Item 1. Business
General
Wolverine Tube, Inc. (the Company, Wolverine, we, our, or us) is a world-class quality manufacturer and distributor of copper and copper alloy tube, fabricated products, and metal joining products. Our focus is on custom-engineered, higher value-added tubular products, including fabricated copper components and metal joining products, which enhance performance and energy efficiency in many applications, including: commercial and residential heating, ventilation and air conditioning, refrigeration, home appliances, industrial equipment, power generation, petrochemicals and chemical processing.
Our technological expertise has helped us to establish strong and long-standing relationships with many of the leading Original Equipment Manufacturers (OEM) that use our higher value-added copper tube, and enables us to maintain a leading market share in our most important product lines and geographic markets.
We are a Delaware corporation organized in 1987, and are the successor to a business founded in Detroit, Michigan in 1916.
Available Information
Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports are available on our website, at no charge, at www.wlv.com, as soon as reasonably practicable after electronic filing or furnishing such information to the Securities and Exchange Commission (SEC). Also available on our website, or in print upon written request at no charge, are our corporate governance guidelines, the charters of our audit, compensation and corporate nominating and governance committees, and a copy of our code of business conduct and ethics that applies to our directors, officers and employees, including our principal executive officer, principal financial officer, principal accounting officer, controller or other persons performing similar functions.
We have filed, as exhibits to our Annual Report on Form 10-K, the certifications of our principal executive officer and principal financial officer under Sections 906 and 302 of the Sarbanes-Oxley Act of 2002 regarding the quality of our public disclosure. We are an accelerated filer with the SEC. You may read and copy any materials filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may also obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site (http://www.sec.gov) that contains our electronically filed reports, proxy and information statements, and other information.
Competition
The copper tube markets in which we compete are highly competitive. Several of our competitors produce only copper tube products of a limited type. In contrast, we produce a broad range of copper products, such as technical tube for large commercial air conditioners used
in high-rise buildings, industrial tube and fabricated components used in residential and light commercial air conditioning units, wholesale tube used in commercial and residential construction, as well as tube used in power generation, petrochemical and marine applications. Moreover, our metal joining products are used in almost all of these applications.
While no single company competes with us in all of our product lines, we face significant competition in each product line. Cerro Flow Products, Inc., Industrias Nacobre S.A. de C.V., KobeWieland Copper Products Inc., Wieland-Werke AG, Mueller Industries Inc., Luvata, The Harris Products Group, Parker Hannifin Corp., Hitachi, Furukawa, Sumitomo and others compete against us in one or more product lines. We also face competition from China-based copper tube manufacturers who compete with us both in China and in other parts of the world.
Minimal product differentiation among competitors in the wholesale product categories creates a pricing structure that enables customers to select products almost exclusively on price. In these product lines, certain of our competitors have significantly larger market shares than us, and tend to be price leaders in the industry. For certain of our higher value-added commercial products, we compete primarily on the technological advantages of these products.
We could be adversely affected if new technologies emerge in the air conditioning, refrigeration or other consumer industries that reduce or eliminate the need for copper and copper alloy tube, fabricated copper components, and metal joining products. Certain of our products, such as plumbing tube, compete with products made of alternative materials, such as polybutylene plastic. Aluminum is also a substitute product in residential air conditioning units. Increases in the price of copper, or sustained high copper prices could decrease the relative attractiveness of copper products in cases where alternatives exist and are allowable by local law or code, thereby adversely affecting our business, operating results or financial condition.
Product Segments
In 2006, we classified our products as commercial products, wholesale products, or rod, bar and other products.
Commercial Products
Commercial products consist of several types of technically enhanced tube and fabricated products made to customer specifications, as well as our metal joining products. We believe that we are the primary supplier of one or more commercial products to some of the world’s largest and best known OEMs, particularly in the commercial and residential heating ventilation and air-conditioning, refrigeration and home appliance industries. Generally, our technical tube and fabricated products are custom designed, are manufactured for specific customer applications, and are sold directly to OEMs. Because of the higher level of added value, profitability tends to be better for commercial products than for our other products.
Commercial products include:
Industrial Tube
Our small and medium diameter copper tube used primarily by residential and light commercial air conditioning, appliance, refrigeration equipment and plumbing fittings and fixture manufacturers is known as “industrial” tube. Much industrial tube is made to customer specifications for equipment manufacturing. Our industrial tube products include smooth straight tube, copper coils both smooth and enhanced, and very small diameter capillary tube. Early in 2005, we began importing for resale in North America both internally enhanced and smooth industrial tube manufactured by a Chinese tube producer with which we have entered into a multi-year exclusive supply arrangement (see Value Added Strategic Sourcing Program below).
Technical Tube
Technical tube is used to increase the heat transfer in large commercial air conditioners, heat exchangers for power generating and chemical processing plants, water heaters, swimming pool and spa heaters and large industrial equipment oil coolers. Small, wedge-like grooves (fins) on the outer surface, together with additional internal enhancements, increase the surface area and refrigerant agitation, thereby increasing heat transfer efficiency. We were the first company to commercially develop integral finned tube, in which the fins are formed directly from the wall of the tube, and we hold patents in this area.
Copper Alloy Tube
Copper alloy tube (principally copper mixed with nickel) is used for certain severe applications and corrosive environments such as condenser tubes and heat exchangers in power generating plants, chemical plants, refineries and ships. Our copper alloy tube products have included smooth and surface enhanced tube produced from a variety of alloys. Also included in the alloy tube category are surface enhanced titanium, brass and steel tube produced from smooth tube supplied by outside sources.
The closure of the Montreal plant in late 2006 allowed us to step away from the unprofitable manufacturing of alloy tube. We buy and resell alloy tube, in some cases introducing value-added features such as finning or internal enhancement.
Fabricated Products
Fabricated products encompass a wide variety of copper, copper alloy, steel, titanium and aluminum tube products and sub-assemblies for a number of different applications. Precision drawn tube in a variety of cross-sectional shapes and alloys can be supplied in customer specified straight lengths or coils. Specialty fabricated parts, complex brazed assemblies and components (such as return bends and manifolds) are produced for a wide range of applications. Capabilities include cutting, bending/swaging, end spinning, hole piercing/drilling, specialized coiling and brazing.
Metal Joining Products
Metal joining products include brazing alloys, fluxes and lead-free solder used in the air conditioning, plumbing, electronic, electrical component, jewelry, catalyst, lighting, shipbuilding, aerospace, general industrial and other metal-joining industries. There are over 2,000 product variations in this category.
Commercial product sales accounted for 72% of our net sales in 2006 as compared with 71% in 2005, and 72% in 2004.
Wholesale Products
Wholesale products consist of plumbing and refrigeration service tube produced in standard sizes and lengths primarily for plumbing, air conditioning and refrigeration service applications. These products are considered commodity products because price, availability and delivery are the driving competitive factors. Wolverine’s plumbing tube and refrigeration service tube are sold primarily through wholesalers and master distributors.
Wholesale product sales accounted for 22% of our net sales in 2006 as compared with 22% in 2005 and 21% in 2004.
Rod, Bar and Other Products
Rod, bar and other products consist of a broad range of copper and copper alloy solid products, including round, rectangular, hexagonal and specialized shapes. Brass rod and bar are used by industrial equipment and machinery manufacturers for valves, fittings and plumbing goods. Copper bars are used in electrical distribution systems and switchgear. Copper and copper alloy rod and bar products are sold directly to manufacturers and to service centers that keep an inventory of standard sizes. Other products consist of various tube, rod, bar and other items sold by our product distribution facility in The Netherlands.
Rod, bar and other products accounted for 6% of our net sales in 2006 as compared with 7% in 2005 and 8% in 2004. On September 13, 2006 our Company announced the planned closure of manufacturing facilities located in Jackson, Tennessee and Montreal, Quebec. The closing of the Montreal plant allowed us to step away from underperforming rod and bar products by the end of 2006.
Sales and Marketing
We employ a direct sales force that is augmented by independent sales agents to pursue global sales opportunities. In addition, customer service representatives are available to respond to customer questions and to undertake or resolve any required customer service issues. Our sales structure forms an integral, critical link in communicating with our customers. Sales and marketing employees are particularly important in the higher value-added product segments, in which we often work side by side with customers in their product enhancement and new product development efforts. The sales function is coordinated through key senior executives responsible for our sales and marketing efforts.
North America
Our sales structure in North America consists of a sales officer, managers, field marketing representatives, inside sales representatives, customer service representatives and independent sales agents who are responsible for selling and servicing customer accounts.
International
Our export sales are derived from both internal salespeople and foreign sales agents. We maintain sales, marketing and business development offices in Apeldorn, The Netherlands and in Shanghai, China.
For information concerning sales, gross profit, and certain other financial information and foreign and domestic operations see Note 22, Industry Segments and Foreign Operations, of the Notes to Consolidated Financial Statements.
Energy Efficiency and Governmental Regulations
Effective January 23, 2006, the U.S. government mandated an increase in the Seasonal Energy Efficiency Ratio (SEER). This new minimum standard is 13 SEER, which is a 30% improvement in energy efficiency from the previous minimum standard rating of 10 SEER. The new standard increased demand for our industrial tube, fabricated product and metal joining product businesses in 2006 as customers increased production of 13 SEER units.
We expect that the demand for our higher value-added, energy efficient tubes will continue to grow as OEMs continue seeking ways to produce products that are less costly, more energy efficient and operate at a lower cost, and as existing commercial air conditioners continue to be replaced in response to the ban on production of chlorofluorocarbons. Government regulations at the local, state and federal levels periodically provide various incentives for consumers to purchase more energy efficient products, such as air conditioners, refrigerators and similar appliances, which we believe may also increase demand for our products. However, there can be no assurance that this anticipated demand will materialize, or that we will not face increased competition, with an adverse effect on profitability, from other manufacturers in this higher value-added segment.
Markets
Major markets for each of our product lines are set forth below:
Products
Major Markets
Commercial Products:
Technical Tube
Commercial air conditioning manufacturers, power and process industry, heat exchanger manufacturers, water, swimming pool and spa heater manufacturers and oil cooler manufacturers.
Industrial Tube
Residential and light commercial air conditioning manufacturers, appliance manufacturers, automotive manufacturers, industrial equipment manufacturers, refrigeration equipment manufacturers plumbing fittings and fixture manufacturers, and redraw mills (which further process the tube).
Copper Alloy Tube
Utilities and other power generating companies, refining and chemical processing companies, heat exchanger manufacturers and shipbuilders.
Fabricated Products
Commercial and residential air conditioning manufacturers, refrigeration manufacturers and consumer appliance manufacturers, automotive, controls, welding, electrical, marine, building, heat transfer industries and other general industrial applications.
Metal Joining Products
Residential and commercial air conditioning manufacturers, plumbing, electronic, lighting, shipbuilding, aerospace, catalysts, jewelry and other metal joining industries.
Wholesale Products
Plumbing and refrigeration service wholesalers and distributors.
Rod, Bar and Other Products
Electrical equipment, power generation and automotive parts manufacturers, locomotive, aluminum smelting and other industrial equipment manufacturers and metal service centers.
Key Customers
In 2006, 2005, and 2004, our 10 largest customers accounted for approximately 48%, 46%, and 44%, respectively, of our consolidated net sales. No single customer accounted for 10% or more of our consolidated net sales in any of the previous three years.
Backlog
A significant part of our sales is based on short-term purchase orders. For this reason, we do not maintain a backlog, and believe that a backlog is not a meaningful indicator of our future results. A significant amount of our sales result from customer relationships wherein we provide a high degree of specialized service and generally become the largest supplier of a customer’s copper and copper alloy requirements. Under these arrangements, our customers provide forecasts of their requirements, against which purchase orders are periodically released. In several cases, we have entered into multi-year arrangements with major customers in order to continue serving as the predominant supplier.
Manufacturing Processes
The manufacture of copper, fabricated products and metal joining products consists of manufacturing processes including casting, extruding, drawing, forming, joining and finishing. In most cases, raw material is first cast into a solid cylindrical shape or “billet.’’ The billet is then heated to a high temperature, a hole is pierced through the center of the cylinder, and the cylinder is then extruded under high pressure. Material is then either drawn down to smaller sizes, or reduced on a forging machine and then drawn down to a smaller size. The outside and/or inside surface may be enhanced to achieve the desired heat transfer qualities. Depending on customer needs, bending, shaping, precision cutting, forming, annealing (heating to restore flexibility), coiling or other operations may be required to finish the product.
Raw Materials, Suppliers and Pricing
Our principal raw materials are copper, nickel, zinc, tin and silver. We contract for our copper requirements through a variety of sources, including producers, merchants, brokers, dealers, industrial suppliers and scrap dealers. Although these raw materials can be obtained from multiple sources, and while historically we have not suffered any significant limitations on our ability to procure them, any delay or disruption in our suppliers’ ability to provide us with the necessary raw materials may significantly affect our business operations and have a negative effect on our operating results or financial condition.
The key elements of our copper procurement and product pricing strategies are the assurance of a stable supply and the avoidance, where possible, of exposures to metal price fluctuations. Copper prices fluctuate daily, typically using the Commodities Exchange (COMEX) or London Metal Exchange (LME) price as a benchmark. We generally have an “open pricing’’ option under which we may fix the price of all or a portion of the metal subject to purchase contracts at any time up to the last COMEX or LME trading day (usually two days before the end of the month) of the last month in a contract period.
Generally, all products delivered to customers, with the exception of wholesale and rod and bar products, are priced in accordance with one of the following methods: (i) a metal charge based on the average market value of metal in the month prior to shipment to the customer and a fixed fabrication charge, (ii) a metal charge based on the market value of metal as of the date of product shipment to the customer and a fixed fabrication charge or (iii) we may quote a firm price to a customer, which covers both the cost of metal and fabrication charges. In the case of (i), our Company believes that this pricing policy, in conjunction with its inventory turns, provides a natural hedge against changes in the COMEX price of copper. In the case of (ii) and (iii), we work to minimize our exposure to metal price fluctuations through a variety of hedging strategies. When firm prices are quoted to customers, we generally, at the time the metal price for the customer is established, either price an equivalent amount of metal under open pricing arrangements with suppliers, or purchase forward contracts for the equivalent amount of metal. Wholesale and rod and bar products are priced with an “all in” market price, which includes both metal and fabrication charges. It is not our policy to attempt to profit from fluctuations in metal prices by taking speculative or risky commodity derivative positions.
We enter into commodity forward contracts to sell copper in order to mitigate the impact that copper price changes could have on the value of our inventory. See the Consolidated Financial Statements, Note 2, Summary of Significant Accounting Policies - Derivatives and Hedging Activities and Note 5, Derivatives of the Notes to Consolidated Financial Statements.
We satisfied the majority of our silver requirements through a silver consignment facility with Bank of America, N.A. (BANA) until mid-December 2006 when the facility terminated. Under this facility, BANA consigned certain amounts of silver to us upon request for a fee. Title to the consigned silver remained with BANA until the products containing the silver were shipped to our customers, at which time we paid for the silver shipped, or replaced that amount of silver in our inventory, at then-current market prices. See Note 10, Financing Arrangements and Debt, of the Notes to Consolidated Financial Statements.
Value Added Strategic Sourcing Program
We have a value added strategic sourcing agreement with one of the largest China-based copper tube manufacturers to provide products to us for resale to our customers in North America. Under this arrangement, we buy certain types of tubing products from this manufacturer, import these products into the U.S., and warehouse the products until they are required by our customers. As part of the agreement, we are the sole representative of the China-based copper tube manufacturer in the U.S.
Research and Development
Our research and development efforts are primarily conducted in our Technology Center located in Decatur, Alabama and Shanghai, China. We utilize both research and development facilities for new product development, manufacturing process improvements and new product applications. While developing new products, we often work closely with certain major customers in order to develop specific new products for their applications. To compliment our research and development capabilities, we occasionally coordinate our efforts with those of universities, and governmental and private research organizations. Through our Technology
Center, we support the engineering and testing of our custom-engineered processes, specialized products and product enhancements, and may make modifications to these based upon customer specifications.
Our company introduced Micro Deformation Technology MDTÔ in 2002. This technology is used to develop highly enhanced new heat transfer products for large chiller applications. We continue to participate in several industry, university and governmental research projects relating to more efficient heat transfer tubes for industrial, commercial and residential heating and cooling applications, as well as refrigeration, power generation, chemical and petrochemical industries. Expenditures relating to the development of new products and processes, including significant improvements and refinements to existing products, are expensed as incurred. Research and development costs were approximately $2.2 million in 2006, $3.1 million in 2005, and $3.5 million in 2004.
Patents and Trademarks
We own a number of trademarks and patents within the U.S. (and in other jurisdictions) on certain products and related manufacturing processes. We have also granted licenses with respect to some of these trademarks and patents. While we believe that our patents and trademarks provide a competitive advantage and have value, we do not consider the success of our business, as a whole, to be primarily dependent on these patents, patent rights or trademarks.
Environmental Matters
We are subject to extensive environmental regulations imposed by federal, state, provincial and local authorities in the U.S., Canada, China, Portugal and Mexico with respect to emissions to air, discharges to waterways, and the generation, handling, storage, transportation, treatment and disposal of waste materials. We have received various communications from regulatory authorities concerning certain environmental matters. We have incurred, and may continue to incur, additional liabilities under environmental statutes and regulations. These potential liabilities may relate to contamination of sites we own or operate (including contamination caused by prior owners and operators of such sites, abutters or other persons), or have previously owned or operated, as well as the off-site disposal of hazardous substances.
We have established a reserve of approximately $11.8 million for undiscounted estimated environmental remediation costs at December 31, 2006. The total cost of environmental assessment and remediation depends on a variety of regulatory, technical and factual issues, some of which are not known or cannot be anticipated. While we believe that the reserve, under existing laws and regulations, is adequate to cover presently identified environmental remediation liabilities, there can be no assurance that such amount will be adequate to cover the ultimate costs of these liabilities, or the costs of environmental remediation liabilities that may be identified in the future. We have accrued undiscounted estimated environmental remediation costs of $0.1 million for our Decatur facility and $0.7 million for our Ardmore facility as of December 31, 2006.
As result of the closure of the Montreal facility, our Company became subject to certain requirements of the Quebec Environmental Quality Act, which include performing a
comprehensive Site Characterization and Rehabilitation Plan. This requires that Phase I and Phase II Environmental Site Assessments (ESA) be performed to determine the amount and extent of any contamination. A Site Rehabilitation Plan and Schedule, based upon the results of the Phase I & II ESAs, also must be submitted to the government for review and approval. Once approved, our Company will perform any required site remediation. The Phase I and Phase II ESAs began in January, 2007.
In 2006, we established an environmental accrual of $11.0 million for the Montreal facility. With the assistance of outside counsel and environmental consultants, our Company re-evaluated environmental reports about the site prepared in 1993 by Technitrol-Eco to support our Company in environmental litigation against the previous owner and used the Technitrol-Eco report to estimate the costs to meet the requirements of the Environmental Quality Act. The established accrual does not include costs associated with areas that could be contaminated but were not assessed in the Technitrol-Eco report. We will reassess the adequacy of our reserve and accrue additional amounts, if necessary, in connection with the completion of the Phase I and Phase II ESAs.
We believe our operations are in substantial compliance with all applicable environmental laws and regulations as currently interpreted. We utilize an active environmental auditing and evaluation process to facilitate compliance with applicable environmental laws and regulations. However, future regulations and/or changes in the text or interpretation of existing regulations may subject our operations to increasingly more stringent standards. While we cannot quantify the effect of any future potential changes on our business, compliance with such requirements may make it necessary, at costs which may be substantial, to retrofit existing facilities with additional pollution control equipment and to undertake new measures in connection with the storage, transportation, treatment and disposal of by-products and wastes.
Employees
As of December 31, 2006, we had a total of 2,623 employees, a reduction of approximately 460 from the previous year, mainly as a result of the closing of manufacturing facilities in Jackson, Tennessee and Montreal, Quebec. Approximately 10% of our current employees are represented by unions comprised of a majority of the hourly employees at our Monterrey, Mexico facility. The Monterrey, Mexico employees are covered by a collective bargaining agreement that expired on January 31, 2007 and was successfully renewed through February 1, 2008.
Executive Officers of the Registrant
The following table sets forth certain information with respect to each of our executive officers as of December 31, 2006:
Johann R. Manning, Jr. had been President and Chief Executive Officer of our Company since December 2005 until his resignation on February 16, 2007. Prior to this, Mr. Manning had been President and Chief Operating Officer since February 2005. Other positions held by Mr. Manning include Senior Vice President, Fabricated Products and General Counsel of our Company from October 2001 until February 2005, Senior Vice President of Human Resources and General Counsel from May 2000 until October 2001 and Vice President of Human Resources and General Counsel from May 1998 until May 2000. Prior to joining our Company, Mr. Manning had served as Senior Counsel for Mercedes-Benz U.S. International, Inc., a vehicle manufacturer, since March 1998. Prior to joining Mercedes-Benz, Mr. Manning was employed for over eight years with Genuine Parts Company, a diversified wholesale distribution company, where he held various positions including Vice President of Human Resources and Corporate Counsel for its Motion Industries, Inc. subsidiary.
Harold M. Karp became the President and Chief Operating Officer of our Company on February 16, 2007. Mr. Karp has been Senior Vice President of Alpine, a publicly traded holding company engaged in the investment and/or acquisition and operation of industrial companies since April 27, 2006 and President of Exeon Inc., formerly known as Essex Electric, Inc., Alpine’s building wire manufacturing subsidiary since December 2002. Previously, Mr. Karp was President of the Electrical Group of Superior TeleCom from January 2001 until December 11, 2002.
James E. Deason has been Senior Vice President, Chief Financial Officer and Secretary of our Company since November 2005. Mr. Deason previously retired from Wolverine on March 31, 2005, and served as a consultant to our Company from his retirement in March 2005 until November 2005. Prior to his retirement, Mr. Deason had served as Executive Vice President, Chief Financial Officer and Secretary since September 1994. Mr. Deason had also been a director of our Company from October 1995 until his retirement in March 2005. Before initially joining our Company in 1994, Mr. Deason, a Certified Public Accountant, spent 19 years with Ernst & Young LLP and was a partner from 1988.
