plan, filed as Exhibit 10-c-3 to ArvinMeritor’s
Annual Report on Form 10-K for the fiscal year ended October 3, 2004 (File No. 1-15983), is incorporated by reference.
*10-d-3 Form of Restricted Stock Agreement under the 2004 Directors Stock Plan, filed as Exhibit 10-c-4 to ArvinMeritor’s Annual
Report on Form 10-K for the fiscal year ended October 2, 2005 (Filed No. 1-15983), is incorporated by reference.
K, dated February 16, 2005 and filed on February 17, 2005 (File No. 1-15983), is incorporated by reference.
*10-e-2 Form of Deferred Share Agreement, filed as Exhibit 10-a to ArvinMeritor’s Quarterly Report on Form 10-Q for the
quarterly period ended January 2, 2005 (File No. 1-15983), is incorporated by reference.
Compensation Policy for Non-Employee Directors, filed as Exhibit 10-f to the 2000 Form 10-K, is incorporated by reference.
September 30, 1998 (File No. 1-13093), is incorporated by reference.
61023), is incorporated by reference.
*10-i
Employee Stock Benefit Plan, as amended, filed as Exhibit (d)(3) to ArvinMeritor’s Schedule TO, Amendment No. 3 (File
No. 5-61023), is incorporated by reference.
ended July 3, 1988, and as Exhibit 10(E) to Arvin's Quarterly Report on Form 10-Q for the quarterly period ended July 4, 1993 (File No. 1-302), is incorporated by reference.
lenders from time to time party thereto and SunTrust Capital Markets, Inc., filed as Exhibit 10a to ArvinMeritor’s Current
Report on Form 8-K, dated September 16, 2005 and filed on September 19, 2005 (File No. 1-15983), is incorporated by reference.
ArvinMeritor Receivables Corporation, the lenders from time to time party thereto and SunTrust Capital Markets, Inc., filed as Exhibit 10a to ArvinMeritor’s Current Report on Form 8-K, dated May 8, 2006 and filed on May 10, 2006 (File No. 1-15983), is incorporated by reference.
ArvinMeritor, ArvinMeritor Receivables Corporation, the lenders from time to time party thereto and SunTrust Capital Markets, Inc., filed as Exhibit 10 to ArvinMeritor’s Current Report on Form 8-K, dated September 18, 2006 and filed on September 20, 2006 (File No. 1-15983), is incorporated by reference.
ArvinMeritor, ArvinMeritor Receivables Corporation, the lenders from time to time party thereto and SunTrust Capital Markets, Inc.
LLC and various affiliates, as Originators, and ArvinMeritor Receivables Corporation, filed as Exhibit 10b to ArvinMeritor’s Current Report on Form 8-K, dated September 16, 2005 and filed on September 19, 2005 (File No. 1-15983), is incorporated by reference.
September 19, 2005, among ArvinMeritor Receivables Corporation and the Originators named therein, filed as Exhibit 10b to ArvinMeritor’s Current Report on Form 8-K, dated May 8, 2006 and filed on May 10, 2006, is incorporated by reference.
of September 19, 2005, among ArvinMeritor Receivables Corporation and the Originators named therein.
*10-m
Employment agreement between the company and Charles G. McClure, Jr., filed as Exhibit 10-s to ArvinMeritor’s Annual
Report on Form 10-K for the fiscal year ended October 3, 2004 (File No. 1-15983), is incorporated by reference.
*10-n
Employment agreement between the company and James D. Donlon, III, filed as Exhibit 10 to ArvinMeritor’s Current
Report on Form 8-K, dated April 12, 2005 and filed on April 13, 2004 (File No. 1-15983), is incorporated by reference.
*10-o
Form of employment letter between ArvinMeritor and its executives, filed as Exhibit 10-a to ArvinMeritor’s Current Report
on Form 8-K, dated October 27, 2004 and filed on December 21, 2004 (File No. 1-15983), is incorporated by reference.
*10-p
Supplement to employment letter between ArvinMeritor and Juan L. De La Riva, filed as Exhibit 10-b to ArvinMeritor’s
Current Report on Form 8-K, dated October 27, 2004 and filed on December 21, 2004 (File No. 1-15983), is incorporated by reference.
*10-q
Supplement to employment letter between ArvinMeritor and Thomas A. Gosnell, filed as Exhibit 10-c to ArvinMeritor’s
Current Report on Form 8-K, dated October 27, 2004 and filed on December 21, 2004 (File No. 1-15983), is incorporated by reference.
Current Report on Form 8-K, dated August 24, 2006 and filed on August 28, 2006 (File No. 1-15983), is incorporated by
reference.
ArvinMeritor’s Current Report on Form 8-K, dated August 24, 2006 and filed on August 28, 2006 (File No. 1-15983), is incorporated by reference.
ArvinMeritor’s Current Report on Form 8-K, dated August 24, 2006 and filed on August 28, 2006 (File No. 1-15983), is incorporated by reference.
ArvinMeritor’s Current Report on Form 8-K, dated August 24, 2006 and filed on August 28, 2006 (File No. 1-15983), is incorporated by reference.
ArvinMeritor’s Current Report on Form 8-K, dated August 24, 2006 and filed on August 28, 2006 (File No. 1-15983), is incorporated by reference.
Computation of ratio of earnings to fixed charges.
23-a
Consent of Vernon G. Baker, II, Esq., Senior Vice President and General Counsel of ArvinMeritor.
23-b
Consent of Deloitte & Touche LLP, independent registered public accounting firm.
Power of Attorney authorizing certain persons to sign this Annual Report on Form 10-K on behalf of certain directors and
officers of ArvinMeritor.
________________
*Management contract or compensatory plan or arrangement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
ARVINMERITOR, INC.
By: /s/ Vernon G. Baker, II
Vernon G. Baker, II
Senior Vice President
and General Counsel
Date: November 17, 2006
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on the 17th day of November, 2006 by the following persons on behalf of the registrant and in the capacities indicated.
Charles G. McClure, Jr. *
Chairman of the Board, Chief Executive
Officer and President (principal executive
officer) and Director
Joseph B. Anderson, Jr., Rhonda L. Brooks,
Directors
David W. Devonshire, Ivor J. Evans,
Joseph P. Flannery, William D. George, Jr.,
Richard W. Hanselman, Victoria B. Jackson,
James E. Marley, William R. Newlin,
Steven G. Rothmeier and Andrew J. Schindler*
James D. Donlon, III*
Senior Vice President and Chief Financial
Officer (principal financial officer)
Jeffrey A. Craig*
Vice President and Controller (principal accounting officer)
* By: /s/ Bonnie Wilkinson
** By authority of powers of attorney filed herewith.
SCHEDULE II
ARVINMERITOR, INC.
VALUATION AND QUALIFYING ACCOUNTS
For the Year Ended September 30, 2006, 2005, 2004
(a)
Uncollectible accounts written off
(b)
Underlying deferred tax asset written off
S-1