Garry K. Johnson has been the Senior Vice President, Sales of our Company since 2002. He previously held the positions of Vice President, Sales from 1998 until 2002, Industrial Marketing Manager from 1990 until 1998, Field Sales Representative from 1981 until 1990 and Production Supervisor from 1979 until 1981. Mr. Johnson has been employed by our Company for twenty-eight years.
Until his resignation on February 22, 2007, Doug Morse had been Vice President - Operations for Wolverine since January 2006, and Director of Operations for the Shawnee, Oklahoma and Decatur, Alabama Operations from 2004 to 2005. Mr. Morse came to Wolverine in 2003 as Plant Manager of the Shawnee, Oklahoma facility. His previous experience included Vice President of Manufacturing at Scott Brass, where he directed management of their multi-plant manufacturing organization including melting, continuous casting, cold finishing, quality, testing and process development. Prior to that Mr. Morse was Director of Manufacturing & Engineering at Inco Alloys. Mr. Morse possesses an MBA from Marshall University and a Bachelor of Science in Mechanical Engineering from the University of Cincinnati and is a licensed professional engineer. Mr. Morse resigned his position on February 22, 2007.
John H. Van Gerwen has been Vice President - Operations since January 2006. He began his career with Wolverine in 1982 at our London, Ontario plant as a Project Engineer. Mr. Van Gerwen was promoted several times at London. He served in a variety of roles, ultimately becoming Plant Manager in 1994. In 1997, Mr. Van Gerwen was promoted to Vice-President of Operations assuming responsibilities for our Altoona, Pennsylvania facility. In 2001, Mr. Van Gerwen became Vice President of Operations - Fabricated Products and, in 2005, Vice President of Fabricated Products and Canadian Operations. Mr. Van Gerwen holds a Bachelor of Applied Science in Mechanical Engineering from University of Waterloo and is a licensed Professional Engineer.
Keith I. Weil has been the Senior Vice President, International and Strategic Development of our Company since February 2005. He has also held the position of Senior Vice President, Tubing Products, from December 1998 until February 2005. Prior to joining our Company, Mr. Weil had been a Global Business Executive and General Manager Consumer/Commercial for AMP Incorporated since 1996. Prior to 1996, Mr. Weil was employed by Philips Electronics NV for fourteen years in positions that included President of Graner Company (a division of Philips), General Manager of Philips Circuit Assemblies and Vice President of Marketing for Philips Broadband.
Allan J. Williamson has been the Corporate Controller since February 2004. He previously held the positions of Group Controller - Tube Group and Wolverine Tube Europe from August 2003 until January 2004, and Group Controller - Fabricated Products Group from September 2002 when he joined our Company until July 2003. Prior to joining our Company, Mr. Williamson was Chief Financial Officer and Vice President of Business Planning of ADS Environmental Services from September 1995 through September 2002, and before that he was Vice President - Operations Controller from January 1995 through August 1995 for Continental Can Company and Vice President of Finance of General Marble from January 1993 to January 1995.
Item 1A.
Item 1A. Risk Factors
This report contains forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include all statements that do not relate solely to current or historical fact, but address events or developments that we anticipate may occur in the future. Forward-looking statements include statements regarding our goals, beliefs, plans or current expectations, taking into account the information currently available to our management. When we use words such as “anticipate,” “intend,” “expect,” “believe,” “plan,” “may,” “should” or “would” or other words that convey uncertainty of future events or outcome, we are making forward-looking statements. Statements relating to future sales, earnings, operating performance, recapitalization and restructuring strategies, capital expenditures and sources and uses of cash, for example, are forward-looking statements.
These forward-looking statements are subject to various risks and uncertainties, including the risks described below and elsewhere in this report, which could cause actual results to differ materially from those stated or implied by such forward-looking statements. You should carefully consider each of the following risks and all other information contained in or incorporated by reference in this report and in our filings with the SEC. The risks described below and in our filings with the SEC are not the only ones we face. Additional risks and uncertainties not presently known to us, or which we currently consider immaterial, also may adversely affect us. If any of the following risks actually occur, our business, financial condition and results of operations could be materially and adversely affected.
Our business and financial condition will suffer if we are unable to execute our recapitalization plan and achieve our plan of operations.
As discussed in more detail in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations - Recapitalization Plan, on February 1, 2007, we announced a recapitalization plan which will ultimately provide at least $75 million, and could provide up to approximately $135 million, of equity proceeds to our Company. We completed the first phase of this recapitalization plan, a sale of $50 million in a new series of convertible preferred stock to an investor group, on February 16, 2007. Under our recapitalization plan, we also plan to raise up to an additional $51.1 million in cash proceeds from a common stock rights offering to our shareholders. If proceeds from the rights offering are less than $25 million, this investor group may invest up to an additional $25 million in preferred equity, and depending on the level of participation in the rights offering, the investor group may make an additional preferred equity investment to maintain a 55% ownership interest. In addition, we plan to initiate an exchange offer to issue senior notes similar to our existing 10.5% Senior Notes, but with less restrictive covenants, in exchange for our 7.375% Senior Notes, and we will also seek consents to remove substantially all of the restrictive covenants contained in the 7.375% Senior Note indenture.
While the initial $50 million in cash proceeds we received pursuant to our recapitalization plan eased immediate liquidity needs, if we are unable to complete the remainder of the recapitalization plan, our future is unclear. As of January 28, 2007, we had working capital of $164.0 million and approximately $20.6 million of available cash and cash equivalents. With
our current cash balances, amounts available under our liquidity facilities and anticipated cash flow from continuing operations, we believe that we will be able to satisfy existing working capital needs, debt service obligations, capital expenditures, and other cash requirements. However, in the absence of further deleveraging of our balance sheet and restructuring of our capital structure (whether as a result of the recapitalization plan or otherwise), we may not have sufficient liquidity to satisfy these obligations and continue our current operations. In this event, we could face a default and acceleration of our debt and other obligations, one result of which is bankruptcy or insolvency.
If our recapitalization plan is successful, our ability to meet our financial projections and our obligations will then depend on our ability to achieve our operating plan. Accomplishing our operating plan may be affected by general economic conditions, commodity prices, industry trends and other factors beyond our control. We may be unable to implement certain elements of our operating plan following completion of the recapitalization plan due to continuing pressures on our operating cash flow.
Our ability to complete the recapitalization plan is subject to a number of conditions, some of which are beyond our control.
The success of our recapitalization plan depends in part on certain events and conditions that are beyond our control. For example, our ability to raise significant additional equity through the proposed common stock rights offering depends upon the level of stockholder participation in the offering as well as stockholder approval of an amendment to our Restated Certificate of Incorporation to increase the number of authorized shares of common stock.
In addition, the success of the proposed offer to exchange our 7.375% Senior Notes and solicit consents to modify the restrictive covenants applicable to those notes depends upon the level of participation of the relevant noteholders in the offer. If we are unable to obtain stockholder approval for the charter amendment, if we do not receive sufficient stockholder participation in the rights offering or noteholder participation in the exchange offer and consent solicitation, or if we are otherwise unable to satisfactorily complete these transactions, our recapitalization plan may fail.
Also, we will be required to obtain amendments or waivers of certain restrictive provisions in the agreements governing our secured revolving credit facility and our receivables sale facility in order to complete the remainder of our recapitalization plan. If the relevant counterparties do not consent to such amendments or waivers, or if material conditions are attached to any such consent that make obtaining the amendments or waivers unreasonable, we may be unable to complete our recapitalization plan on the proposed terms and timeframe.
We may need additional financing after completion of our recapitalization plan, which may be unavailable or costly.
Our actual funding requirements could vary materially from our current estimates. We base our financial projections on assumptions that we believe are reasonable but which contain significant uncertainties that could affect our business, our future performance and our liquidity. Our ability to achieve and sustain operating profitability will depend on many factors, including the price of copper and our ability to pass on cost increases in certain markets, our ability to
convert certain customers to foreign sourced products on terms mutually acceptable and profitable to us and our customers, our ability to absorb some of the business from our recently closed Montreal facility into our London, Ontario facility and continued availability of sufficient amounts under our liquidity facilities to support the cyclicality of our business. In addition, our business, our future performance and our liquidity would be affected by general industry and market conditions and growth rates and general economic and political conditions, including the global economy and other future events.
Consequently, we may have to raise additional funds, which may be costly, to operate our business and provide other needed capital, and we may be unable to do so on favorable terms or at all. If we were unable to raise such needed additional funds or could only do so on unfavorable terms, our operations could be adversely affected and we could have insufficient capital to meet our expenses and operate our business.
If we are unable to renew or replace our current liquidity facilities as they expire or if we are unable to refinance the senior notes as they mature, our financial condition and ability to operate our business will be significantly affected.
Our $35 million secured revolving credit facility and our $90 million receivables sale facility expire in April 2008. On August 1, 2008, we must repay or refinance $136.8 million in aggregate principal amount of our outstanding 7.375% Senior Notes, and on April 1, 2009, we must repay or refinance $99.4 million in aggregate principal amount of our outstanding 10.5% Senior Notes. Under our recapitalization plan, we plan to make an offer to exchange the outstanding 7.375% Senior Notes before they mature with new senior notes similar to our existing 10.5% Senior Notes, but with less restrictive covenants.
Additionally, we may enter into discussions with our commercial banks and other institutional lenders regarding the possible refinancing of our liquidity facilities in connection with our recapitalization plan. However, there is no assurance that we will be successful in our proposed exchange offer or in completing any such refinancing prior to the applicable maturity dates.
While we have been able to access the commercial bank financing markets in the past, due to our significant leverage, our financial condition and the debt incurrence limitation and other restrictions imposed by our indentures and other financing agreements, we may not be able to renew or replace our liquidity facilities upon their expiration on terms at least as favorable as the existing facilities, if at all. Similarly, we may not be able to access the capital markets to refinance our senior notes upon their maturity on acceptable terms, if at all. If we are unable to access the capital and commercial bank credit markets, obtain additional equity capital, sell assets or otherwise restructure our liquidity facilities and senior notes in a timely manner, our financial condition and ability to operate our business will be significantly affected and one possible outcome may be bankruptcy or insolvency.
In addition, our senior management has spent, and will continue to spend, significant time managing these liquidity and other planning issues, which diverts management’s attention from operational and other business concerns and could negatively affect our results of operations.
If we are not able to meet the conditions in our receivables sale facility and our secured revolving credit facility, the counterparties to these facilities may restrict our access to available amounts thereunder.
Currently, we view our receivables sale facility and our secured revolving credit facility as sources of liquidity. The agreements governing these liquidity facilities contain various conditions, covenants (including financial covenants) and representations with which we must comply in order to access available amounts under the facilities. There can be no assurances that we will be able to waive or amend the terms of our liquidity facilities, including financial covenants, should we not meet any terms in the agreements. Our ability to comply with these requirements may be affected by events beyond our control. If we are not in compliance with the conditions, covenants and representations required for draw-downs under these facilities, and if we are unable to secure necessary waivers or other amendments from the counterparties, we will not have access to these facilities, which could significantly affect our ability to meet our expenses and operate our business.
In September 2005, we entered into amendments to our receivables sale facility and secured revolving credit facility to suspend the application of the required minimum consolidated EBITDA covenants until quarterly testing (calculated on a rolling four quarter basis) resumes for the second quarter of 2007. We have reported significant operating and restructuring losses in the third and fourth quarters of 2006, and we anticipate that we may need to negotiate with the relevant counterparties regarding a waiver or amendment of the EBITDA covenant in order to remain in compliance with the covenant once testing resumes. If the respective counterparties do not consent to an appropriate amendment or waiver on a timely basis, we will be unable to access available amounts under these facilities.
If we are unable to comply with the operating and financial covenants contained in the indentures for our outstanding senior notes and in our other liquidity facilities, which impose significant restrictions on our ability to capitalize on business opportunities and take some corporate actions, we could face an acceleration of our debt.
The indentures governing our outstanding senior notes and the agreements governing our liquidity facilities contain a number of significant operating and financial covenants. These restrictions limit our ability to, among other things:
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incur other indebtedness;
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engage in transactions with affiliates;
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create or incur liens to secure debt;
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prepay or repurchase indebtedness;
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make certain restricted payments;
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enter into certain business combinations and asset sale transactions; and
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make investments.
These restrictions significantly limit our ability to undertake future financings, secure additional or alternative liquidity, make needed capital expenditures, dispose of certain assets,
withstand a future downturn in our business or the economy in general, conduct operations or otherwise take advantage of business opportunities that may arise. We are currently attempting to obtain consents necessary to amend the 7.375% Senior Note indenture to remove substantially all of the restrictive covenants contained therein, and we intend to conduct an exchange offer to replace the 7.375% Senior Notes with senior notes that have less restrictive covenants.
In addition, the agreements governing our current liquidity facilities contain certain financial covenants and requirements, including the minimum consolidated EBITDA covenant discussed above, with which we must comply. Changes in economic or business conditions, results of operations or other factors could make us unable to comply with the covenants in effect at that time and cause us to default under any of those agreements. Because our current liquidity facilities and indentures contain cross-default provisions, a default, if not waived by the relevant counterparties, could result in acceleration of our debt and other obligations under multiple agreements.
Significant debt levels may limit our future ability to obtain additional financing and to pursue business opportunities.
As of December 31, 2006 our total debt was $240.0 million. We are permitted under the agreements governing our liquidity facilities and the indentures governing our outstanding senior notes to incur additional debt under certain limited circumstances.
There are several important consequences of having significant debt levels, including the following:
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a substantial portion of any cash generated from operating activities must be used to pay principal and interest and other fees on our debt and related obligations and may not be available for other purposes, thereby reducing the availability of such available cash flow to fund working capital, capital expenditures, research and development efforts and other general corporate purposes;
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our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions or other purposes may be limited;
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our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate may be limited;
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adverse economic or industry conditions are more likely to have a negative effect on our business;
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we may be at a competitive disadvantage to our competitors that have relatively less indebtedness;
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our ability to make acquisitions, develop new technologies and products and take advantage of significant business opportunities may be negatively affected; and
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the need to use available cash from operating activities to service and pay our debt and for operating expenses may limit or impair our future ability to pay dividends, if any, on our common stock.
Variable interest rates, or other variable liquidity costs, may increase substantially.
A substantial portion of the interest, fees and other costs associated with our current liquidity facilities accrue at variable rates. As of March 2, 2007, we had no outstanding borrowings under our secured revolving credit facility and no amounts outstanding under our receivables sale facility. However, any future borrowings under the secured revolving credit facility and any future utilization of our receivables sale facility will accrue interest and other costs at certain market rates that vary over time. At March 2, 2007, our receivables sale unused line fee facility costs were accruing at a rate of 0.5%. As of March 2, 2007, we had $12.7 million of consigned silver in our inventory under our new silver consignment facility. Consignment fees on consigned silver accrue at a rate that is set daily by the counterparty. At March 2, 2007, this rate was 1.5%. If interest rates increase, we may not have the ability to service the interest, fees and other costs of our liquidity facilities. Furthermore, if we were to default in our payments under our liquidity facilities, our rates would increase substantially.
Changes in payment terms applicable to our commercial customers may cause these customers to move their business to competitors who, because of their greater financial resources, may offer more generous payment terms.
Beginning with shipments on April 24, 2006, we modified the payment terms applicable to most commercial customers to net 15 days. We made this change to proactively address increasing copper prices. We took this measure to help manage liquidity in this unprecedented period of changing metal prices. However, this change may cause certain of these customers to move their business to competitors who may offer more generous payment terms.
If any of our largest commercial customers, or a significant number of smaller commercial customers, move business to a competitor, demand for our products may fall, or we may be unable to maintain our modified payment terms, and our revenues, results of operations, liquidity and financial condition might suffer as a result.
Our business is dependent upon the availability and price of raw materials, particularly copper. Significant disruptions in the supply of raw materials or continued periods of historically high copper prices will materially adversely affect our operating results.
Our profitability generally depends upon the gross margins of our products and the overall supply of copper and other raw materials. Average monthly COMEX copper prices in 2006 increased from a low of $2.18 per pound in January to a high of $3.76 per pound in May. After briefly reaching an all time high above $4.00 per pound in May, prices eased into the $3.00 to $3.60 per pound range during the last half of the year. We believe this volatility in copper prices is the result of several factors, including an imbalance between the global supply and demand for copper, exacerbated by Asian demand, and financial speculation in the commodity market. We expect the price to continue to remain at historically high levels.
We base the selling prices of our products upon the associated raw materials costs to us either at the time of sale of the finished product, the time of purchase of the raw material or as set by our purchases for forward delivery or hedging with futures and options contracts. However, we may not be able to pass all increases in copper costs and ancillary acquisition costs associated with the metal through to our customers.
Although we are currently able to obtain adequate supplies of copper, it is impossible to predict future availability. Future growth in demand for copper may result in copper shortages and increased prices. Any future increase in the price of copper or the maintenance of the price at historically high rates, if not offset by sufficient product price increases, or the inability to obtain copper or other needed raw materials, would have a material adverse effect on our consolidated financial condition, results of operations and cash flows.
In addition, certain of our copper products compete with products made of alternative substances, such as polybutylene plastic and aluminum. Any sustained increase in the price of copper could diminish the relative attractiveness of our copper products, particularly our wholesale products and in some commercial residential applications, in cases where an alternative exists and thereby adversely affect our sales volumes and results of operations.
Costs for energy and other natural resources may adversely affect our profitability.
Changes in prices for natural gas and for other sources of fuel, electricity and gasoline have historically negatively affected the costs associated with our manufacturing operations. Certain of our operations are dependent upon natural gas to produce tubing. We have purchased on a forward basis a portion of our natural gas requirements which will continue to be available over the next two years. Accordingly, as these prices for natural gas are locked in, we will not be able to take advantage of any decrease in spot prices for natural gas. Significant increases for other sources of fuel, electricity, and gasoline would further increase our operating costs and have a material negative effect on our gross profit.
Although we try to pass along increased costs in the form of price increases to our customers, we may be unsuccessful in doing so for competitive reasons, and even when successful, the timing of such price increases may lag behind our incurrence of higher costs.
Our customers operate in industries that are subject to cyclical and seasonal demand and that are affected by other global economic and regulatory conditions, which can adversely affect our sales volumes and profitability.
Our business is affected by changes in demand in our customers’ markets as well as by global economic conditions that affect our customers’ operations. Any significant downturn in our customers’ businesses could result in a reduction in demand for our products and could reduce our revenue.
Demand for our products, particularly our wholesale products, is cyclical and is significantly affected by changes in general economic conditions that affect our customers’ markets and that are beyond our control. These conditions include, among other things, the level of economic growth, employment levels, financing availability, interest rates, consumer confidence, housing demand and construction activity.
In addition, demand in certain of the industries to which we sell our products, including the residential air conditioning industry, and to a lesser extent, the commercial air conditioning industry, is seasonal. Our sales to the residential air conditioning industry are generally greater in the first half of the year and lower in the second half of the year due to our customers’ increase of inventory in anticipation of annual air conditioning sales and housing starts.
We face significant competition in many cases from competitors that have manufacturing and financial resources greater than ours.
We face significant competition in each of our product lines. We have numerous competitors, some of which are larger than us and have greater financial resources. We may not be able to compete successfully, and the competition may have a negative affect on our business, operating results or financial condition by reducing volume of products sold and/or selling prices and accordingly, reducing revenues and profits and depleting capital. Minimal product differentiation among competitors in our wholesale product line creates a pricing structure where customers differentiate between products almost exclusively on price. In these product areas, certain of our competitors have significantly larger market shares than us and tend to be the industry pricing leaders. If our competitors in these product lines were to significantly reduce prices, our unit sales and profit margins could be reduced. We currently face limited competition for certain of our higher value-added commercial products that have higher profit margins. If our existing competitors expand operations in these product categories or if new competitors enter these product lines, our sales of these higher margin products could fall and our profitability could be reduced or eliminated.
For certain of our higher value-added commercial products, which have higher profit margins, we compete primarily on the basis of technological advantages of these products. Technological improvements by competitors could reduce our advantage in these product lines and thereby reduce our revenue.
We could also be adversely affected if new technologies emerge in the air conditioning, refrigeration or other consumer industries that reduce or eliminate the need for copper and copper alloy tube, fabricated products and metal joining products.
Increasing competition from Asian competitors who sell both within China and for export to other parts of the world may negatively impact our business and adversely affect our revenue and operating results.
We face increased competition for the products we manufacture within China. Due to our relative market share for sales within China, we are subject to continuing competitive pricing pressures in this country. Further, as Asian competitors continue to increase their exports into the U.S. and other markets we serve world-wide, our ability to maintain price, market share and operating margins may be negatively impacted.
The loss of any of our major customers could adversely affect our revenues and financial health.
In 2006, 2005 and 2004, our 10 largest customers accounted for approximately 48%, 46% and 44%, respectively, of our consolidated net sales. If we were to lose any of our relationships with these customers, our revenues and results of operations and financial condition might suffer.
Risks associated with the operation of our manufacturing facilities may have a material adverse effect on our business.
Our revenues are dependent on the continued operation of our various manufacturing facilities. The operation of manufacturing plants involves many risks including:
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the breakdown, failure or substandard performance of equipment;
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inclement weather and natural disasters;
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the need to comply with directives of, and maintain all necessary permits from, governmental agencies;
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raw material supply disruptions;
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labor force shortages, work stoppages, or other labor difficulties; and
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transportation disruptions.
The occurrence of material operational problems, including but not limited to the above events, may have an adverse effect on the productivity and profitability of a particular manufacturing facility or to us as a whole.
We may engage in divestitures that could have a negative impact on our operations and financial results and the availability under certain of our current liquidity facilities.
Although the indentures governing our senior notes and the agreements governing our current liquidity facilities impose certain limitations on our ability to sell assets, we may seek waivers of these restrictions under such indentures and agreements to engage in certain divestitures or we may otherwise engage in certain permitted divestitures that could have a negative impact on our operations and financial results, and could, for example, decrease the assets included in our secured revolving credit facility borrowing base. A future divestiture of one or more of our plants or operations may require a restructuring of operations and could divert management’s attention from other business concerns.
Currency fluctuations may place us at a competitive disadvantage and reduce our revenue.
Our manufacturing costs, profit margins and competitive position may be affected by the strength of the currencies in countries where our products are manufactured relative to the strength of the currencies in the countries where our products are sold. Although we have closed our Montreal facility, we continue to maintain manufacturing operations in Canada which in the past has supplied numerous U.S. customers. For the fiscal year ended December 31, 2006, our Canadian operations accounted for 21% of consolidated net sales. If the Canadian dollar strengthens materially against the U.S. dollar, our Canadian operations could be subject to increased competition from U.S. suppliers, which could reduce our revenue from operations and affect our results of operations and financial position.
Our international operations expose us to various risks that other companies that are not global may not face.
We have manufacturing and/or sales operations in Canada, China, The Netherlands, Portugal and Mexico. In 2006, foreign operations represented 28% of our consolidated net sales (including our operations in Montreal, Quebec, which we closed in December 2006). We are
subject to the risks inherent in conducting business across national boundaries, any one of which could adversely impact our business. In addition to currency fluctuations, these risks include:
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economic downturns;
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changes in or interpretations of local law, governmental policy or regulation, particularly in countries with developing legal systems such as China;
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restrictions on the transfer of funds into or out of the country;
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import and export duties and quotas and other trade barriers;
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domestic and foreign customs and tariffs;
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varying tax systems;
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different regimes controlling the protection of our intellectual property;
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political unrest;
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military outbreaks;
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government instability;
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nationalization of foreign assets; and government protectionism.
We intend to continue to evaluate opportunities to establish new manufacturing and sales operations outside the U.S. One or more of the foregoing factors could impair our current or future international operations and, as a result, harm our overall business.
We, and some of our major customers, have unionized employees and could be adversely affected by labor disputes.
Some of our employees and some employees of our major customers are unionized. At December 31, 2006, approximately 10% of our employees were unionized. Our unionized employees are hourly workers located at our Monterrey, Mexico facility, where technical copper and copper alloy tube and fabricated products are manufactured. The collective bargaining agreement with the employees at our Monterrey, Mexico facility expired on January 31, 2007. On February 1, 2007 the collective bargaining agreement was renewed for one year. Further labor disputes by any of our employees, or our customers’ employees, could again have a significant negative effect on our financial results and operations.
If we are unable to attract and retain key personnel, our ability to operate effectively may be impaired.
Our ability to operate our business and implement strategies depends, in part, on the efforts of our executive officers and other key employees. Our management philosophy of cost-control means that we operate with a limited number of corporate personnel, and our commitment to a less centralized organization also places greater emphasis on the strength of local management. Our future success will depend on, among other factors, our ability to attract and retain qualified personnel. The loss of the services of any of our key employees or the failure to attract or retain other qualified personnel, domestically or abroad, could have a material adverse effect on our business or business prospects.
We could incur significant costs, including remediation costs, as a result of complying with environmental laws.
Our facilities and operations are subject to extensive environmental laws and regulations imposed by federal, state, provincial and local authorities in the U.S., Canada, China, The Netherlands, Portugal and Mexico relating to the protection of the environment and human health and safety, including those governing emissions to air, discharges to waterways and the generation, handling, storage, transportation, treatment and disposal of, and exposure to, hazardous materials. We could incur substantial costs, including cleanup costs, fines or sanctions, and third-party claims for property damage or personal injury, as a result of violations of or liabilities under environmental laws. We have incurred, and in the future may continue to incur, liability under environmental statutes and regulations with respect to the contamination detected at sites owned or operated by us (including contamination caused by prior owners and operators of such sites, abutters or other persons) and the sites at which we disposed hazardous substances. We have established a reserve with respect to certain presently estimated environmental remediation costs. As of December 31, 2006, this reserve is $11.8 million, of which $11.0 million was established for potential environmental remediation costs associated with the closure of our Montreal, Quebec facility. This reserve may not be adequate to cover the ultimate costs of these liabilities (or ones that may be identified in the future) and the discovery of additional contaminants or the imposition of additional cleanup obligations could result in significant costs. In addition, we expect that future regulations and changes in the text or interpretation of existing regulations may subject us to increasingly stringent standards. Compliance with such requirements may make it necessary, at costs which may be substantial, for us to retrofit existing facilities with additional pollution-control equipment, undertake new measures in connection with the storage, transportation, treatment and disposal of by-products and wastes or take other steps.
Our competitive advantage could be reduced if our intellectual property becomes known by our competitors, or if technological changes reduce our customers’ need for our products.
We own a number of trademarks and patents (in the U.S. and other jurisdictions) on our products and related manufacturing processes and we have granted licenses with respect to some of our trademarks and patents. In addition to trademark and patent protection, we rely on trade secrets, proprietary know-how and technological advances that we seek to protect. If our intellectual property is not properly protected or is independently discovered by others or otherwise becomes known, our protection against competitive products could be diminished. Because we compete primarily on the basis of these technical advantages of our commercial products, technical improvements by our competitors could reduce our competitive advantage in these product lines and thereby reduce our unit sales and profits per unit. In addition, the development of new technologies in the air conditioning, refrigeration or other consumer industries, including technologies developed in response to the elimination of CFCs and certain refrigerants, could reduce or eliminate the need for copper and copper alloy based products and thereby reduce our sales volumes and have a negative impact on our operating results.
If our internal computer network and applications suffer disruptions or fail to operate as designed, our operations will be disrupted and our business may be harmed.
We rely on network infrastructure and enterprise applications, and internal technology systems for our operational, marketing support and sales, and product development activities. The hardware and software systems related to such activities are subject to damage from earthquakes, floods, lightning, tornadoes, fire, power loss, telecommunication failures and other similar events. They are also subject to acts such as computer viruses, physical or electronic vandalism or other similar disruptions that could cause system interruptions and loss of critical data, and could prevent us from fulfilling our customers’ orders. We have developed disaster recovery plans and backup systems to reduce the potentially adverse effects of such events, but there are no assurances such plans and systems would be sufficient. Any event that causes failures or interruption in our hardware or software systems could result in disruption of our business operations, have a negative impact on our operating results, and damage our reputation.
Current U.S. military action and any future armed conflict or terrorist activities may cause the economic conditions in the U.S. or abroad to deteriorate, which could harm our business.
Current U.S. military action, future terrorist attacks against U.S. targets, rumors or threats of war, additional conflicts involving the U.S. or its allies or trade disruptions may impact our operations or cause general economic conditions in the U.S. and abroad to deteriorate. A prolonged economic slowdown or recession in the U.S. or in other areas of the world could reduce the demand for our products and, therefore, negatively affect our future sales and profits. Any of these events could have a significant impact on our business, financial condition or results of operations and may result in the volatility of the market price for our common stock and other securities.
We have experienced net losses in recent periods and we may experience net losses in the future.
We have experienced net losses in the past, including a net loss of approximately $79.2 million in 2006 and approximately $38.6 million in 2005. Competitive price pressure, cyclical demand for our products and an economic downturn in the industries we serve, among other factors, can have a material adverse effect on the prices we receive for our products, unit sales volumes and gross profit. These factors may in turn reduce our Company’s cash flow and operating results in future periods. If we are unable to generate positive cash flow in the future, we may not be able to make payments on our debt obligations.
Our decision to close two of our manufacturing plants will result in certain charges and may cause disruption.
In December 2006, we closed our manufacturing facilities located in Jackson, Tennessee and Montreal, Quebec and relocated our U.S. wholesale distribution facility to our Decatur, Alabama plant site. We estimate that we will incur a total of approximately $38.5 million in closure expenses. We also recorded a non-cash pre-tax impairment charge of $29.6 million during the third quarter of 2006 to write down the carrying amounts of assets to be sold at fair value. The actual sale price of the plants’ assets that are not redeployed for use at other locations may vary from our estimates and could cause this charge to differ. In addition, we could experience disruption in our operations as part of the transfer of assets that can be redeployed at other locations.
Our stock price may be volatile.
The market price of our common stock could be subject to significant fluctuations. Among the factors that could affect our stock price are:
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quarterly variations in our operating results;
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our ability to meet our liquidity needs;
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changes in revenue or earnings estimates or publication of research reports by analysts;
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failure to meet analysts’ or our own revenue or earnings estimates;
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speculation in the press or investment community;
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strategic actions by us or our competitors, such as acquisitions or restructurings;
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the impact of the risks discussed herein and our ability to react effectively to those risks;
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limited trading volume of our common stock;
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a change in technology that may add to manufacturing costs;
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actions by institutional stockholders;
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general market conditions; and
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domestic and international economic factors unrelated to our performance.
The stock markets in general have experienced extreme volatility that has often been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the trading price of our common stock.
Limited trading volume of our common stock may contribute to its price volatility.
Our common stock may be quoted on the OTC Bulletin Board and Pink Sheets. Prior to January 4, 2007, our common stock was traded on the New York Stock Exchange. During the year ended December 31, 2006, the average daily trading volume of our common stock as reported by Bloomberg L.P. was approximately 61,141 shares. From January 4, 2007 through March 5, the average daily trading volume of our common stock as reported by Bloomberg L.P. was approximately 373,500 shares. It is uncertain whether a more active trading market in our common stock will develop or if we will be re-listed on the New York Stock Exchange or any other securities exchange. Also, many investment banks no longer find it profitable to provide securities research on small-cap and mid-cap companies. Further, many investment banks do not encourage trading on the OTC Bulletin Board. If analysts were to discontinue coverage of our common stock, our trading volume may be further reduced. As a result, relatively small trades may have a significant impact on the market price of our common stock, which could increase the volatility and depress the price of our stock. We cannot assure you that will be able to sell such common stock at a particular time or that the prices that you receive when you sell will be favorable.
Future issuances of our equity securities, or sales of our securities by stockholders in the public market, may cause the price of our common stock to decline or impair our ability to raise capital in the equity markets.
In the future, we may issue additional shares of our common stock in public or private offerings, perhaps in significant quantities, including pursuant to the proposed rights offering. Also, shares of our common stock are available for future sales pursuant to stock options and/or restricted stock that we have granted to certain employees and directors, and in the future we may grant additional stock options and/or restricted stock to our employees and directors. Our new preferred stock investors currently own 50,000 shares of our Series A Convertible Preferred Stock, which is convertible into common stock, and which we have agreed to register for resale under the relevant securities laws. We may issue significantly more shares to these investors in connection with the recapitalization plan.
The sale of a substantial amount of shares by these investors, or the sale of substantial amounts of common stock by other stockholders, could significantly affect the market prices for shares of our common stock and ultimately could impair our ability to raise capital through future offerings.
Our new preferred stock investors have the ability to exert significant influence over our affairs and may have interests that differ from those of our other stockholders.
Our new investors, who hold shares of Series A Convertible Preferred Stock issued in connection with our recapitalization plan, vote with the holders of our common stock on an as-converted basis on all matters. Although the preferred stock investors currently hold shares representing approximately 75% of the total actual voting power of all our voting securities on an as-converted basis, their voting power is limited to 49% of the total voting power while any of our 10.5% Senior Notes remain outstanding. However, during this period the preferred stock investors have a contractual right to designate a majority of our board of directors. With their majority representation on our board of directors and through their voting power, these investors have the ability to exert significant control over our business, policies and affairs, and to substantially influence the outcome of any action requiring stockholder approval, including amendments to our charter or bylaws, mergers or sales of substantially all of our assets, or other extraordinary transactions. The interests of these investors with respect to such matters may differ from the interests of our other stockholders.
Provisions in our charter documents, Delaware law and in other agreements, coupled with the preferred stock investors’ ownership of a significant amount of our voting power, may delay or prevent an acquisition of Wolverine that some stockholders may consider attractive.
Our certificate of incorporation and bylaws and Delaware law contain provisions that could make it more difficult for a third party to acquire us without the consent of our board of directors. These provisions include a classified board of directors, removal of directors only for cause, and the inability of stockholders to act by written consent or to call special meetings. Delaware law also imposes some restrictions on mergers and other business combinations between us and any holder of 15% or more of our outstanding common stock. Although we believe these provisions provide for an opportunity to receive a higher bid by requiring potential acquirers to negotiate with our board of directors, these provisions apply even if the offer may be
considered beneficial by some stockholders. In addition, the preferred stock investors’ ownership of a significant amount of our voting power and their majority representation on our board of directors provide them with substantial influence over the transfer of control of Wolverine to any third party. It is possible that these investors may not pursue transactions that some stockholders consider attractive, or may pursue transactions that may not result in a premium upon a change of control.
In addition, under the indenture governing our 10.5% Senior Notes, in the event a change in control occurs, we may be required to repurchase all of our outstanding 10.5% Senior Notes at 101% of their original aggregate principal amount plus accrued interest. A change in control, without an appropriate waiver or amendment, would also result in an event of default or amortization event under our liquidity facilities.
We will not pay any dividends on our common stock in the foreseeable future.
We do not anticipate that we will pay any dividends on our common stock in the foreseeable future. We intend to retain any future earnings to fund operations, debt service requirements and other corporate needs, and to fund required dividend payments on our Series A Convertible Preferred Stock. The terms of our Series A Convertible Preferred Stock prohibit us from paying cash dividends on our common stock while such preferred stock is outstanding. In addition, our current liquidity facilities and our 10.5% Senior Note indenture limit our ability to declare and pay dividends on our capital stock.
Item 1B.
Item 1B. Unresolved Staff Comments
We have no unreported written comments from the SEC staff that have been outstanding for more than 180 days at December 31, 2006.
Item 2.
Item 2. Properties
We have a total of approximately two million square feet of manufacturing capacity at facilities located in the United States, Canada, Mexico, Portugal, and China. Our corporate headquarters is located in Huntsville, Alabama. We maintain various warehouse operations in the United States and Canada, as well as warehouse and office space in Apeldorn, The Netherlands. Listed below are our manufacturing facilities:
Domestic Facilities
International Facilities
We lease a 45,000 square foot warehouse in London, Ontario to service the wholesale products market in Canada employing one employee. We also lease a facility in Apeldorn, The Netherlands, comprised of a 20,000 square foot warehouse and 4,000 square feet of office space. There were 7 employees at the Apeldorn facility at December 31, 2006.
We believe that our facilities are adequate for our current and reasonably anticipated future needs.
Item 3.
Item 3. Legal Proceedings
Our facilities and operations are subject to extensive environmental laws and regulations, and we are currently involved in various proceedings relating to environmental matters as described under Note 15, Environmental Remediation, of the Notes to Consolidated Financial Statements and incorporated herein by reference. We are not involved in any other legal proceedings that we believe could have a material adverse effect upon our business, operating results or financial condition.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth quarter of 2006.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
During 2006 our common stock was traded on the New York Stock Exchange under the symbol “WLV.” On December 26, 2006, we were advised by the New York Stock Exchange, Inc. (NYSE) that our common stock would be suspended from trading on the NYSE prior to the opening on January 3, 2007, and the suspension actually took effect on January 4, 2007. The NYSE advised us that its decision to suspend trading and initiate delisting procedures was a result of our Company not meeting the NYSE’s continued listing standard regarding average global market capitalization over a consecutive 30 trading-day period of at least $25 million, which is a minimum threshold under Section 802.01B of the NYSE Listed Company Manual for continued listing.
Our common stock may be quoted on the OTC Bulletin Board and Pink Sheets. On March 7, 2007, the NYSE filed a Form 25 to remove our common stock from listing and registration on the NYSE effective March 19, 2007. Our new ticker symbol is “WLVT.” Stock trading is currently being provided through Pink Sheets LLC, the leading provider of pricing and financial information for the over-the-counter (OTC) securities markets.
As of March 9, 2007, there were 15,089,934 shares of common stock outstanding, held by 241 stockholders of record.
The following table sets forth, for the periods indicated, the range of high and low reported sale prices for our common stock on the New York Stock Exchange:
We did not declare or pay cash dividends on our common stock during the years ended December 31, 2006, 2005 or 2004. We do not currently plan to pay cash dividends on our common stock. In the foreseeable future, any future determination to pay cash dividends will depend on our results of operations, financial condition, contractual restrictions and other factors deemed relevant by the Board of Directors. We intend to retain earnings to support the growth of our business. The agreement governing our secured revolving credit facility generally prohibits the payment of cash dividends on our common stock. In addition, the terms of our Series A Convertible Preferred Stock prohibit us from paying cash dividends on our common stock while such preferred stock is outstanding. The indenture governing our 10.5% Senior Notes limits our ability to pay cash dividends on the common stock unless certain financial and other tests are met.
For many years, we have maintained a 401(k) plan through which employees may invest in our common stock and other investment choices. We have a registration statement on Form S-8 in effect that registered 50,000 shares of our common stock for this 401(k) plan. Current investments in our common stock exceed the 50,000 shares registered. Effective May 1, 2006, participants in the 401(k) plan may not make any new or additional investments in our common stock, but continue to have other investment options. Because certain participants in the 401(k) plan purchased unregistered shares of our common stock, they may have the right to rescind their purchases or recover damages if they no longer own the shares, subject to the applicable one year statute of limitations under securities laws. Due to the limited number of participants holding the shares and the small number of unregistered shares sold, we do not believe that any potential liability would be material.
Item 6.
Item 6. Selected Financial Data
The historical consolidated financial data presented below should be read in conjunction with the information set forth under Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations and our Consolidated Financial Statements.
The balance sheet data presented below as of December 31, 2006 and 2005 and the statement of operations data presented below for each of the years in the three-year period ended December 31, 2006, are derived from our audited Consolidated Financial Statements. The other balance sheet and statement of operations data presented below are derived from our previously audited Consolidated Financial Statements for the years ended December 31, 2004, 2003 and 2002, which are not presented herein.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is designed to provide readers of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. Our MD&A is presented in eleven sections:
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Business Overview
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Recapitalization Plan
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Strategic Initiatives
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Results of Continuing Operations
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Liquidity and Capital Resources
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Off-Balance Sheet Arrangements
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Contractual Obligations and Commercial Commitments
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Financing Arrangements
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Market Risks
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Environmental Matters
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Critical Accounting Policies
Our MD&A should be read in conjunction with the Consolidated Financial Statements and related Notes beginning on page 72.
Business Overview
Wolverine Tube, Inc. is a world-class quality manufacturer of copper and copper alloy tube, fabricated products, and metal joining products. We currently operate our 11 facilities in the United States, Mexico, Canada, China and Portugal. We also have a distribution operation in The Netherlands. Our focus is on custom-engineered, higher value-added tubular products, including fabricated copper components and metal joining products, which enhance performance and energy efficiency in many applications, including: commercial and residential heating, ventilation and air conditioning, refrigeration, home appliances, industrial equipment, power generation, petrochemicals and chemical processing.
Effective January 23, 2006, the U.S. government mandated an increase in the Seasonal Energy Efficiency Ratio (SEER). This new minimum standard is 13 SEER, which is a 30% improvement in energy efficiency from the previous minimum standard rating of 10 SEER. The new standard increased demand for our industrial tube, fabricated product and metal joining product businesses in 2006.
Our wholesale products segment was negatively affected by the continued high and erratic price of copper. Shipments increased in the second quarter of 2006 as compared with 2005, reflecting the increased global customer demand caused by shortages in worldwide supply. Pricing of our wholesale products during the year, but most especially in the second quarter, benefited from the supply and demand imbalance.
Restructuring expenses in 2006 were $57.6 million related to the closing of our Jackson, Tennessee and Montreal, Quebec manufacturing facilities and the relocation of our Tanner, Alabama warehouse into the Decatur, Alabama plant. This restructuring was necessary to eliminate underperforming and unprofitable businesses. We also incurred financial and legal advisory fees of $7.4 million related to the restructuring of our balance sheet.
We have a significant amount of net operating loss carryforwards associated with our North American operations. These net operating loss carryforwards expire at various times beginning in 2007 through 2026. During 2006, we increased the valuation allowance for U.S. and foreign deferred tax assets from $20.0 million to $56.3 million because it was determined that it was more likely than not that some of these deferred tax assets, including those related to U.S. and foreign net operating loss carryforwards, would not be realized.
Recapitalization Plan
On February 1, 2007 we announced entry into a recapitalization plan to strengthen our balance sheet, reduce financing costs and enhance our overall capital structure. An investor group comprised of Plainfield Special Situations Master Fund Limited, a fund managed by Plainfield Asset Management LLC (Plainfield), and The Alpine Group, Inc. (Alpine) agreed to ultimately invest up to $75 million in our Company through purchasing new convertible preferred equity and providing a standby commitment to a common stock rights offering, which will be available to all of our common stockholders. This recapitalization plan will provide a minimum of $75 million and could reach as much as approximately $135 million of equity proceeds. We also announced that we will initiate an exchange offer to exchange and modify the terms of our existing debt.
Under the terms of the definitive investment agreement among the parties (the “Agreement”), Plainfield and Alpine invested $50 million in cash in our Company on February 16, 2007 in exchange for 50,000 newly issued shares of Series A Convertible Preferred Stock. The Series A Preferred Stock has an annual dividend rate of 8.0%, payable quarterly. Each share of Series A Preferred Stock will be convertible, at the option of the holders, into a number of shares of our common stock equal to $1,000 divided by the conversion price, which will initially be $1.10 per share, subject to customary anti-dilution adjustments (the “Conversion Price”). We may defer payment of the dividend in certain circumstances. Any deferred dividend will accrue at a rate of 10% per annum if the dividend payment date is prior to January 31, 2012 and at a rate of 12% if the payment date is on or after January 31, 2012. The Series A Preferred Stock will vote with the common stock on an as-converted basis on all matters. However, while our 10.5% Senior Notes remain outstanding, the holders of the Series A Preferred Stock will not be entitled to vote common stock or preferred stock in excess of 49% of the voting power of the total voting securities of our Company. The Series A Preferred Stock is mandatorily redeemable at par plus any accrued and unpaid dividends on January 31, 2017 and upon the occurrence of certain change of control transactions. Our Company may redeem all, but not less than all, of the Series
A Preferred Stock at our option, at par plus accrued and unpaid dividends, after January 31, 2014, if certain conditions have been satisfied.
We also plan to raise up to an additional $51.1 million through an equity rights offering to our common stockholders at the Offer Price. Pursuant to the rights offering, our existing stockholders will receive, pro rata in proportion to the number of shares of common stock owned by them, rights to purchase, in the aggregate, up to $51.1 million of common stock to be issued at a price per share equal to the Conversion Price of the new Series A Preferred Stock. Plainfield and Alpine will provide a standby commitment of up to $25 million in cash for the rights offering by agreeing to purchase additional shares of Series A Preferred Stock to the extent that proceeds from the rights offering are less than $25 million. If the participation of our stockholders in the rights offering would cause Plainfield and Alpine to own less than 55% of our Company on a fully diluted, as-converted basis, Plainfield and Alpine have an option to purchase additional shares of Series A Preferred Stock at the Offer Price to bring their collective ownership to 55% on a fully diluted, as-converted basis. Stockholder approval of a charter amendment to increase the number of authorized shares of common stock is necessary in order to conduct the rights offering, and the additional investment by Plainfield and Alpine is dependent on the consummation of the rights offering.
We have agreed to file a shelf registration statement registering the resale of the Series A Preferred Stock and the common stock into which the Series A Preferred Stock is convertible and to grant one “demand” registration right and unlimited “piggyback” registration rights to the holders of such shares.
Additionally, the Agreement provides that we will conduct an exchange offer with respect to our 7.375% Senior Notes. In this exchange offer, we will offer to issue $1,000 principal amount of senior notes similar to our existing 10.5% Senior Notes, but with less restrictive covenants, in exchange for each $1,000 principal amount of our 7.375% Senior Notes validly tendered. Plainfield and Alpine have agreed to cause to be tendered at least $25 million of 7.375% Senior Notes into the exchange offer. We will also seek consents to amend the Indenture under which the 7.375% Senior Notes were issued to remove substantially all of the restrictive covenants contained therein.
The net proceeds from the initial $50 million sale of Series A Preferred Stock to Plainfield and Alpine have been used to repay amounts under our liquidity facilities and for working capital. Additional proceeds will be utilized for general corporate purposes, including debt repayment, capital expenditures, and working capital.
Following the closing of the initial $50 million sale of Series A Preferred Stock, our Board of Directors was reconstituted to consist of seven directors: three continuing directors, John L. Duncan, David M. Gilchrist, Jr. and William C. Griffiths; and four new directors designated by Plainfield and Alpine, Steven S. Elbaum, Alan Kestenbaum, K. Mitchell Posner and Brett Young. Johann R. Manning, Jr. resigned from his position as Chief Executive Officer effective February 16, 2007, and Harold M. Karp, Senior Vice President of Alpine, became President and Chief Operating Officer of the Company on that date. In addition, Mr. Elbaum, Chairman and Chief Executive Officer of Alpine, became Chairman of our Company on February 16, 2007. We have also entered into a two-year Management Agreement with Alpine
under which Alpine will provide us with certain services in exchange for a $1.25 million annual fee and reimbursement of expenses.
In connection with the proposed rights offering, exchange offer and resale transactions described in this section, Wolverine will file with the SEC one or more registration statements, and/or amendments thereto, each of which will include a prospectus related to the applicable transaction. The discussion in this section does not constitute an offer of any securities for sale; no securities may be sold nor may offers to buy be accepted prior to the time the relevant registration statement (containing the applicable prospectus) becomes effective. Investors and security holders are urged to read the relevant prospectus regarding the applicable proposed transaction when it becomes available because it will contain important information. You may obtain a free copy of the relevant registration statement and prospectus (when available) and other related documents filed by Wolverine with the SEC at the SEC’s website at www.sec.gov. The relevant registration statement and prospectus (when it is available) and the other documents may also be obtained for free by accessing Wolverine’s website at www.wlv.com under the “Investor Relations” link and then under the heading “SEC Filings.”
In addition, on November 1, 2006, we announced that, in connection with our discussions with representatives of our senior noteholders and other groups as to the most appropriate transaction, if any, to reduce debt and maintain value for our shareholders in light of upcoming maturities of our liquidity facilities and senior notes and our other liquidity needs, we had filed a registration statement with the SEC for an exchange offer and consent solicitation to exchange newly issued equity and a new issue of secured notes for our outstanding senior notes. This registration statement also included solicitation for a prepackaged plan of reorganization of Wolverine and certain of its subsidiaries under chapter 11 of the Bankruptcy Code. In view of the above-described recapitalization plan that we subsequently implemented and the transactions that we have entered into with Alpine and Plainfield in connection with this recapitalization plan, we are no longer pursuing the exchange offer and consent solicitation or the prepackaged plan of reorganization that were described in the November registration statement.
Strategic Initiatives
Our vision is to be the leading innovator and global partner for our markets and customers by providing unequaled value in all of our products and services. Our business strategy, called “Path to Profitability,” includes eight business initiatives (discussed below) designed to satisfy our customers’ needs while maximizing overall profitability.
Customers First
Our customers are at the core of all of our business strategies. We are committed to providing them with significant competitive advantages. We have maintained long-term relationships with many of our customers and we have a diverse customer base. We understand our customers’ business and support their success with a broad product line, global presence, new technology, and quality products designed with their applications in mind. Customer focus has been, and will continue to be, a growth driver for us.
Path to Profitability
In 2006 we implemented the following eight key strategies to improve our profitability:
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First, we increased our liquidity and cash flow by significantly improving our inventory turns from 9 to 11 by reducing inventory on hand and decreasing our receivables days sales outstanding by 10 days by reducing payment terms.
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Second, with the assistance of outside consultants we began to analyze our business operations and developed strategies for pricing, cost reductions, increased productivity, and improved flexibility in our operations.
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Third, we addressed the globalization of our business and rationalized our existing manufacturing facilities by closing two underperforming manufacturing facilities.
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Fourth, we focused on increasing productivity and output through lean manufacturing initiatives.
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Fifth, we embarked on a plan to restructure our balance sheet which resulted in the recapitalization plan previously described.
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Sixth, we continued to capitalize on our customers’ outsourcing initiatives by providing expanded services and products.
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Seventh, we stepped up quality and yield initiatives with our Six Sigma initiatives.
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And finally, we expanded our value added strategic sourcing opportunities by extending our value added strategic sourcing contract with our supplier in China.
Profitably Grow Our Company
Increasing profitability and cash flow remains our primary focus for 2007. We have set several priorities for fiscal 2007 that support our transformation including:
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Finalizing our recapitalization.
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Continuing to grow through customers’ outsourcing and value added strategic sourcing opportunities.
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Further building our capabilities in lean manufacturing, quality and yield.
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Driving productivity improvements.
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Providing complete solutions to customers through our research and product development.
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Pursuing international growth opportunities by leveraging our investments and business alliances in Mexico, China, and other foreign locations.
Results of Continuing Operations
Executive Summary
Year-Ended December 31, 2006, Compared with Year-Ended December 31, 2005
The following table presents a comparison of total pounds shipped by business segment for the past two years:
The increase in pounds shipped in the commercial products segment was due primarily to demand in industrial tube reflecting the transition to production of 13 SEER air conditioning units and increases in our value added strategic sourcing program. Annual shipments of wholesale products were negatively affected by the continued high and erratic price of copper. Wholesale shipments increased in the second quarter of 2006 as compared with 2005, reflecting the increased global customer demand caused by shortages in worldwide supply. With the exception of the second quarter, wholesale shipments in all other quarters in 2006 were less than the same periods in 2005. Pounds shipped in the rod, bar and other products segment decreased due to competitive forces, lower demand and the closing of our Montreal facility.
The following table presents a comparison of net sales by business segments:
Overall, the increase in net sales was the result of the rise in the average COMEX price of copper increasing to $3.09 per pound in 2006 from $1.68 per pound in 2005. Average annual unit fabrication revenues (net sales less the cost of metal) increased $0.10 per pound to $1.13 per pound in 2006, versus $1.03 per pound in 2005, primarily reflecting price increases in our wholesale products segment during the second and third quarters and the impact of our Chinese value added strategic sourcing program.
Commercial product sales increased to $4.08 per pound in 2006 versus $2.89 per pound in 2005, a 41.2% increase. The improvement is due to the sharp rise in copper prices year over year. Wholesale product sales increased to $3.93 per pound in 2006 versus $2.21 in 2005, a 77.8% increase. This increase reflects the rising COMEX price of copper and the impact of higher selling prices due to favorable market conditions primarily in the second and third quarters. Net sales for rod, bar and other products increased to $3.36 per pound as compared with $2.18 per pound, also reflecting the increase in copper prices.
The following table presents a comparison of gross profit by business segment:
NM - Not meaningful
The increase in gross profit for our commercial products is attributable to increased volume, a richer mix of products sold, and a $0.03 reduction in the cost of manufacturing per pound on products produced internally. The increase in gross profit for our wholesale products was largely due to increases in pricing in the second and third quarters of 2006, offset in part by a slight increase in the cost of manufacturing per pound mostly due to lower volume. Rod, bar and other products gross profit declined primarily due to poor manufacturing performance in Montreal leading to the closure thereof in December 2006. This decline in rod and bar profitability was partly offset by improved performance in our Apeldorn trading company.
Our selling, general & administrative (SG&A) expenses decreased to $31.1 million in 2006 as compared with $37.0 million in 2005. The decrease was primarily due to reductions in compensation expenses from our salary restructuring program initiated in the fourth quarter of 2005 totaling $1.7 million and post retirement related expense savings in the amount of $2.2 million resulting from the freezing and termination of certain retirement programs initiated and recorded in 2005. We recorded a non-recurring curtailment charge of $3.6 million associated with the freezing and termination of those plans in 2005. Professional fees, primarily audit fees, were reduced by $0.6 million by bringing in house the majority of our internal audit program and from reduced compliance expenses of the Sarbanes-Oxley Act of 2002, Section 404 compliance. Depreciation was also reduced by $0.3 million. These savings were partly offset by increased performance-based bonus compensation accruals in the amount of $2.5 million recorded in 2006 over the amount accrued in 2005.
Restructuring expenses in 2006 were $57.6 million and were related to the closing of our Jackson, Tennessee and Montreal, Quebec manufacturing facilities and the relocation of our Tanner, Alabama warehouse into the Decatur, Alabama plant (see Note 23, Restructuring and Other Charges, of the Notes to Consolidated Financial Statements). We also incurred financial and legal advisory fees of $7.4 million related to the restructuring of our balance sheet. The restructuring expenses of $1.4 million in 2005 were for severance and benefit charges related to a reduction in workforce at our corporate headquarters and for the elimination of certain support functions in our U.S. manufacturing operations, expenses and a valuation write-down associated with the sale of our corporate aircraft, and credits associated with the Booneville, Mississippi facility closure.
The loss from operations was $79.2 million for 2006 as compared with a loss from operations of $38.6 million for 2005.
Net interest expense increased approximately $4.8 million to $25.6 million in 2006 from $20.7 million in 2005 as a result of greater utilization of our liquidity facilities in 2006 versus 2005. Significant increases in copper prices placed an unprecedented demand on our working capital. Higher interest rates on our liquidity facilities and interest rate swap also contributed to
higher interest expense. We terminated our swap agreement on August 25, 2006 and incurred a swap termination fee that is being amortized over the remaining life of the applicable bond issue.
A net tax expense of $9.4 million was recorded in 2006 as compared with a net tax benefit of $1.8 million in 2005. The effective tax expense rate in 2006 was 13.4% as compared with an effective tax benefit rate of 4.4% in 2005. The 2006 and 2005 tax benefits were reduced by non-cash charges of $35.8 million and $12.6 million, respectively, which were recorded to establish valuation allowances for our U.S. and Canadian deferred tax assets.
The net loss in 2006 was $79.2 million, or $5.26 per basic share, compared with a net loss of $38.6 million, or $2.57 per basic share in 2005.
Year-Ended December 31, 2005, Compared with Year-Ended December 31, 2004
The following table presents a comparison of total pounds shipped by business segment:
The decrease in pounds shipped in the commercial products segment was due primarily to demand weakness in industrial tube reflecting the continued uncertainty by customers surrounding the transition to production of 13 SEER air conditioning units. Shipments of wholesale products throughout the first half of 2005 were negatively affected by the continued high and erratic price of copper.
Shipments began to increase late in the third quarter reflecting the increased customer demand caused by rebuilding in the aftermath of several major hurricanes. Pounds shipped in the rod, bar and other products segment decreased due to the organized work slowdown by unionized employees and strikes at our Montreal, Quebec facility during 2005.
The following table presents a comparison of net sales by business segment:
Overall, the increase in net sales was the result of the rise in the average COMEX price of copper increasing to $1.68 per pound in 2005 from $1.29 per pound in 2004. Average unit fabrication revenues (sales less cost of metal) decreased two cents per pound to $1.03 per pound in 2005, versus $1.05 per pound in 2004, primarily reflecting price erosion in our wholesale products segment and the impact of our Chinese value added strategic sourcing program implemented in 2005.
Commercial product sales increased $0.36 per pound, to $2.89 per pound in 2005 versus $2.53 per pound in 2004, a 14.2% increase. The majority of the improvement is due to the sharp rise in copper prices year over year partly offset by lower volumes. Fabrication revenue per pound for the commercial product segment decreased 1% in 2005 to $1.24 per pound from $1.25 per pound in 2004. Wholesale product sales increased $0.35 per pound to $2.21 per pound in 2005 versus $1.86 in 2004, an 18.8% increase. This increase reflects the rising COMEX price of copper on flat volume, partly offset by lower fabrication revenue. Fabrication revenue per pound for the wholesale products segment decreased 8.6% in 2005 to $0.53 per pound, from $0.58 per pound in 2004. Rod, bar and other product sales decreased to $59.0 million, or 4.8% from 2004, primarily reflecting reduced volumes related to our Montreal labor issues, offset by the increase in copper prices. On a per unit basis, net sales for rod and bar products increased 23.2% in 2005 over 2004 to $2.18 per pound, reflecting the increase in copper prices. Fabrication revenue increased to $0.96 per pound in 2005 from $0.87 per pound in 2004, a 10.3% increase principally due to price increases from the exit of a competitor in this product segment.
The following table presents a comparison of gross profit by business segment for past two years
The decrease in gross profit is mainly attributable to reduced production volumes resulting in the under-absorption of fixed costs during 2005 given the fixed cost nature of our business. In addition, gross margins were impacted by $9.1 million in pre-tax hedge and metal valuation expenses (including backwardation losses and increased premiums over COMEX) versus $2.3 million in 2004. Significant increases in energy costs, including natural gas, also had a negative effect on gross profit, combined with weak pricing in the wholesale product segment. The strike at our Montreal, Quebec facility, along with the impact of the pre- and post-strike effects, and the year-over-year translation impact of the Canadian dollar versus the U.S. dollar also negatively affected gross profit in 2005. For 2005, the percentage of sales made by our Canadian facilities denominated in U.S. dollars was approximately 48% versus 51% in 2004.
Selling, general and administrative (SG&A) expenses were $37.1 million for 2005 versus $37.3 million for 2004, a decrease of $0.2 million, or 0.5%. The decrease in SG&A expense for 2005 as compared with 2004 is mostly the result of a decrease in compensation expense related to reduced incentive accruals in 2005 and benefits achieved from reductions related to the September 2005 workforce reduction. These gains were mostly offset by increased pension curtailment expenses and accelerated vesting of certain restricted shares of $3.6 million.
Restructuring expenses in 2005 were $1.4 million, as compared with $2.5 million in 2004. The restructuring expenses incurred in 2005 were for severance and benefit charges related to a reduction in workforce at our Company’s corporate headquarters’ and for the elimination of certain support functions in its U.S. manufacturing operations, expenses and a valuation write-down associated with the sale of our corporate aircraft, and credits associated with the Booneville, Mississippi facility closure.
The operating loss from continuing operations was $16.8 million for the year ended December 31, 2005, as compared with an operating income from continuing operations of $23.9 million for the year ended December 31, 2004.
Net interest expense decreased $0.2 million to $20.7 million in 2005 from $20.9 million in 2004 as a result of interest expense reductions from the repurchase of $18.6 million of our
10.5% Senior Notes in the second and third quarters of 2004 and increased interest income. This was offset in 2005 by increased interest expense and fees due to a greater utilization of our liquidity facilities in 2005 versus 2004, along with the impact of higher interest rates on our liquidity facilities and interest rate swap.
In 2004, our Company incurred charges of $3.0 million ($2.0 million net of tax), associated with a loss on the extinguishment of debt, related to the repurchase of $18.6 million of our 10.5% Senior Notes. Amortization and other, net was $2.8 million of expense in 2005, as compared with $1.3 million of expense in 2004 primarily due to the loss in the 4th quarter of 2005 on the sale of the Jackson, Tennessee facility. Amortization and other, net in 2005 also included $0.5 million of foreign currency gains.
A net tax benefit of $1.8 million was recorded in 2005 as compared with a net tax benefit of $1.9 million in 2004. The effective tax benefit rate in 2005 was 4.4%. The 2005 effective tax benefit rate was reduced by a $12.6 million non-cash charge recorded to establish a valuation allowance for its U.S. deferred tax assets. A $1.9 million tax benefit was recorded in 2004 on pre-tax losses from continuing operations of $1.2 million. The high effective tax benefit rate recorded in 2004 reflects federal tax benefits generated in the United States, where tax rates are generally higher than in our foreign jurisdictions and where we had significant pre-tax losses. The higher effective rate on adjusted pre-tax losses also reflects lower foreign tax rates and tax holidays applicable to our profitable operations in China, Portugal and Canada.
The consolidated loss from continuing operations in 2005 was $38.6 million, or $2.57 per diluted share, compared with income from continuing operations of $0.6 million, or $0.05 per diluted share, in 2004.
Liquidity and Capital Resources
The following table presents selected information concerning our financial condition:
Overview and Outlook
Record levels of copper prices severely burdened our business by impeding our ability to generate sufficient unrestricted cash flow from operations to satisfy our working capital needs, interest payment obligations, capital expenditures and other cash requirements. We accessed amounts under our receivables sale facility and our secured revolving credit facility during the year in order to fund these requirements.
On February 1, 2006, Standard and Poor’s Ratings Services (S&P) lowered its rating on our senior notes to CCC from CCC+, with an outlook of negative. On April 27, 2006, Moody’s
Investors Service (Moody’s) lowered its rating on our senior notes to Caa2 from Caa1 and the corporate family rating to Caa1 from B3 with an outlook of negative. On November 1, 2006, S&P once again lowered its rating on our senior notes to C from CCC with a continued outlook of negative. S&P also lowered our corporate rating to CC from CCC+ with a continued negative outlook. And finally, on November 2, 2006, Moody’s lowered its rating on our senior notes from Caa2 to Caa3. Moody’s also lowered our corporate family rating from Caa1 to Caa2. Both Moody’s and S&P’s expectations are that higher copper prices, operating losses and the negative impacts of a potential prepackaged bankruptcy would result in a continued drain of our liquidity position.
Working with our commercial banks we amended our receivables sale facility during 2006 to increase the maximum amount available under the facility to $90 million. As of February 23, 2007, we paid down the entire balance on our receivables sale facility, totaling $47.5 million, using the proceeds from the initial sale of $50 million of our Series A Preferred Stock pursuant to our recapitalization plan described in Recapitalization Plan above. Under our secured revolving credit facility, at February 23, 2007 we had $23.3 million in letters of credit and no revolving loans outstanding, leaving approximately $5.0 million in additional borrowing availability as of that date. We believe that the availability under these facilities, combined with unrestricted cash on hand in North America, and the capital infusions we have received and plan to receive in connection with the execution of our recapitalization plan, should provide the liquidity required in 2007 to support our operations and continue our strategic initiatives.
Sources of Liquidity
Our principal sources of liquidity are cash and cash equivalents, cash provided by operations, amounts available under our liquidity facilities and, in 2007, cash proceeds from the sale of equity in connection with our recapitalization plan outlined in Recapitalization Plan above. We believe funds generated from these sources will be adequate to finance anticipated business plans and strategic initiatives.
Cash and cash equivalents. We ended 2006 with $23.7 million of cash and cash equivalents, a decrease from $27.3 million at the end of 2005, of which $14.4 million and $15.9 million, respectively, were held by subsidiaries located outside of the U.S. On February 28, 2005, our Company repatriated approximately $10.2 million in previously unremitted earnings from our Chinese subsidiary. These funds had historically been considered as being “indefinitely invested,” and thus unavailable for use in the U.S. The repatriation of these funds was mostly used to reduce amounts outstanding under our secured revolving credit facility.
Our liquidity is affected by restricted cash balances which are included in other current assets and are not available for general corporate use, which totaled $6.0 million at December 31, 2006 and $6.6 million as of December 31, 2005. Restricted cash at December 31, 2006 included $3.6 million related to deposits for margin calls on our metal and natural gas hedge programs, $1.3 million as collateral to secure our travel and purchase credit card programs, $0.4 million to secure a letter of credit for a loan made by the Portuguese government, $0.4 million as a deposit for the Monterrey, Mexico facility lease, $0.3 million in escrow related to the sale of our former Roxboro, North Carolina facility, and $4 thousand to secure a letter of credit for the Canadian Customs Bureau. Restricted cash at December 31, 2005 included $2.4 million related to deposits
for margin calls on our metal and natural gas hedge programs, a $1.4 million deposit related to our silver consignment facility, $1.2 million as collateral to secure our former travel and purchase credit card programs, $0.7 million to secure a letter of credit for a loan made by the Portuguese government, $0.4 million as a deposit for the Monterrey, Mexico facility lease, $0.3 million in escrow related to the sale of our former Roxboro, North Carolina facility, and $0.2 to secure a letter of credit for the Canadian Customs Bureau.
Cash provided by operations. Cash provided by operations in 2006 was $1.9 million as compared with cash used by operating activities in 2005 of $4.9 million and $8.6 million for 2004.
Amounts available under liquidity facilities. Our receivables sale facility and secured revolving credit facility, as well as a credit facility in The Netherlands, are available for working capital needs. Our ability to access these liquidity facilities depends on the amount of available borrowing base or eligible receivables, less any required reserves or holdbacks, and is subject to our compliance with the terms and conditions of the facility agreements, including financial covenants. At the end of fiscal 2006, we were in compliance with all such covenants. In the event we were to default on any of our other debt, it may constitute a default under our liquidity facilities as well. The terms of the agreements governing these liquidity facilities are described in more detail in Note 10, Financing Arrangements and Debt, and Note 11, Receivables Sale Facility, of the Notes to the Consolidated Financial Statements.
Borrowings under our secured revolving credit facility. We had borrowings of $2.0 million under our secured revolving credit facility at December 31, 2006. We also had approximately $6.8 million of standby letters of credit outstanding at December 31, 2006. After taking into account an additional $3.2 million of reserves and other holdbacks we had $19.5 million in additional borrowing availability under our secured revolving credit facility as of that date. As of December 31, 2005, we had no outstanding borrowings under our secured revolving credit facility, approximately $12.5 million of standby letters of credit outstanding, and approximately $11.9 million in additional borrowing capacity available thereunder. Borrowing capacity available as of December 31, 2005 reflects a reduction in the available amount for the value of the interest rate swap outstanding of $1.8 million.
Cash from our receivables sale facility. The amount of cash available to us under our receivables sale facility is based upon the amount of eligible receivables and certain reserves required by the facility. Accordingly, availability may fluctuate over time, but in no case will it exceed the facility’s $90.0 million purchase limit. Based upon a servicing report as of December 31, 2006, the value of receivables eligible to be purchased totaled approximately $45.4 million. We had utilized $43.9 million under the facility at December 31, 2006, leaving approximately $1.5 million in availability as of this date.
Borrowings under our liquidity facility in The Netherlands. We have a credit facility in The Netherlands, payable on demand and providing for available credit of up to 2.9 million euros or approximately $3.8 million. At December 31, 2006, we had outstanding borrowings of approximately 0.9 million euros or approximately $1.2 million under this facility. There were no borrowings as of December 31, 2005.
Uses of Liquidity
Our principal uses of liquidity are funding the losses from operations, working capital needs, capital expenditures, payments related to our outstanding debt, and pension obligations.
Working capital needs. During the year, inventory turns improved from 9 to 11 and receivables days sales outstanding were reduced by 10 days. These improvements were partly offset by accelerated payment terms on our accounts payable applied by some of our suppliers. We reduced our working capital by $30.8 million during 2006, however reductions in post-retirement benefits in 2006, versus increases in those same non-current liabilities in 2005 totaling $23.8 million, partly offset the benefit from lower working capital.
Capital expenditures. In 2006, capital expenditures totaled $5.8 million versus $10.0 million in 2005 and $11.7 million in 2004. Capital expenditures include asset replacement, environmental and safety compliance, cost reduction and productivity improvement items, and, expenditures for our Monterrey, Mexico manufacturing facility in 2005 and 2004.
Payments related to our outstanding debt and other financing facilities. In 2006, we made interest and other fee payments on our senior notes, liquidity facilities and other debt totaling $22.8 million, versus payments of $21.1 million in 2005 and $21.5 million in 2004. The increase in interest and other fee payments from 2005 to 2006 is the result of increased usage of our liquidity facilities in 2006 due to the increase in copper prices and the impact of higher interest rates on our liquidity facilities, and to a lesser extent, the impact of increased interest rates on our interest rate swap which was terminated in August of 2006.
Funding of pension obligations. In 2006, we made contributions to our U.S. defined benefit pension plan in the amount of $1.8 million, while in 2005 and 2004, we did not make any contributions. In 2006, 2005 and 2004, we made contributions of $1.7 million, $1.1 million and $1.1 million, respectively, to our Canadian defined benefit pension plans. In 2007, we anticipate making mandatory contributions totaling $7.5 million to our U.S. qualified defined benefit plan as required by funding regulations or laws. In addition, we expect to make a $3.1 million contribution to our Canadian pension plans in 2007.
We have frozen benefits under the U.S. defined benefit pension plan and Supplemental Benefit Restoration Plan, effective February 28, 2006. In conjunction with the freezing of these plans, on March 1, 2006, we made enhancements to our 401(k) plan for the employees impacted by this action. These enhancements include an automatic three percent contribution to each affected employee’s 401(k) account, a match of employees’ contributions, the addition of a success sharing component to the 401(k) plan, and the provision of transition contributions for five years for certain employees based upon an employee’s age and years of service as of February 28, 2006. The expense associated with the 401(k) plan was $4.8 million in 2006 as compared with $0.7 million in 2005.
In 2006, lump sum benefits due to Dennis Horowitz, our former Chief Executive Officer in the amount of $5.7 million were paid, $4.4 million from funds previously held in a rabbi trust and $1.3 million from the general operating funds of our Company. In 2005, we paid James E. Deason $1.6 million from our general operating funds due to his retirement in March 2005, which represented Mr. Deason’s vested benefits under the 2002 Supplemental Executive
Retirement Plan and the Supplemental Benefit Restoration Plan. We also made payments of $0.1 million to participants of the Supplemental Benefit Restoration Plan in 2006 to cover expected normal payouts. In 2007, we anticipate making payments to participants of the Supplemental Benefit Restoration Plan totaling $0.1 million, which represents the equivalent of the normal amount of benefits.
Off-Balance-Sheet Arrangements
On April 28, 2005, we established a three-year receivables sale facility under which we could sell on a revolving basis up to $45 million of eligible accounts receivable. During 2006, we amended the facility to, among other things, increase the maximum amount available under the facility from $45 million to $90 million. We consider the receivables sale facility to be a critical component of our overall liquidity. Along with our secured revolving credit facility, we look to the receivables sale facility as a primary source of funding for our working capital requirements. Generally, the receivables sale facility allows us to fund these cash requirements more cost effectively than the secured revolving credit facility.
Under the receivables sale facility, our Company and certain of our subsidiaries (the Originators) sell certain receivables at a discount and without recourse to DEJ 98 Finance, LLC (DEJ), a bankruptcy-remote, special purpose entity that is a 100% owned subsidiary of our Company. In turn, DEJ may sell undivided interests in a specified portion of these receivables, as needed, to certain third-party purchasers. The sale of receivables by the Originators to DEJ and the sale of receivable interests by DEJ to the purchasers are structured as “true sales” under applicable laws. Any interests in the sold receivables which are retained by DEJ will not be available to our Company or our creditors. The third-party purchasers have no recourse to our Company’s or the Originators’ assets for losses resulting from the financial inability of customers to pay amounts owed on the receivables when they become due. Our Company has guaranteed the performance by our subsidiaries of their obligations under the receivables sale facility. Monthly costs associated with amounts outstanding under the receivables sale facility vary in relation to short-term interest rates and our fixed charge coverage ratio. We also pay commitment and other fees related to this facility.
The amount of cash available to us under the receivables sale facility (within the $90 million limit) is based upon the amount of eligible receivables and certain reserves required by the facility. Accordingly, availability may be reduced, perhaps materially, as a result of adverse changes in receivables eligibility balances and facility reserves, which are affected primarily by changes in various criteria related to the quality of receivables within the receivables pool. In addition, the third-party purchasers can terminate purchases of receivables interests prior to the scheduled expiration date of the receivables sale facility on April 28, 2008 upon the occurrence of certain “amortization events,” including, among others, our non-compliance with the facility’s various covenants and requirements and a default on (or termination of) certain of our other financing arrangements. An amortization event under the receivables sale facility, without waivers from the relevant counterparties, would trigger an event of default under our secured revolving credit facility, which in turn could result in the acceleration of our obligations under those arrangements as well as under our senior note indentures. As a result, if we are unable to obtain appropriate waivers, a termination of the receivables sale facility would not only prevent us from accessing our alternative source of working capital funding (the secured revolving credit
facility), but would also require us to refinance or restructure the receivables sale facility and the secured revolving credit facility (and possibly our senior note financings) in a timely manner.
The terms of the agreements governing the receivables sale facility and the 2006 amendments to these agreements, along with usage and availability information as of the end of the 2006 fiscal year, are more fully described in Note 11, Receivables Sale Facility, of the Notes to Consolidated Financial Statements.
Other than the receivables sale facility, our Company had no other off-balance sheet arrangements as of December 31, 2006 that either have, or are reasonably likely to have, a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Contractual Obligations and Commercial Commitments
The following table provides a summary of our contractual obligations and commercial commitments as of December 31, 2006. Other non-current liabilities included in our Consolidated Balance Sheet that may not be fully disclosed below include accrued pension, post- retirement and environmental costs. Refer to Notes 13, 14, 15, 16, and 21 of the Notes to the Consolidated Financial Statements.
At December 31, 2006, we also had commitments to purchase approximately 49.3 million pounds of copper during 2007, to be priced when purchased at COMEX plus an average fixed spread of $0.04 per pound. During 2006, the average monthly COMEX price of copper ranged from $2.18 to $3.76 per pound. These commitments were negotiated in the normal course of business and represent a portion of our copper requirements for 2007, which we anticipate will exceed 291 million pounds.
Financing Arrangements
As of December 31, 2006, our financing arrangements consisted of (i) our 7.375% Senior Notes due 2008 and our 10.5% Senior Notes due 2009; (ii) our liquidity facilities, consisting of a $90 million receivables sale facility and a $35 million secured revolving credit facility; and (iii) certain other credit arrangements with respect to our non-U.S. operations. The agreements governing our liquidity facilities, and the indentures governing our senior notes, contain cross default provisions. As of December 31, 2006, we were in compliance with the covenants contained in the agreements governing our liquidity facilities and in the indentures governing our senior notes. The terms of these financing arrangements, including 2006 amendments and amounts outstanding as of December 31, 2006, are discussed in more detail in Notes 10, Financing Arrangements and Debt and 11, Receivables Sale Facility of the Notes to Consolidated Financial Statements.
During 2006 and 2005, we maintained a silver consignment and forward contracts facility with Bank of America N.A. (BANA), pursuant to which BANA consigned certain amounts of silver to us upon request, and we could enter into forward contracts to purchase certain amounts of silver from BANA in the future for a set price. During the third quarter of 2006, BANA notified us of its intention to exit its precious metals business in its entirety, which included BANA’s silver consignment and forward contracts business with us. In connection with BANA’s preparations to exit this business and our evaluation of alternatives to replace the facility, during the fourth quarter of 2006, we entered into two amendments to the facility to, among other things, decrease the maximum value of consigned silver available to us, provide collateral to secure our obligations under the facility, permit certain accounts receivable generated through the sale of inventory containing consigned silver to be sold through our receivables sale facility, and provide for the ultimate termination of the BANA facility on December 21, 2006. On December 22, 2006, we paid BANA approximately $13.0 million to purchase 1.0 million troy ounces of silver on consignment at the termination date of the facility. We continued pursuing alternatives for a suitable replacement facility with a different provider. On February 16, 2007, we entered into a new silver consignment facility with HSBC Bank USA, N.A. (HSBC), under which we may request consignments of silver with an aggregate value of up to the lesser of $25 million and 85% of the aggregate undrawn face amount of letters of credit required to be provided to HSBC pursuant to the new facility. See Note 10, Financing Arrangements and Debt, of the Notes to Consolidated Financial Statements.
Market Risks
We are exposed to various market risks, including changes in interest rates, commodity prices and foreign currency rates. Market risk is the potential loss arising from adverse changes in market rates and prices. In the ordinary course of business, we enter into various types of
transactions involving derivative financial instruments to manage and reduce the impact of these market risks, primarily risks with respect to the valuation of our base inventory of copper and silver, the future costs associated with firm forward price guarantees with our customers, the future costs of purchases of natural gas and, with respect to certain foreign subsidiaries, the variability in cash flows from the forecasted payment or receipt of currencies other than the functional currency. We do not enter into derivatives or other financial instruments for trading or speculative purposes.
Commodity Price Risk
The price our customers pay for a product includes a metal charge that represents, in some cases, the market value of the copper used in that product as of the date we ship the product to the customer. Effective, September 1, 2005, we changed our method of charging certain customers from COMEX price for metal at date of shipment to the previous monthly average COMEX price for metal. This pricing model is expected to serve as a natural hedge against changes in the commodity price of copper, and allows us to better match the cost of copper with the selling price to our customers. However, as an accommodation to our customers, we often enter into fixed price commitments to purchase copper on their behalf in order to fix the price of copper in advance of shipment. We account for these transactions as cash flow hedges under Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by Statement of Financial Accounting Standards No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, and by Statement of Financial Accounting Standards No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, (hereinafter collectively referred to as SFAS 133). The fair values of these derivative assets are recognized in accrued liabilities in the Consolidated Balance Sheet. Hedge ineffectiveness is recognized in the Consolidated Statement of Operations under cost of goods sold. Information regarding this type of derivative transaction is as follows:
We have firm-price purchase commitments with some of our copper suppliers under which we agree to buy copper at a price set in advance of the actual delivery of that copper to us. Under these arrangements, we assume the risk of a price decrease in the market price of copper between the time this price is fixed and the time the copper is delivered. In order to reduce our market exposure to price decreases, at the time we enter into a firm-price purchase commitment, we also often enter into commodity forward contracts to sell a like amount of copper at the then-
current price for delivery to the counterparty at a later date. We account for these transactions as cash flow hedges under SFAS 133. The fair value of these derivative liabilities is recognized in prepaid expenses and other in the Consolidated Balance Sheet. Hedge ineffectiveness is recognized in the Consolidated Statement of Operations under cost of goods sold. Information on this type of derivative transaction is as follows:
We have entered into commodity forward contracts to sell copper in order to hedge or protect the value of the copper carried in our inventory from price decreases. During the first three quarters of 2004, these forward contracts were not designated as hedges, and were marked to market each period, with the corresponding gains and losses recorded in cost of goods sold. Beginning in the fourth quarter of 2004, we began accounting for these forward contracts as fair value hedges under SFAS 133. The fair value of these derivative liabilities is recognized in prepaid expenses and other in the Consolidated Balance Sheet. Hedge ineffectiveness is recognized in the Consolidated Statement of Operations under cost of goods sold. Information on this type of derivative transaction is as follows:
During 2006, we leased our silver inventory from Bank of America, N.A. pursuant to a consignment arrangement, and as a result of the termination of the facility in December 2006, we purchased the silver on hand and simultaneously entered into commodity forward contracts to sell silver in order to hedge or protect the value of the silver carried in our inventory from price decreases. Beginning in the fourth quarter of 2006, we began accounting for these forward
contracts as fair value hedges under SFAS 133. The fair value of these derivative liabilities is recognized in accrued liabilities in the Consolidated Balance Sheet. Hedge ineffectiveness is recognized in the Consolidated Statement of Operations under cost of goods sold. Information on this type of derivative transaction is as follows:
We have also entered into commodity futures contracts to purchase natural gas to reduce our risk of future price increases. We account for these transactions as cash flow hedges under SFAS 133. The fair value of these derivative assets is recognized in accrued liabilities in the Consolidated Balance Sheet. Hedge ineffectiveness is recognized in the Consolidated Statement of Operations under cost of goods sold. Information on this type of derivative transaction is as follows:
Foreign Currency Exchange Risk
We are subject to market risk exposure from fluctuations in foreign currencies. Foreign currency exchange forward contracts may be used from time to time to hedge the variability in cash flows from the forecasted payment or receipt of currencies other than the functional currency. We do not enter into forward exchange contracts for speculative purposes. These forward currency exchange contracts and the underlying hedged receivables and payables are carried at their fair values, with any associated gains and losses recognized in current period earnings. These contracts cover periods commensurate with known or expected exposures, generally within three months. As of December 31, 2006, we had forward exchange contracts outstanding to sell foreign currency with a notional amount of $2.4 million. The estimated fair
value of these forward exchange contracts to sell foreign currency was an immaterial loss. The effect of a 10% adverse change in exchange rates would reduce the fair value by approximately $0.2 million.
We also used foreign currency forward exchange contracts to hedge our inventory currency risk in Canada. These contracts were denominated in U.S. and Canadian dollars. Due to the closure of our Montreal facility and the resulting reduction in the mix of Canadian and U.S. dollar denominated sales, we elected to cancel the foreign currency forward exchange hedge as of December 29, 2006.
Interest Rate Risk
In October 2002, we entered into an interest rate swap transaction on $50.0 million of our 7.375% Senior Notes. The interest rate swap called for semi-annual interest payments on February 1 and August 1, a floating interest rate based upon the nine month LIBOR rate plus a spread of 3.76%, and an August 1, 2008 maturity date.
On August 25, 2006, we terminated the interest rate swap and paid Wachovia Bank National Association (Wachovia) $1.8 million representing the interest accrued through the date of termination in August and the termination fee. The termination fee of $1.7 million will be amortized over the remaining life of the 7.375% Senior Notes. As of December 31, 2006, the unamortized amount was $1.4 million. The termination fee, which was locked in on the date of the termination, is the net present value of the amount of interest which exceeded the fixed rate of 7.375% for the balance of the term of the interest rate swap. Taking into account the gain recorded from the inception of the interest rate swap to the termination of $1.1 million and the termination fee of $1.7 million or a net increase in interest of $0.6 million, the effective annual rate of the underlying Senior Notes is 7.578% through the maturity date.
The disclosures with respect to the above noted risks do not take into account the underlying commitments or anticipated transactions. If the underlying items were included in the analysis, the gains or losses on the forward contracts may be offset. Actual results will be determined by a number of factors that are not generally under our control and could vary significantly from those factors disclosed.
We are exposed to credit losses in the event of nonperformance by counterparties on the above instruments, as well as credit or performance risk with respect to our hedged customers’ commitments. Although nonperformance is possible, we do not anticipate nonperformance by any of these parties.
Environmental Matters
We are subject to extensive environmental regulations imposed by federal, state, provincial and local authorities in the U.S., Canada, China, Portugal and Mexico with respect to emissions to air, discharges to waterways, and the generation, handling, storage, transportation, treatment and disposal of waste materials. We have received various communications from regulatory authorities concerning certain environmental matters. See Note 15, Environmental Remediation, of the Notes to Consolidated Financial Statements for further details regarding environmental matters.
Critical Accounting Policies
Our significant accounting policies are discussed in Note 2, Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements. Management believes that the following accounting policies are the most critical to aid in fully understanding and evaluating our reported financial results.
The preparation of the financial statements in conformity with generally accepted accounting principles in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Inventory
Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out (FIFO) method. Inventory costs include material, labor, and factory overhead. Our maintenance and operating supplies inventory is valued using an average cost method to determine cost. In assessing the ultimate realization of inventories, we are required to make judgments as to future demand requirements and compare these with our current inventory levels. Obsolete or unsaleable inventories are reflected at their estimated net realizable values.
Derivatives and Hedging Activities
Our operations and cash flows are subject to fluctuations due to changes in commodity prices, foreign currency exchange rates and interest rates. We use derivative financial instruments to manage commodity prices, foreign currency exchange rates and interest rate exposures, though not for speculative purposes. Derivatives used are primarily commodity forward contracts, foreign currency forward contracts and interest rate swaps. We apply the provisions of Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by Statement of Financial Accounting Standards No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, and by Statement of Financial Accounting Standards No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, (hereinafter collectively referred to as SFAS 133), for most of our derivatives. Some of our derivatives are designated as either a hedge of a recognized asset or liability or an unrecognized firm commitment (fair value hedge), or a hedge of a forecasted transaction (cash flow hedge). For fair value hedges, both the effective and ineffective portion of the changes in the fair value of the derivative, along with any gain or loss on the hedged item that is attributable to the hedged risk, are recorded directly to operations. The effective portion of changes in fair value of derivatives that are designated as cash flow hedges are recorded in accumulated other comprehensive income/(loss), until the hedged item is realized, when the gain/(loss) previously included in accumulated other comprehensive income/(loss) is recognized in operations. Our foreign currency hedges are accounted for under Statement of Financial Accounting Standards No. 52 (SFAS 52), Foreign Currency Translation.
Long-lived Assets
The values assigned to long-lived assets such as property, plant and equipment, assets held for sale and goodwill are reviewed as appropriate. We estimate the depreciable lives of property, plant and equipment, and review the assets for impairment if events, or changes in circumstances, indicate that we may not recover the carrying amount of an asset.
Statement of Financial Accounting Standards No. 142 (SFAS 142), Goodwill and Other Intangible Assets, addresses financial accounting and reporting for acquired goodwill and other intangible assets. SFAS 142 presumes that goodwill has an indefinite useful life and thus should not be amortized, but rather tested at least annually for impairment using a lower of cost or fair value approach. During 2006, we conducted the required annual goodwill impairment review, and based upon the results of this review, determined that there is no impairment of goodwill. We also conducted the required annual goodwill impairment review in 2005, and based upon the results of that review, determined that there was no impairment of goodwill for 2005. In evaluating goodwill, we make certain assumptions regarding estimated growth rates, profit projections, rates of interest and other estimates. If we fail to achieve estimated growth rates and/or profit projections, if interest rates increase, or if other estimates or assumptions change in the future, we may record additional impairment charges for goodwill in the future.
Income Taxes
For financial reporting purposes, we determine our current and deferred tax liabilities in accordance with the liability method of accounting for income taxes as specified in Statement of Financial Accounting Standards No. 109 (SFAS 109), Accounting for Income Taxes. Under SFAS 109, deferred tax liabilities and assets are recorded for differences between the expected future tax consequences of events that have been recognized in our financial statements and those recognized in the tax returns. Property, plant and equipment, inventories, prepaid pension, postretirement benefit obligations, and certain other accrued liabilities are the primary sources of these temporary differences. Deferred income tax assets also included operating loss and tax credit carryforwards. Our Company establishes valuation allowances to reduce deferred tax assets to amounts we believe are more than likely than not to be realized. These valuation allowances are adjusted based upon changing facts and circumstances.
Pension and Postretirement Benefit Costs
Our pension and postretirement benefit costs are developed from actuarial valuations. Inherent in these valuations are key assumptions including discount rates and expected long-term rates of return on plan assets. Material changes in our pension and postretirement benefit costs may occur in the future due to changes in these assumptions, changes in the number of plan participants, changes in the level of benefits provided, changes to the level of contributions to these plans and other factors.
We determine our actuarial assumptions for the U.S. and Canadian pension and post retirement plans, after consultation with our actuaries, on December 31 of each year to calculate liability information as of that date and pension and postretirement expense for the following year. The discount rate assumption is determined by using a yield curve.
The expected long-term rate of return on plan assets of the various plans reflects projected returns for the investment mix of the various pension plans that have been determined to meet each plan’s investment objectives. The expected long-term rate of return on plan assets is
selected by taking into account the expected weighted averages of the investments of the assets, the fact that the plan assets are actively managed to mitigate downside risks, the historical performance of the market in general and the historical performance of the retirement plan assets over the past ten years.
We adopted the principles of SFAS 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans for our reporting and disclosures in December 31, 2006, see Note 2, Summary of Significant Account Policies, and Note 13, Retirement and Pension Plans of the Notes to Consolidated Financial Statements.
Stock Options
On October 18, 2005, our Company accelerated the vesting of all out-of-the-money, unvested, non-qualified stock options held by officers and employees. All options priced above $7.42, the closing market price of our Company’s common stock on October 18, 2005, were considered to be out-of-the-money. The acceleration was effective as of October 18, 2005. The options were granted under our Company’s 2003 Equity Incentive Plan. No options held by non-employee directors were subject to the acceleration.
Effective January 1, 2006, we adopted SFAS 123(R) using the modified prospective transition method, which requires measurement and recognition of compensation expense for all stock-based payment awards made to employees and directors, including stock options, based on fair values. Our financial statements as of December 31, 2006 reflect the impact of SFAS 123(R). Our financial statements for prior periods have not been restated to reflect the impact of SFAS 123(R). Stock-based compensation expense is based on the portion of stock-based payment awards that is ultimately expected to vest. Stock-based compensation expense in our Condensed Consolidated Statements of Operations as of December 31, 2006 included compensation expense for unvested stock-based payment awards granted prior to December 31, 2005 (based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123) and compensation expense for the stock-based payment awards granted subsequent to December 31, 2005 (based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R)). In conjunction with the adoption of SFAS 123(R), we elected to attribute the value of stock-based compensation to expense over the periods of service during which each tranche of stock options is earned, which was previously in our pro forma information required under SFAS 123(R).
Our Company accelerated the vesting of the options in anticipation of the impact of SFAS 123R. The primary purpose of the accelerated vesting was to avoid recognizing compensation expense associated with these options upon adoption by our Company of SFAS 123R. Without the acceleration, we estimate that pre-tax charges under SFAS 123R relating to these options would have been $0.9 million, of which $0.7 million and $0.2 million would have been recognized in fiscal 2006 and 2007, respectively. Additionally, because these options had exercise prices in excess of then current market values and were not fully achieving their original objectives of incentive compensation and employee retention, our Company believed that the acceleration would have a positive effect on employee morale and retention.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The information required by this item is contained in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and is incorporated herein by reference.
Item 8.
Item 8. Financial Statements and Supplementary Data
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of management, including our Principal Executive Officer (PEO) and our Chief Financial Officer (CFO), we carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) as of the end of the period covered by this report. Based upon that evaluation our PEO and CFO have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective.
Changes in Internal Control over Financial Reporting
Based upon the evaluation performed by our management, which was conducted with the participation of our PEO and CFO, there has been no change in our internal control over financial reporting during the fourth quarter of 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f). Management, with the participation of our PEO and CFO, assessed the effectiveness of our internal control over financial reporting as of December 31, 2006. In making this assessment, management used the framework set forth in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based upon this assessment, our management concluded that, as of December 31, 2006, our internal control over financial reporting was effective.
Management’s assessment of the effectiveness of internal control has been audited by KPMG LLP, independent registered public accounting firm, as stated in their report included in this Annual Report on Form 10-K.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The information required by this item with respect to our directors, audit committee, and our audit committee financial experts is incorporated by reference from the information under the caption “Election of Directors” contained in our definitive proxy statement for the 2007 Annual Meeting of Stockholders. The required information concerning our executive officers is contained in Part I - Item 1 - “Business - Executive Officers of the Registrant.” The required information concerning our adoption of a code of ethics that applies to our principal executive officer, principal financial officer, principal accounting officer or controller or persons performing similar functions and the availability of this code of ethics upon written request is contained in Part I - Item 1 - “Business - Available Information” of this report.
The required information concerning compliance with Section 16(a) of the Exchange Act is incorporated by reference from the information under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” contained in our definitive proxy statement for the 2007 Annual Meeting of Stockholders.
Item 11.
Item 11. Executive Compensation
The information required by this item is incorporated by reference from the information under the captions “Executive Compensation” in our definitive proxy statement for the 2007 Annual Meeting of Stockholders.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this item is incorporated by reference from the information under the caption “Stock Ownership of Certain Beneficial Owners and Management” and “Executive Compensation” in our definitive proxy statement for the 2007 Annual Meeting of Stockholders.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this item is incorporated by reference from the information contained under the captions “Election of Directors” and “Certain Relationships and Related Transactions” in our definitive proxy statement for the 2007 Annual Meeting of Stockholders.
Item 14.
Item 14. Principal Accounting Fees and Services
The information required by this item is incorporated by reference from the information under the caption “Ratification of Appointment of Independent Auditors - Principal Accounting Firm Fees” and “Ratification of Appointment of Independent Auditors - Audit Committee’s Pre-Approval Policies and Procedures” contained in our definitive proxy statement for the 2007 Annual Meeting of Stockholders.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) Index to exhibits, financial statements and schedules.
All other financial statements and schedules not listed have been omitted since the required information is included in the consolidated financial statements or the notes thereto, or is not applicable or required.
The following exhibits are incorporated by reference:
*
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, in the City of Huntsville, State of Alabama, on the 15th day of March 2007.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated.
Wolverine Tube, Inc. and Subsidiaries
Consolidated Statements of Operations
The accompanying notes are an integral part of the consolidated financial statements.
Wolverine Tube, Inc. and Subsidiaries
Consolidated Balance Sheets
The accompanying notes are an integral part of the consolidated financial statements.
Wolverine Tube, Inc. and Subsidiaries
Consolidated Statements of Stockholders’ Equity
and Comprehensive Income/(Loss)
The accompanying notes are an integral part of these consolidated financial statements.
Wolverine Tube, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
The accompanying notes are an integral part of the consolidated financial statements.
Wolverine Tube, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
1. Nature of Operations
Wolverine Tube, Inc. (the Company, Wolverine, we, our, or us) is a world-class quality manufacturer of copper and copper alloy tube, fabricated products, and metal joining products. Our focus is on custom-engineered, higher value-added tubular products, including fabricated copper components and metal joining products, which enhance performance and energy efficiency in many applications, including: commercial and residential heating, ventilation and air conditioning, refrigeration, home appliances, industrial equipment, power generation, petrochemicals and chemical processing.
During 2006 our common stock was traded on the New York Stock Exchange under the symbol “WLV”. On December 26, 2006, we were advised by the New York Stock Exchange, Inc. (NYSE) that our common stock would be suspended from trading on the NYSE prior to the opening on January 3, 2007. The NYSE advised us that its decision to suspend trading and initiate delisting procedures was a result of our Company not meeting the NYSE’s continued listing standard regarding average global market capitalization over a consecutive 30 trading-day period of at least $25 million, which is a minimum threshold under Section 802.01B of the NYSE Listed Company Manual for continued listing.
On February 1, 2007 we announced the entry into a recapitalization plan to strengthen our balance sheet, reduce financing costs and enhance our overall capital structure. An investor group comprised of Plainfield Special Situations Master Fund Limited, a fund managed by Plainfield Asset Management LLC (Plainfield), and The Alpine Group, Inc. (Alpine) will invest up to $75 million in our Company through purchasing new convertible preferred equity and providing a standby commitment to a common stock rights offering, which will be available to all of our shareholders. This recapitalization plan will provide a minimum of $75 million and could reach as much as approximately $135 million of equity proceeds. We also announced that we will initiate an exchange offer to exchange and modify the terms of our existing debt.
Under the terms of the definitive investment agreement among the parties (the “Agreement”), Plainfield and Alpine invested $50 million in cash in our Company on February 16, 2007 in exchange for 50,000 newly issued shares of Series A Convertible Preferred Stock. The Series A Preferred Stock will has an annual dividend rate of 8.0%, payable quarterly, and will be convertible into shares of Wolverine common stock at the option of the holders, in whole or in part, at any time. We may defer payment of the dividend in certain circumstances. Any deferred dividend will accrue at a rate of 10% per annum if the dividend payment date is prior to January 31, 2012 and at a rate of 12% if the payment date is after January 31, 2012. The conversion price will be initially $1.10 per share (the “Offer Price”), subject to customary anti-dilution requirements. The Series A Preferred Stock will vote with the common stock on an as-converted basis on all matters. However, while the 10.5% Senior Notes due in 2009 remain outstanding, the holders of the Series A Preferred Stock will not be entitled to vote common stock or preferred stock in excess of 49% of the voting power of the total voting securities of our Company. The Preferred Stock is mandatorily redeemable at par plus any
accrued and unpaid dividends on January 31, 2017 and upon the occurrence of certain change of control transactions. Our Company may redeem all, but not less than all, of the Preferred Stock at our option, at par plus accrued and unpaid dividends, after January 31, 2014, if certain conditions have been satisfied.
The net proceeds from the initial phase of the Preferred Stock Agreement have been used to repay amounts under our Company’s liquidity facilities and for working capital. Additional proceeds will be utilized for general corporate purposes, including debt repayment, capital expenditures, and working capital.
Based on the financing provided by the recapitalization plan discussed above and based on our 2007 operating plan and cash flow projections, we believe that the availability under our facilities, combined with the unrestricted cash on hand in North America, should provide the liquidity required during 2007.
2. Summary of Significant Accounting Policies
The significant accounting policies followed by us are described below:
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Wolverine and its subsidiaries. All significant intercompany transactions and accounts have been eliminated in consolidation.
Uses of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Revenue Recognition Policy
Revenues are generally recognized when title to products transfer to an unaffiliated customer, and the product is shipped. Sales are made under normal terms and usually do not require collateral. Revenues are recorded net of estimated returns and allowances and volume discounts. The reserve for sales returns and allowances is calculated by applying a historical percentage against certain receivables. The reserve for volume discounts is calculated by applying a customer specific discount percentage to sales made to that customer.
Cash Equivalents
We consider all highly liquid short-term investments purchased with a maturity of three months or less to be cash equivalents. Cash equivalents are carried at cost, which approximates market value. Approximately $6.0 million and $6.6 million of cash included in cash on hand was restricted as of December 31, 2006 and 2005, respectively, and is not available for general corporate use.
Allowance for Doubtful Accounts
Allowance for doubtful accounts ensure that trade receivables are not overstated due to issues of collectability and are established for certain customers based upon a variety of factors: including past due receivables, macroeconomic conditions, significant one-time events and historical experience. Specific reserves for individual accounts may be established due to a customer’s inability to meet their financial obligations, such as in the case of bankruptcy filings or the deterioration in a customer’s operating results or financial position. As circumstances related to customers change, estimates of the recoverability of receivables are adjusted.
Sales of Accounts Receivable
Our Company’s sales of our receivables to a special purpose entity is accounted for as a sale in accordance with Statement of Financial Accounting Standards No. 140 (SFAS 140), Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out (FIFO) method. Inventory costs include material, labor, and factory overhead. Our maintenance and operating supplies inventory is valued using an average cost method to determine cost. Obsolete or unsaleable inventories are reflected at their estimated net realizable values.
Total inventories in 2006 and 2005 included the following classifications (in thousands):
Property, Plant and Equipment
Land, buildings and equipment are carried at cost. Expenditures for maintenance and repairs are charged directly against operations, while major renewals/betterments are capitalized. When properties are retired or otherwise disposed of, the original cost and accumulated depreciation are removed from the respective accounts, and the profit or loss resulting from the disposal is reflected in income. Depreciation is provided over the estimated useful lives of the assets, generally on the straight-line method. Depreciation for financial reporting purposes for office and other equipment is 5 to 7 years, computers and other service equipment 5 to 7 years, heavy machinery 20 to 30 years and other machinery 10 years.
Impairment of Long-Lived Assets
Impairments of long-lived assets are recognized under the provisions of Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards No. 144 (SFAS 144), Accounting for the Impairment or Disposal of Long-Lived Assets. When facts and circumstances indicate that long-lived assets used in operations may be impaired, and the undiscounted cash flows estimated to be generated from those assets are less than their carrying values, an impairment charge is recorded equal to the excess of the carrying value over fair value. Long-lived assets held for disposal are valued at the lower of the carrying amount or estimated fair value less cost to sell.
Employment-Related Benefits
Employment-related benefits associated with pensions and postretirement health care are expensed as actuarially determined. The recognition of expense is impacted by estimates made by management, such as discount rates used to value certain liabilities, investment rates of return on plan assets, increases in future wage amounts and future health care costs. Our Company uses third-party specialists to assist management in appropriately measuring the expense and liabilities associated with employment-related benefits.
We determine our actuarial assumptions for the U.S. and Canadian pension and post retirement plans, after consultation with our actuaries, on December 31 of each year to calculate liability information as of that date and pension and postretirement expense for the following year. In 2006 we began using the Hewitt yield curve method to determine the appropriate discount rate. For the years 2005 and prior the discount rate assumption was based on Moody’s Aa corporate bonds using the average for the month of December.
The expected long-term rate of return on plan assets of the various plans reflects projected returns for the investment mix of the various pension plans that have been determined to meet each plan’s investment objectives. The expected long-term rate of return on plan assets is selected by taking into account the expected weighted averages of the investments of the assets, the fact that the plan assets are actively managed to mitigate downside risks, the historical performance of the market in general and the historical performance of the retirement plan assets over the past ten years.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158 (SFAS 158), Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, which amends SFAS 87 and SFAS 106 to require recognition of the overfunded or underfunded status of pension and other postretirement benefit plans on the balance sheet. Under SFAS 158, gains and losses, prior service costs and credits and any remaining transition amounts under SFAS 87 and SFAS 106 that have not yet been recognized through net periodic benefit cost will be recognized in accumulated other comprehensive income, net of tax effects, until they are amortized as a component of net periodic cost. Also, the measurement date, the date at which the benefit obligation and plan assets are measured, is required to be our Company’s fiscal year end. As required by SFAS 158, we adopted the balance sheet recognition provisions at December 31, 2006 which resulted in our Company recording $1.7 million in accumulated comprehensive income for amounts that had not been previously recorded in net periodic benefit cost.
Income Taxes
Under Statement of Financial Accounting Standards No. 109 (SFAS 109), Accounting for Income Taxes, deferred tax liabilities and assets are recorded for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. Property, plant and equipment, inventories, prepaid pension, postretirement benefit obligations, and certain other accrued liabilities are the primary sources of these temporary differences. Deferred income tax also includes operating loss and tax credit carryforwards. Our Company establishes valuation allowances to reduce deferred tax assets to amounts it believes are more
than likely than not to be realized. These valuation allowances are adjusted based upon changing facts and circumstances.
Goodwill
Goodwill is evaluated utilizing Statement of Financial Accounting Standards No. 142 (SFAS 142), Goodwill and Other Intangible Assets. Under this statement, goodwill is presumed to have an indefinite useful life and, thus, is not amortized, but tested no less than annually for impairment using a lower of cost or fair value approach.
During the third quarter of 2006, 2005 and 2004, we conducted goodwill impairment reviews, and prepared updated valuations using a discounted cash flow approach based on forward-looking information regarding market share, revenues and costs. Based on the results of these reviews, the fair value exceeded its carrying values, and thus, no impairment charge was recorded. At December 31, 2006 and 2005, we had $77.2 million and $77.1 million of goodwill, net of $10.7 million of accumulated amortization in both 2006 and 2005, which represents our only non-amortizable intangible asset. See Note 8, Deferred Charges of the Notes to Consolidated Financial Statements for a discussion of certain amortizable intangible assets.
Earnings/(Loss) Per Common Share
Basic earnings/(loss) per share were computed by dividing net income/(loss) by the weighted average number of common shares outstanding. Where applicable, diluted earnings/(loss) per share were calculated by including the effect of all dilutive securities, including stock options and unvested restricted stock. To the extent that stock options and unvested restricted stock are anti-dilutive, they are excluded from the calculation of diluted earnings/(loss) per share.
Derivatives and Hedging Activities
Our operations and cash flows are subject to fluctuations due to changes in commodity prices, foreign currency exchange rates and interest rates. We use derivative financial instruments to manage commodity prices, foreign currency exchange rates and interest rate exposures, though not for speculative purposes. Derivatives used are primarily commodity forward contracts, foreign currency forward contracts and interest rate swaps.
We apply the provisions of Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by Statement of Financial Accounting Standards No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, and by Statement of Financial Accounting Standards No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, (hereinafter collectively referred to as SFAS 133), for most of our Company’s derivatives. Some of our derivatives are designated as either a hedge of a recognized asset or liability or an unrecognized firm commitment (fair value hedge), or a hedge of a forecasted transaction (cash flow hedge). For fair value hedges, both the effective and ineffective portion of the changes in the fair value of the derivative, along with any gain or loss on the hedged item that is attributable to the hedged
risk, are recorded directly to operations. The effective portion of changes in fair value of derivatives that are designated as cash flow hedges are recorded in accumulated other comprehensive income, until the hedged item is realized, when the gain/(loss) previously included in accumulated other comprehensive income is recognized in operations. Our foreign currency hedges are accounted for under Statement of Financial Accounting Standards No. 52 (SFAS 52), Foreign Currency Translation.
Fair Values of Financial Instruments
We use the following methods in estimating fair value disclosures for financial instruments:
Cash and equivalents, accounts receivable and accounts payable: The carrying amount reported in the Consolidated Balance Sheets for these assets approximates their fair value.
Revolving credit facility and long-term debt: The carrying amount of our borrowings under our revolving credit facilities approximates fair value. The fair value of our 7.375% Senior Notes and our 10.5% Senior Notes and any derivative financial instruments are based upon quoted market prices.
Derivatives: The fair value of our interest rate, foreign currency and commodity derivative instruments are determined by reference to quoted market prices.
The following table summarizes fair value information for our financial instruments:
Environmental Expenditures
Environmental expenditures that pertain to our current operations and relate to future revenues are expensed or capitalized consistent with our capitalization policy. Expenditures that result from the remediation of an existing condition caused by past operations, and that do not contribute to future revenues, are expensed. Liabilities, which are undiscounted, are recognized for remedial activities when the cleanup is probable and the cost can be reasonably estimated.
Stock Options
Effective January 1, 2006, we adopted SFAS 123(R) using the modified prospective transition method, which requires measurement and recognition of compensation expense for all stock-based payment awards made to employees and directors, including stock options, based on fair values. Our financial statements as of December 31, 2006 reflect the impact of SFAS 123(R). Our financial statements for prior periods have not been restated to reflect the impact of SFAS 123(R). Stock-based compensation expense is based on the portion of stock-based payment awards that is ultimately expected to vest. Stock-based compensation expense in our Condensed Consolidated Statements of Operations as of December 31, 2006 included compensation expense for unvested stock-based payment awards granted prior to December 31, 2005 (based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123) and compensation expense for the stock-based payment awards granted subsequent to December 31, 2005 (based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R)). In conjunction with the adoption of SFAS 123(R), we elected to attribute the value of stock-based compensation to expense over the periods of service during which each tranche of stock options is earned, which was previously in our pro forma information required under SFAS 123(R).
Prior to January 1, 2006, our Company applied the intrinsic value method of accounting for stock options as prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). Since all options granted during 2005 and 2004 had an exercise price equal to or greater than the closing market price of the underlying common stock on the grant date, no compensation expense was recognized. If compensation cost for the Company’s stock-based compensation plans had been recognized for the years ended December 31, 2005 and 2004 under the provisions of SFAS 123(R), the Company’s net loss and loss per share would have increased to the following pro forma amounts:
Translation to U.S. Dollars
Assets and liabilities denominated in foreign currency are translated to U.S. dollars at rates of exchange at the balance sheet date. Revenues and expenses are translated at average exchange rates during the period. Translation adjustments arising from changes in exchange rates are included in the accumulated other comprehensive loss component of stockholders’
equity. Realized exchange gains and losses are included in “Amortization and other, net” in the consolidated statements of operations.
Research and Development Costs
Expenditures relating to the development of new products and processes, including significant improvements and refinements to existing products, are expensed as incurred. Research and development costs were approximately $2.2 million in 2006, $3.1 million in 2005, and $3.5 million in 2004.
Reclassifications
Certain prior year amounts have been reclassified to conform with the current year presentation. In addition, for 2004, our Company has separately disclosed the operating, investing and financing portions of the cash flows attributable to our discontinued operations, which in prior periods were reported on a combined basis as a single amount. We had no discontinued operations for 2006 or 2005.
Recent Accounting Pronouncements
During 2006, our Company adopted SFAS 158 and SFAS 123(R) as noted above.
In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151 (SFAS 151), Inventory Costs, an amendment of ARB No. 43, Chapter 4, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and spoilage. SFAS 151 requires that these costs be recognized as current-period charges. In addition, this Statement requires that allocation of fixed production overheads be based on the normal capacity of the production facilities. SFAS 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Our Company adopted SFAS 151 on January 1, 2006, and the adoption of SFAS 151 did not have a material impact on its consolidated financial statements.
In March 2005, the FASB issued FASB Interpretation No. 47 (FIN 47), Accounting for Conditional Asset Retirement Obligations, which requires conditional asset retirement obligations to be recognized if a legal obligation exists to perform asset retirement activities and a reasonable estimate of the fair value of the obligation can be made. FIN 47 also provides guidance as to when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. Our Company adopted the provisions of FIN 47 on December 31, 2005. No conditional asset retirement obligations were recognized and, accordingly, the adoption of FIN 47 had no effect on our Company’s financial condition or results of operation.
On July 13, 2006, the Financial Accounting Standards Board issued Interpretation No 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, clarifying the way companies account for uncertainty in income taxes. This pronouncement is
effective for years beginning after December 15, 2006. Based on our current evaluation, management does not anticipate that it will have a material impact.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157 (SFAS 157), Fair Value Measurements. SFAS 157 provides a common definition of fair value and a framework for measuring assets and liabilities at fair values when a particular standard prescribes it. In addition, the Statement expands disclosures about fair value measurements. As required by SFAS 157, we will adopt this new accounting standard effective January 1, 2008. We are currently reviewing the impact of SFAS 157 on our financial statements. We expect to complete this evaluation in 2007.
In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (SAB108). SAB 108 provides interpretive guidance on how the effects of the carryover or the reversal of prior year misstatements should be considered when quantifying a current year misstatement. The SEC staff believes that registrants should quantify errors using both the balance sheet and income statement approach when quantifying a misstatement. Effective December 31, 2006 our Company adopted SAB 108 which did not have a material impact on our Company’s consolidated financial statements.
3. Discontinued Operations
During the year ended December 31, 2001, we discontinued the operations of Wolverine Ratcliffs, Inc. (WRI), which was previously included in the rod, bar and other products segment. Operating results of the discontinued WRI operations in excess of the previous provision for losses recorded in the fourth quarter of 2001, are as follows:
4. Prepaid Expenses and Other
Prepaid expenses and other are as follows at December 31:
5. Derivatives
Commodity Price Risk
The price our customers pay for a product includes a metal charge that represents, in some cases, the market value of the copper used in that product as of the date we ship the product
to the customer. Effective September 1, 2005, we changed our method of charging certain customers from COMEX price for metal at date of shipment to the previous monthly average COMEX price for metal. This pricing model is expected to serve as a natural hedge against changes in the commodity price of copper, and allows us to better match the cost of copper with the selling price to our customers. However, as an accommodation to our customers, we often enter into fixed price commitments to purchase copper on their behalf in order to fix the price of copper in advance of shipment. We account for these transactions as cash flow hedges under Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by Statement of Financial Accounting Standards No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, and by Statement of Financial Accounting Standards No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, (hereinafter collectively referred to as SFAS 133).
The fair values of these derivative assets are recognized in accrued liabilities in the Consolidated Balance Sheet. Hedge ineffectiveness is recognized in the Consolidated Statement of Operations under cost of goods sold. Information regarding this type of derivative transaction is as follows:
We have firm-price purchase commitments with some of our copper suppliers under which we agree to buy copper at a price set in advance of the actual delivery of that copper to us. Under these arrangements, we assume the risk of a price decrease in the market price of copper between the time this price is fixed and the time the copper is delivered. In order to reduce our market exposure to price decreases, at the time we enter into a firm-price purchase commitment, we also often enter into commodity forward contracts to sell a like amount of copper at the then-current price for delivery to the counterparty at a later date. We account for these transactions as cash flow hedges under SFAS 133. The fair value of these derivative liabilities is recognized in prepaid expenses and other in the Consolidated Balance Sheet. Hedge ineffectiveness is recognized in the Consolidated Statement of Operations under cost of goods sold. Information on this type of derivative transaction is as follows:
We have entered into commodity forward contracts to sell copper in order to hedge or protect the value of the copper carried in our inventory from price decreases. During the first three quarters of 2004, these forward contracts were not designated as hedges, and were marked to market each period, with the corresponding gains and losses recorded in cost of goods sold. Beginning in the fourth quarter of 2004, we began accounting for these forward contracts as fair value hedges under SFAS 133. The fair value of these derivative liabilities is recognized in prepaid expenses and other in the Consolidated Balance Sheet. Hedge ineffectiveness is recognized in the Consolidated Statement of Operations under cost of goods sold. Information on this type of derivative transaction is as follows:
During 2006, we leased our silver inventory from Bank of America, N.A. (BANA) pursuant to a consignment arrangement, and as a result of the termination of the facility in December 2006, we purchased the silver on hand and simultaneously entered into commodity forward contracts to sell silver in order to hedge or protect the value of the silver carried in our inventory from price decreases. Beginning in the fourth quarter of 2006, we began accounting for these forward contracts as fair value hedges under SFAS 133. The fair value of these derivative liabilities is recognized in accrued liabilities in the Consolidated Balance Sheet. Hedge ineffectiveness is recognized in the Consolidated Statement of Operations under cost of goods sold. Information on this type of derivative transaction is as follows:
We have also entered into commodity futures contracts to purchase natural gas to reduce our risk of future price increases. We account for these transactions as cash flow hedges under SFAS 133. The fair value of these derivative assets is recognized in accrued liabilities in the Consolidated Balance Sheet. Hedge ineffectiveness is recognized in the Consolidated Statement of Operations under cost of goods sold. Information on this type of derivative transaction is as follows:
Foreign Currency Exchange Risk
We are subject to market risk exposure from fluctuations in foreign currencies. Foreign currency exchange forward contracts may be used from time to time to hedge the variability in cash flows from the forecasted payment or receipt of currencies other than the functional currency. We do not enter into forward exchange contracts for speculative purposes. These forward currency exchange contracts and the underlying hedged receivables and payables are carried at their fair values, with any associated gains and losses recognized in current period earnings. These contracts cover periods commensurate with known or expected exposures, generally within three months. As of December 31, 2006, we had forward exchange contracts outstanding to sell foreign currency with a notional amount of $2.4 million. The estimated fair value of these forward exchange contracts to sell foreign currency was an immaterial loss. The effect of a 10% adverse change in exchange rates would reduce the fair value by approximately $0.2 million.
We also used foreign currency forward exchange contracts to hedge our inventory currency risk in Canada. These contracts were denominated in U.S. and Canadian dollars. Due to the closure of our Montreal facility and the resulting reduction in the mix of Canadian and U.S. dollar denominated sales, we elected to cancel the foreign currency forward exchange hedge as of December 29, 2006.
Interest Rate Risk
In October 2002, we entered into an interest rate swap transaction on $50.0 million of our 7.375% Senior Notes. The interest rate swap called for semi-annual interest payments on February 1 and August 1, a floating interest rate based upon the nine month LIBOR rate plus a spread of 3.76%, and an August 1, 2008 maturity date.
On August 25, 2006, we terminated the interest rate swap and paid Wachovia Bank, National Association (Wachovia) $1.8 million representing the interest accrued through the date of termination in August and the termination fee. The termination fee of $1.7 million will be amortized over the remaining life of the 7.375% Senior Notes. As of December 31, 2006, the unamortized amount was $1.4 million. The termination fee, which was locked in on the date of the termination, is the net present value of the amount of interest which exceeded the fixed rate of 7.375% for the balance of the term of the interest rate swap. Taking into account the gain recorded from the inception of the interest rate swap to the termination of $1.1 million and the termination fee of $1.7 million or a net increase in interest of $0.6 million, the effective annual rate of the underlying Senior Notes is 7.578% through the maturity date.
The disclosures with respect to the above noted risks do not take into account the underlying commitments or anticipated transactions. If the underlying items were included in the analysis, the gains or losses on the forward contracts may be offset. Actual results will be determined by a number of factors that are not generally under our control and could vary significantly from those factors disclosed.
We are exposed to credit losses in the event of nonperformance by counterparties on the above instruments, as well as credit or performance risk with respect to our hedged customers’ commitments. Although nonperformance is possible, we do not anticipate nonperformance by any of these parties.
6. Property, Plant and Equipment
Property, plant and equipment at December 31 are as follows:
7. Assets Held for Sale
On September 13, 2006, we announced the planned closure of our manufacturing facilities located in Jackson, Tennessee and Montreal, Quebec. In addition, we also announced our intentions to consolidate the U.S. wholesale distribution facility into the Decatur, Alabama plant location. These actions constitute the first phase of Wolverine’s restructuring and rationalization program, as a part of a strategic planning process and in conjunction with our “Path to Profitability” initiatives, which focus on reducing Wolverine’s North American footprint while continuing to serve and support our customers globally.
On December 31, 2006, we had a net book value of $11.1 million in assets held for resale as a result of these closings. Assets associated with our Jackson, Tennessee facility account for $6.6 million and assets being held for sale from our Montreal, Quebec closing make up the remaining $4.5 million. The write down or impairment of these fixed assets accounted for a $29.6 million reduction in income from continuing operations.
The amount of the impairment was determined by comparing the carrying amount of these assets with preliminary estimates of their fair value. The following is the asset impairment charge by location and amount which has been included in “Restructuring and Other Charges” in the accompanying Consolidated Statements of Operations:
Fixed Asset Impairment Charge
The following indicates the carrying value of assets held for sale:
Assets Held for Sale
8. Deferred Charges
Deferred charges include debt issuance costs, patents and an intangible pension asset. Debt issuance costs are deferred and amortized over the terms of the debt to which they relate using a method which approximates the interest method.
Deferred charges are as follows at December 31:
Deferred charges other than unrecognized prior service cost for pensions are subject to amortization. There were no unrecognized prior service costs for 2006 as a result of adopting SFAS 158. Net deferred debt issuance and deferred interest rate swap costs of $5.7 million will be amortized utilizing a method which approximates the interest method over a weighted average remaining life of 2 years, resulting in amortization expense of $3.4 million, $2.0 million, and $0.3 million in each of the next three succeeding years beginning in 2007. Net capitalized patents costs of $0.8 million are being amortized on a straight line basis over the patent life. Other net deferred costs of $0.6 million are amortized over the estimated useful life of the intangible asset.
9. Accrued Liabilities
Accrued liabilities are as follows at December 31:
10. Financing Arrangements and Debt
Long-term debt consists of the following at December 31:
Aggregate maturities of long-term debt are as follows:
Liquidity Facilities
As of December 31, 2006, our liquidity facilities consisted of a receivables sale facility of up to $90 million (see Note 11, Receivables Sale Facility) and a secured revolving credit facility of up to $35 million. In addition, during 2006, we maintained a silver consignment and forward contracts facility that terminated in December 2006. The agreements governing our liquidity facilities contain cross default provisions. As of December 31, 2006, we were in compliance with
the covenants, including the financial covenants, contained in the agreements governing our liquidity facilities.
Secured Revolving Credit Facility
On April 28, 2005, we entered into a $35 million amended and restated secured revolving credit facility with Wachovia Bank. During 2006, we amended the agreements governing the secured revolving credit facility four times, principally to accomplish the following:
In addition, effective as of February 16, 2007, we amended one of the agreements governing the receivables sale facility in connection with the implementation of the new HSBC silver consignment facility. This amendment adjusted the receivables sale facility’s minimum fixed charge coverage ratio requirement to be consistent with the same covenant in the secured revolving credit facility, discussed in Note 10, Financing Arrangements and Debt, of the Notes to Consolidated Financial Statements.
The following summary of our secured revolving credit facility reflects the terms of the governing agreements as amended through December 31, 2006.
Availability. Our secured revolving credit facility provides for maximum aggregate borrowing availability of up to $35.0 million. The aggregate amount available under the secured revolving credit facility included an $18.0 million sub-limit for letters of credit, and this sub-limit was increased to $24.0 million in the February 2007 amendments.
Borrowing Base. At any time before the maturity of the facility, we may draw, repay and re-borrow amounts available under the borrowing base up to the maximum aggregate availability discussed above. The borrowing base generally equals the sum of (i) 85% of our eligible U.S. accounts receivable (other than accounts of Wolverine Joining Technologies, LLC and accounts sold pursuant to the receivables sale facility); (ii) 60% of our eligible U.S. inventory (eligible inventory attributable to Wolverine Joining Technologies, LLC is capped at $3.0 million); and (iii) 25% of the net book value of our eligible U.S. equipment, capped at $11.0 million. Currently, none of our accounts receivable are eligible for inclusion in the borrowing base calculation. The administrative agent may establish reserve requirements against the borrowing base, and those reserve requirements and eligibility standards may be adjusted during the term. As of December 31, 2006, the reserve requirement was $3.2 million.
Interest and Fees. Under our secured revolving credit facility, borrowings generally bear interest, at our option, at the following rates (i) the Eurodollar rate or the LMIR rate plus a margin between 1.75% to 3.00%, depending on the fixed charge coverage ratio of our Company and our consolidated subsidiaries, or (ii) the greater of the prime rate or adjusted federal funds rate plus a margin between 0.00% to 0.50%, depending on the fixed charge coverage ratio. Accrued interest is payable monthly on outstanding principal amounts, quarterly in the case of Eurodollar loans. In addition, fees and expenses are payable based on unused borrowing availability (0.25% to 0.50% per annum, depending on the fixed charge coverage ratio), outstanding letters of credit (1.75% to 3.00% fee, depending on the fixed charge coverage ratio) and administrative and legal costs.
Maturity. The maturity date of the secured revolving credit facility is April 28, 2008, at which time all amounts borrowed under the facility will be due and outstanding letters of credit must be cash collateralized. The facility may be terminated early upon the occurrence of an event of default.
Security. The obligations under the secured revolving credit facility are secured by (i) a first priority lien on substantially all of our U.S. assets, including inventory, accounts receivable not sold in the receivables sale facility (but excluding real estate) and equipment (other than leased or owned aircraft) and (ii) a first priority pledge of the capital stock of existing and future first-tier foreign subsidiaries of our Company and our U.S. subsidiaries.
Covenants. The secured revolving credit facility contains customary representations and warranties, as well as covenants which, among other things, limit our ability to incur additional indebtedness and liens; enter into transactions with affiliates; make acquisitions; pay dividends; redeem or repurchase capital stock or senior notes; make investments or loans; make negative pledges; consolidate, merge or effect asset sales; or change the nature of our business. The secured revolving credit facility also contains the following covenants:
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a requirement that consolidated Earnings Before Interest, Depreciation and Amortization (EBITDA) for our Company and all of our consolidated subsidiaries (the “Consolidated Parties”) must be greater than or equal to $32.0 million, calculated on a rolling four quarter basis, commencing with the fiscal quarter of the Consolidated Parties ending closest to June 30, 2007 and for each fiscal quarter thereafter (consolidated EBITDA is calculated as the sum of (a) consolidated net income after taxes of the Consolidated Parties for such period excluding extraordinary items of income and as adjusted for certain non-cash items relating to changes in accounting methods and hedge gains and losses, plus (b) the aggregate amount of depreciation and amortization charges made in calculating consolidated net income for such period, plus (c) aggregate consolidated interest expense (net of interest income) for such period, plus (d) the aggregate amount of all income taxes reflected on the consolidated income statements of the Consolidated Parties for such period, plus (e) any backwardation losses between $1.3 and $3.0 million in the last three production months of 2005, plus (f) up to $12.0 million in aggregate non-cash
restructuring charges and up to $6.0 million in aggregate cash restructuring charges through December 31, 2006);
•
a requirement that the Consolidated Parties shall not make consolidated capital expenditures (current expenditures for fixed or capital assets as reflected on the financial statements of the Consolidated Parties) in excess of $15.0 million during any fiscal year; and
•
a requirement that, during any period beginning on the date on which the outstanding obligations under the secured revolving credit facility equal or exceed $18.0 million (the February 2007 amendments changed this threshold to $25 million) and continuing until the termination of the facility and repayment of such obligations, the Consolidated Parties shall maintain a fixed charge coverage ratio of not less than the following amounts as of the last day of each month in the periods indicated below:
(the fixed charge coverage ratio is calculated as the ratio of the following (measured for the 12 consecutive month period ending on the measurement date): (a) consolidated EBITDA less certain unfinanced capital expenditures, taxes paid in cash by the Consolidated Parties and cash dividends paid by our Company, to (b) total consolidated cash interest expense (net of interest income) plus the sum of all scheduled principal payments on consolidated funded debt (other than intercompany debt) for the 12 consecutive months beginning on the measurement date).
Events of Default and Acceleration. The secured revolving credit facility contains customary events of default for credit facilities of this size and type, and includes, without limitation, payment defaults; defaults in performance of covenants or other agreements contained in the transaction documents; inaccuracies in representations and warranties; certain defaults, termination events or similar events with respect to the receivables sale facility; certain defaults with respect to our outstanding senior notes or other indebtedness in excess of $2.5 million; certain bankruptcy or insolvency events; the rendering of certain judgments in excess of $2.5 million; certain ERISA events; certain change in control events and the defectiveness of any liens under the secured revolving credit facility. Obligations under the secured revolving credit facility may be accelerated upon the occurrence of an event of default. Our Company is in compliance with all covenants as of December 31, 2006.
We had borrowings of $2.0 million under our secured revolving credit facility at December 31, 2006. We also had approximately $6.8 million of standby letters of credit outstanding at December 31, 2006. After taking into account an additional $3.2 million of reserves and other holdbacks we had $19.5 million in additional borrowing availability under our secured revolving credit facility as of that date. As of December 31, 2005, we had no outstanding borrowings under our secured revolving credit facility, approximately $12.5 million
of standby letters of credit outstanding, and approximately $11.9 million in additional borrowing capacity available thereunder.
Our Company is in compliance with the above covenants as of December 31, 2006.
Silver Consignment and Forward Contracts Facility
During 2006 and 2005, we maintained a silver consignment and forward contracts facility with BANA, pursuant to which BANA consigned certain amounts of silver to us upon request, and we could enter into forward contracts to purchase certain amounts of silver from BANA in the future for a set price. During the third quarter of 2006, BANA notified us of its intention to exit its precious metals business in its entirety, which included BANA’s silver consignment and forward contracts business with us. In connection with BANA’s preparations to exit this business and our evaluation of alternatives to replace the facility, during the fourth quarter of 2006, we entered into two amendments to the facility to, among other things, decrease the maximum value of consigned silver available to us, provide collateral to secure our obligations under the facility, permit certain accounts receivable generated through the sale of inventory containing consigned silver to be sold through our receivables sale facility, and provide for the ultimate termination of the BANA facility on December 21, 2006. On December 22, 2006, we paid BANA approximately $13.0 million to purchase 1.0 million troy ounces of silver on consignment at the termination date of the facility.
New Silver Consignment Facility
Subsequent to the termination of the BANA facility, we continued pursuing alternatives for a suitable replacement facility with a different provider. On February 16, 2007 we entered into a new silver consignment facility with HSBC Bank USA N.A. (HSBC). Under the consignment facility, we may from time to time request from HSBC, and HSBC may in its sole discretion provide, consignments of silver with an aggregate value of up to the lesser of (a) $25 million and (b) 85% of the aggregate undrawn face amount of letters of credit required to be provided to HSBC pursuant to the consignment facility. Consignment fees, payable monthly, are computed daily based on the rate established by HSBC for each day and are charged on the aggregate value of silver on consignment each day. In addition, upon making a consignment request, we also pay a market premium per troy ounce set by HSBC at the time of the consignment. Upon purchase of any consigned silver, we must either pay HSBC the cash value of the purchased silver or, in certain circumstances with HSBC’s consent, deliver an equal amount of silver to HSBC’s account.
The consignment facility includes customary representations, warranties, covenants and conditions with which we must comply in order to access the consignment facility. In addition, the consignment of silver to us by HSBC under the consignment facility is conditioned on HSBC’s prior receipt and the continued effectiveness of letters of credit in an aggregate amount such that the value of all outstanding consigned silver under the consignment facility is not more than 85% of the aggregate undrawn face amount of the letters of credit. These letters of credit may be drawn by HSBC to cover any amounts owed to HSBC by us under the consignment facility, as well as any amounts paid to HSBC within 90 days of a bankruptcy filing by us.
The HSBC consignment facility is a demand facility. Consequently, upon demand by HSBC, all outstanding consigned silver (or the value thereof) and all other obligations under the consignment facility will become due and payable, and HSBC may draw on the letters of credit to cover such amounts. HSBC may make such a demand, in its sole discretion, at any time and from time to time, whether or not an event of default has occurred or we are otherwise in compliance with the consignment facility. Further, at any time upon notice to us, HSBC may terminate the consignment facility and its obligation to consign silver thereunder. Upon termination of the facility, we must make immediate payment for any consigned silver that has not been purchased and paid for (or deliver a like amount of silver to HSBC’s account), and HSBC may credit any amounts then held by it toward our outstanding obligations or draw on the letters of credit.
Moreover, upon the occurrence of any of the events of default under the consignment facility, our obligations under the consignment facility will become immediately due and payable upon demand by HSBC (or immediately in the case of a bankruptcy or insolvency event), and HSBC may draw on the letters of credit. These events of default include, among others: default in payment or performance of our obligations (or default under any agreement securing or guaranteeing such performance) in connection with the consignment facility; default in payment or performance of any obligations or indebtedness to HSBC or any affiliate; inaccuracy of representations or warranties; certain bankruptcy or insolvency events; loss, theft or damage to, or attachment of, the consigned silver; certain defaults with respect to indebtedness, obligations or liabilities in excess of $2.5 million; the determination by HSBC in good faith that we have suffered a material adverse change; the discontinuance of the operation of our business; failure to renew any letter of credit at least 90 days prior to its expiration date; and certain ratings downgrades with respect to the financial institution issuing the letters of credit.
On February 16, 2007, we delivered to HSBC letters of credit in an aggregate face amount of $16.5 million, which would permit us to request up to an aggregate of $14.025 million in consigned silver under the facility. On or about February 21, 2007, we sold to HSBC approximately 970,000 troy ounces of silver based on the applicable market price on that date or approximately $13 million, and we immediately consigned 970,000 troy ounces of silver under the facility.
10.5% Senior Notes due 2009
There was $99.4 million in principal amount of 10.5% Senior Notes at December 31, 2006. The 10.5% Senior Notes were issued pursuant to an Indenture, dated as of March 27, 2002 between us and Wachovia Bank, national Association, as trustees. The 10.5% Senior Notes (i) have interest payment dates of April 1 and October 1 of each year; (ii) are redeemable after the dates and at the prices (expressed in percentages of principal amount on the redemption date), as set forth below:
(iii) are senior unsecured obligations and are senior in right of payment to any of our future subordinated obligations, (iv) are guaranteed by certain of our subsidiaries and (v) are subject to the terms of the Indenture governing such Senior Notes, which contain certain covenants, including covenants that limit our ability to, among other things, incur unsecured indebtedness, incur indebtedness for borrowed money secured by certain liens, make certain restricted payments, dispose of certain assets, enter into affiliate transactions, or engage in sale/leaseback transactions.
7.375% Senior Notes due 2008
There was $136.8 million in principal amount of 7.375% Senior Notes outstanding at December 31, 2006. The 7.375% Senior Notes were issued pursuant to an Indenture, dated as of August 4, 1998 between us and Wachovia, as trustee. The 7.375% Senior Notes: (i) have interest payment dates of February 1 and August 1 of each year; (ii) are redeemable at our option at a redemption price equal to the greater of (a) 100% of the principal amount of the Senior Notes to be redeemed, or (b) the sum of the present value of the remaining scheduled payments of principal and interest thereon from the redemption date to the maturity date, discounted to the redemption date on a semiannual basis at a rate based upon the yield of the specified treasury securities plus 25 basis points, plus, in each case, accrued interest thereon to the date of redemption; (iii) are senior unsecured obligations and are equal priority in right of payment with any of our existing and future senior unsecured indebtedness; (iv) are guaranteed by certain of our subsidiaries; and (v) are subject to the terms of the Indenture governing such senior notes, which contains certain covenants, including covenants that limit our ability to incur indebtedness for borrowed money secured by certain liens and to engage in sale/leaseback transactions.
Our financing agreements also contain covenants that among other things, require us to maintain certain financial ratios and place other restrictions and limitations on us, including restrictions on our payment of dividends, limitations on the issuance of additional debt and limitations on investments, contingent obligations, the redemption of capital stock and the sale or transfer of assets.
Our Company is in compliance with the above covenants as of December 31, 2006.
Other Credit Facilities
We have a credit facility with a Netherlands bank, payable on demand and providing for available credit of up to 2.9 million euros or approximately $3.8 million. At December 31, 2006, we had outstanding borrowings of approximately 0.9 million euros or approximately $1.2 million under this facility. There were $4 thousand in borrowings as of December 31, 2005.
In 2002, we obtained an interest free loan from the Portuguese government in the amount of 1.9 million euros that matures in 2008. Based on the performance of our Portugal facility, the Portuguese government forgave 40% of the loan, or 0.7 million euros in 2003. Accordingly, we classified 0.7 million euros of the loan as deferred income in 2003, and are amortizing this into income over the life of the equipment purchased with the loan proceeds. The loan balance at December 31, 2006 is 0.9 million euros which equates to $1.0 million U.S. dollars (based on
current exchange rates). The loan provides for annual payments in U.S. dollars $0.5 million in 2007 and $0.5 million in 2008.
11. Receivables Sale Facility
On April 28, 2005, we established a three-year receivables sale facility of up to $45.0 million. During 2006, we amended the agreements governing the receivables sale facility four times, principally to accomplish the following:
The following summary of our receivables sale facility reflects the terms of the governing agreements as amended through December 31, 2006.
Structure. Under the receivables sale facility, our Company and our 100% owned subsidiaries Small Tube Manufacturing, LLC, Tube Forming, L.P, Wolverine Joining Technologies, LLC and Wolverine Tube (Canada) Inc. (collectively, the “Originators”) continuously sell certain receivables without recourse to DEJ 98 Finance, LLC (DEJ), a 100% owned, bankruptcy-remote special purpose entity. Wolverine Finance, LLC (Wolverine Finance), a 100% owned subsidiary of our Company, has been engaged by DEJ to service the sold receivables. The books and records of DEJ are included in the consolidated financial statements of our Company for financial reporting purposes.
The Originators sell, or transfer as a contribution of capital, certain receivables, at a discount and without recourse, to DEJ, whose sole business purpose is the acquisition and financing of the receivables. DEJ can then further sell undivided interests in a specified portion of these receivables, as necessary, to the CIT Group Business Credit Inc. (CIT/BC) and to Variable Funding Capital Company LLC (VFCC), or, to the extent that VFCC elects not to purchase, to Wachovia Bank, National Association (Wachovia) or certain other liquidity banks (collectively, the “Purchasers”) in order to provide the funds required to purchase receivables from the Originators. Proceeds from the collection of the receivables are used by DEJ to purchase additional receivables from the Originators, repay the Purchasers in the event that sufficient additional receivables are not available to maintain their investment, and pay fees and expenses. Our Company has guaranteed the performance by Wolverine Finance and the other
Originators of their obligations under the receivables sale facility. Our Company structured the sale of receivables by the Originators to DEJ and the sale of receivable interests by DEJ as “true sales” under applicable laws. Any interests in the sold receivables which are retained by DEJ, the special purpose, bankruptcy-remote entity, will not be available to our Company or its creditors. The Purchasers have no recourse to our Company’s or the Originators’ assets for losses resulting from the financial inability of customers to pay amounts owed on the receivables when they become due. DEJ is a separate corporate entity with its own creditors who, in the event of DEJ’s liquidation, will be entitled to a claim on DEJ’s assets prior to any distribution to our Company.
Available Amounts. The amount of cash available to us under the receivables sale facility is based upon the amount of eligible receivables and certain reserves required by the facility. Accordingly, availability may fluctuate over time, perhaps materially, given changes in eligible receivables balances and calculation of reserves, but in no case will it exceed the facility’s $90 million purchase limit. Currently, CIT/BC funds a maximum of $45 million of this purchase limit, with the remainder funded by Wachovia.
Based upon the servicing report prepared by Wolverine Finance as of December 31, 2006, the value of receivables eligible to be purchased under the receivables sale facility totaled approximately $45.4 million. We had utilized $43.9 million under the facility at December 31, 2006, leaving remaining availability at this date of approximately $1.5 million.
Costs. Our costs associated with the receivables sale facility depend on which Purchaser funds purchases. Currently, purchases are funded by Wachovia (as liquidity provider, rather than by VFCC, Wachovia’s commercial paper conduit) and by CIT/BC. To the extent that purchases are funded directly by Wachovia (as liquidity provider), our costs, payable monthly, accrue on outstanding balances at the LIBO rate plus 2.00% per annum or at our Company’s option at the base rate plus 50 basis points if our Company’s fixed charge coverage ratio is less than 1:1. Our monthly costs on purchases funded by CIT/BC are based on the LIBO rate plus 2.00% per annum. Commitment fees on the unused portion of the facility are payable monthly at a per annum rate of between 0.35% to 0.50% for Wachovia, depending on our fixed charge coverage ratio, and 0.50% for CIT/BC. DEJ also pays certain fees and expenses of the Purchasers, including an annual administration fee and audit and legal fees of the Purchasers. We also paid structuring fees to Wachovia and CIT/BC at closing.
Representations, Warranties, Covenants and Indemnities. The receivables sale facility contains representations, warranties, covenants and indemnities customary for facilities of this type.
Termination. The receivables sale facility is scheduled to expire on April 28, 2008. Although VFCC may elect to purchase undivided ownership interests in receivables, CIT/BC, Wachovia and the other liquidity banks have committed to purchase receivables interests, on the terms and subject to the conditions in the receivables sale facility, until this expiration date. We can terminate the receivables sale facility upon 10 days notice without a termination fee.
Wachovia, as agent for the Purchasers, can terminate purchases of receivables interests prior to the scheduled expiration date upon the occurrence of certain events, including, among others, non-performance by us of payments or other agreements under the receivables sale facility; inaccuracy of the representations and warranties made in the facility documents; defaults with respect to other obligations of DEJ; defaults with respect to indebtedness in excess of $2.5 million of our Company or our subsidiaries other than DEJ; bankruptcy or insolvency events regarding us or any of our subsidiaries; certain statistics concerning collections of the receivables not meeting specified criteria; certain change of control events; the rendering of judgments in excess of specified amounts against DEJ, us or our subsidiaries; the termination of any of the transaction documents, the cessation of any transfers of receivables under the receivables sale agreements or the ineffectiveness of our performance guarantee; the agent’s interest in the receivables ceasing to be valid; the outstanding amount received by us exceeding the $90 million purchase limit or the aggregate adjusted amount of outstanding receivables; certain events that materially adversely affect the credit quality of receivables or our Company and our subsidiaries taken as a whole; certain ERISA events; defaults in certain financial requirements, which are the same as the financial covenants required under the secured revolving credit facility; and termination of the secured revolving credit facility.
In accordance with the provisions of SFAS 140, we include in accounts receivable in its consolidated balance sheets the portion of receivables sold to DEJ which have not been resold by DEJ to the Purchasers. At December 31, 2006, the outstanding amount of investment by the Purchasers under the agreements was $43.9 million. Accordingly, accounts receivable in the consolidated balance sheets have been reduced by $43.9 million at December 31, 2006, representing the face amount of the outstanding receivables sold at that date.
Our Company is in compliance with the above covenants as of December 31, 2006.
12. Interest Expense
The following table summarizes interest expense, net:
13. Retirement and Pension Plans
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106 and 132(R) (SFAS 158). We adopted the provisions of the statement as of December 31, 2006. This statement requires balance sheet
recognition of the overfunded or underfunded status of pension and postretirement benefit plans. Under SFAS 158, actuarial gains and losses, prior service costs or credits, and any remaining transition assets or obligations that have not been recognized under previous accounting standards must be recognized in accumulated other comprehensive income in equity, net of tax effects, until they are amortized as a component of net periodic benefit cost. In addition, the measurement date (the date at which plan assets and the benefit obligation are measured) is required by SFAS 158 to be our Company’s fiscal year end which is consistent with the measurement we use.
The following table illustrates the impact adopting SFAS 158 had on the consolidated balance sheets as of December 31, 2006:
In January 2006, we announced the modernization of our retirement program for the majority of our active U.S. employees. As part of the retirement benefit modernization program, we froze both our U.S. qualified defined benefit plan and Supplemental Benefit Restoration Plan, effective February 28, 2006. Additionally, we terminated the 2002 Supplemental Executive Retirement Plan in December 2005, as previously disclosed. On March 1, 2006, we made enhancements to our 401(k) plan for the employees impacted by the freeze of the defined benefit plan. These enhancements include an automatic three percent contribution to each affected employee’s 401(k) account, a match (the percentage of which is determined annually for the next year) of employees’ discretionary contributions, the addition of a success sharing component to
the 401(k) plan, and the provision of transition contributions for five years, based upon an employee’s age and years of service.
In accordance with Statement of Financial Accounting Standards No. 88 (SFAS 88), Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Plans we recorded charges of $645 thousand and $159 thousand in the fourth quarter of 2005 related to the freezing of the qualified defined benefit plan and the Supplemental Benefit Restoration Plan. We also recorded a $2.6 million charge relating to the termination of the 2002 Supplemental Executive Retirement Plan in the fourth quarter of 2005 that would have otherwise been recorded over time.
We recorded expense with respect to the 401(k) plans for the three years ended December 31, 2006, 2005 and 2004 as shown in the table below:
The 401(k) employer match and the 3% defined contribution programs were funded during 2006. We anticipate funding the employees’ 401(k) accounts approximately $2.6 million for success share and the transition credit by the end of the first quarter of 2007.
U.S. Qualified Retirement Plan
We have a U.S. defined benefit pension plan (U.S. Retirement Plan) that is noncontributory covering the majority of all our U.S. employees fulfilling minimum age and service requirements. Benefits are based upon years of service and a prescribed formula based upon the employee’s compensation. As mentioned above, on February 28, 2006 we froze the benefits available under this plan. As a result of the freeze, all future benefit accruals ceased for U.S. Retirement Plan participants as of February 28, 2006. Participants maintain U.S. Retirement Plan benefits accrued through that date.
The weighted average asset allocations for our U.S. Retirement Plan at December 31 are as follows:
The investment policy of our U.S. Retirement Plan states that the overall target allocation of investments should be 60% equities and 40% bonds. The investment policy of our U.S. Retirement Plan states that all assets selected for the portfolio must have a readily ascertainable
market value and must be readily marketable. The policy expressly prohibits certain types of assets or transactions including commodities, futures, private placements, warrants, purchasing of securities on margin, selling short, options, derivatives, interest rate swaps, limited partnerships and real estate.
The investment policy of our U.S. Retirement Plan states that investments in equity securities must be of good quality and diversified so as to avoid undue exposure to any single economic sector, industry or group or individual security. The policy states that investments in debt securities should be rated “A” or better, allowing debt securities with a rating of “BBB” as long as the total amount rated “BBB” does not exceed 10% of the debt securities portfolio at the time of purchase and as long as the debt securities portfolio maintains an overall rating of at least “A”. The investment policy limits the debt securities of any one issuer, excluding investments in U.S. Government guaranteed obligations, and states that no debt securities should have a maturity of longer than thirty years at the time of purchase.
The U.S. qualified pension plans use a December 31 measurement date.
The amounts recognized in the Consolidated Balance Sheets before taxes are as follows at December 31:
As of December 31, 2006, included in accumulated other comprehensive loss was a net actuarial loss of $24.6 million.
Certain assumptions utilized in determining the benefit obligations for the U.S. Retirement Plan for the years ended December 31 are as follows:
*
Historically, we used Moody’s Aa Corporate Bond Index as a discount rate. Beginning in 2006, we began using the Hewitt Yield Curve, believing it to be a more accurate method to determine bond yield rates. The effect of changing this method increased the discount rate by 0.17%. Had our Company continued to use the Moody’s Aa rate index, the benefit obligation for the qualified pension plan would be $3.4 million higher at December 31, 2006.
A summary of the components of net periodic pension cost for the U.S. Retirement Plan for the years ended December 31 is as follows:
The amortization of our net actuarial loss in 2006 of $0.9 million is the amortization of total unrecognized losses as of January 1, 2006 that exceeds 10% of our projected benefit obligation, approximately $11.3 million, and is being amortized over the 12 years of the expected average remaining years of service of the plan participants.
The estimated net actuarial loss that will be amortized from accumulated other comprehensive loss during 2007 is $705 thousand.
Certain assumptions utilized in determining the net periodic benefit cost for the years ended December 31 are as follows:
The expected long-term rate of return on plan assets is selected by taking into account the expected weighted averages of the investments of the assets, the fact that the plan assets are actively managed to mitigate downside risks, the historical performance of the market in general and the historical performance of the U.S. Retirement Plan assets over the past ten years. For the ten year period ended December 31, 2006 and 2005, the U.S. Retirement Plan assets have provided a weighted rate of return of 9.8% and 10.6%, respectively.
The accumulated benefit obligations at December 31, 2006 and 2005 were $161.7 million and $164.7 million, respectively. The following table sets forth a reconciliation of the projected benefit obligation for the years ended December 31:
The actuarial gain for the year ended December 31, 2006 results from a $1.5 million gain due to personnel experience and a $3.4 million gain due to the change in the discount rate from 5.75% to 5.92%. The actuarial loss for the year ended December 31, 2005 results from a $4.0 million loss due to personal experience, a $3.1 million gain due to the decrease in the future salary increase assumption from 3.5% to 3.0%, a $5.9 million loss due to the change in the discount rate from 6.00% to 5.75%, and a $4.0 million loss due to the use of an updated mortality rate.
The following table sets forth a reconciliation of the plan assets for the years ended December 31:
In 2007, with regard to the U.S. Retirement Plan, we anticipate making mandatory contributions totaling $7.5 million as required by funding regulations or laws.
The following table sets forth the funded status of the plan and the amounts recognized in our Consolidated Balance Sheets at December 31:
The expected future benefits payments for the plan are as follows:
U.S. Nonqualified Pension Plans
Our Company previously had two nonqualified pension plans in the United States. The Supplemental Benefit Restoration Plan (the Restoration Plan) was established as of January 1, 1994. The Restoration Plan is a non-funded, defined benefit pension plan that provides benefits to employees identical to the benefits provided by the U.S. Retirement Plan, except that under the U.S. Retirement Plan final average annual compensation for purposes of determining plan benefits for 2006 was capped at $220,000 by Internal Revenue Code. Benefits under the Restoration Plan are not subject to this limitation. However, Restoration Plan benefits are offset by any benefits payable from the U.S. Retirement Plan. We announced the freezing of the Restoration Plan, effective February 28, 2006. As a result of the freeze, all future benefit accruals ceased for Plan participants as of February 28, 2006. Participants maintain Plan benefits accrued through that date.
Our Company also had previously established, on January 1, 2002, the 2002 Supplemental Executive Retirement Plan (the Executive Plan) to provide retirement benefits to executives who were employed at the level of senior vice president or above and who were approved for participation by the Compensation Committee upon the recommendation of the Chief Executive Officer (CEO). The Executive Plan, in general, provided a monthly benefit to participants at the normal retirement age of 65 of 55% of average pay reduced by benefits under the U.S. Retirement Plan, the Restoration Plan and Social Security. The annual benefit payable to the CEO was increased by $6,000 for each year of service. Benefits became fully vested upon a change in control and were immediately payable in the event of a termination of employment following a change in control. Otherwise, benefits vested upon attaining age 55 and earning 12 years of service. The Executive Plan was terminated by our Company on December 9, 2005, effective December 16, 2005. At the time of the termination of the Executive Plan, there were four participants. No current participants were vested under the Executive Plan on the date of termination other than Dennis Horowitz, our former CEO who retired on December 9, 2005. With the exception of Mr. Horowitz (who retired on December 9, 2005 and whose Executive Plan benefits were paid in 2006), no further benefits will be payable to any participant under the Executive Plan. Benefits due to Mr. Horowitz were paid in 2006: $4.4 million from funds previously held in a rabbi trust and $1.3 million from the general operating funds of our Company.
The U.S. nonqualified pension plans use a December 31 measurement date.
The amounts recognized in the Consolidated Balance Sheets before taxes are as follows at December 31:
As of December 31, 2006, included in accumulated other comprehensive loss was a net actuarial loss of $133 thousand.
Certain assumptions utilized in determining the benefit obligations for the nonqualified pension plans for the years ended December 31 are as follows:
*
Historically, we used Moody’s Aa Corporate Bond Index as a discount rate. Beginning in 2006, we began using the Hewitt Yield Curve, believing it to be a more accurate method to determine bond yield rates. The effect of changing this method increased the discount rate by 0.17%. Had our Company continued to use the Moody’s Aa rate index, the benefit obligation for the nonqualified pension plan would be $10 thousand higher at December 31, 2006.
A summary of the components of net periodic pension cost for the nonqualified pension plans for the years ended December 31 is as follows:
The estimated net actuarial loss that will be amortized from accumulated other comprehensive loss during 2007 is $2 thousand.
The unfunded accumulated benefit obligation for the nonqualified pension plan was $1.2 million at December 31, 2006. The following table sets forth a reconciliation of the projected benefit obligation for the years ended December 31:
The following table sets forth a reconciliation of the plan assets for the years ended December 31:
In 2007, we anticipate making payments to participants of $0.1 million, which represents the equivalent of the normal amount of benefits.
The following table sets forth the funded status of the plans and the amounts recognized in our Consolidated Balance Sheets at December 31:
The expected future benefits payments for the plan is as follows:
Canadian Plans
We sponsor a defined contribution profit-sharing retirement plan for our London, Ontario facility employees who are required to contribute 4% of regular wages, subject to a maximum contribution limit specified by Canadian income tax regulations. Company contributions were $0.1 million in 2006, $0.4 million in 2005 and $0.3 million in 2004.
We also have established two noncontributory defined benefit pension plans covering substantially all our employees at the Montreal, Quebec facility (Canadian Plans). The two plans are the Wolverine Tube (Canada) Inc. Pension Plan for Salaried Employees (the Salaried Plan) and the Wolverine Tube (Canada) Inc. Pension Plan for Operational Employees (the Operational Plan). We contribute the actuarially determined amounts annually into the plans. Benefits for the hourly employees are based on years of service and a negotiated rate. Benefits for salaried employees are based on years of service and the employee’s highest annual average compensation over five consecutive years.
On September 13, 2006, we announced the decision to close the Montreal, Quebec facility. On January 31, 2007, in connection with the closure, the two Canadian plans were terminated. In accordance with Statement of Financial Accounting Standards No. 88 (SFAS 88), Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Plans during 2006 we recorded $4.2 million in curtailment charges for the Canadian operational and salaried pension plans. It is expected that these plans will be settled late in the second quarter of 2007 and we currently anticipate funding a total of approximately $3.2 million for the two plans. On February 23, 2007 we purchased annuities for the two plans at a rate of return greater than assumed in our disclosures. The result of this positive event will be reflected in a settlement gain net of any remaining funding. We estimate this settlement gain to be approximately $0.8 million.
The investment policy of our Canadian Plans states that all assets selected for the portfolio must have a readily ascertainable market value and must be readily marketable. The policy expressly limits the use of certain types of assets or transactions including commodities, futures, private placements, warrants, purchasing of securities on margin, selling short, options, derivatives, interest rate swaps and limited partnerships.
The investment policy of our Canadian Plans states that investments in equity securities must be of good quality and diversified so as to avoid undue exposure to any single economic
sector, industry or group or individual security. The policy states that investments in debt securities should be rated “BBB” or better. The investment policy limits the debt securities of any one issuer, excluding investments in federal government guaranteed obligations.
The investment policy of our Canadian Plans state that investments in assets should be in accordance with the maximum and minimum ranges for each asset category as follows:
The expected long-term rate of return on plan assets is selected by taking into account the expected weighted averages of the investments of the assets, the fact that the plan assets are actively managed to mitigate downside risks, the historical performance of the market in general and the historical performance of the Canadian Plans assets over the past ten years. For the ten year period ended December 31, 2006 and 2005, the Canadian Plans assets have provided a weighted average rate of return of 8.9% and 9.2%, respectively.
The discount rates utilized in determining the benefit obligations for the Canadian Salaried and Operational Plans were 4.15% and 4.28%, respectively, for the years ended December 31, 2006 and 2005, respectively. The expected rate of increase in compensation used in accounting for the Salaried Plan was 0.0% and 3.0% for the years ended December 31, 2006, and 2005 respectively. The rate of increase in compensation is not applicable in accounting for the Operational Plan for the same periods.
The December 31, 2006 discount rates reflect the wind-up of the plans in 2007, and are a weighted average of the assumed annuity purchase rate for retirees of 4.0% and the following prescribed rates for determining the present value of benefits for the non-retired members for the Salaried and Operational plans in 2007:
Salaried Plan
The weighted average asset allocation for our Salaried Plan at December 31 is as follows:
The amounts recognized in the Consolidated Balance Sheets before taxes are as follows at December 31:
As of December 31, 2006, included in accumulated other comprehensive loss was a net actuarial loss of $2.0 million.
A summary of the components of net periodic pension cost for the Salaried Plan for the years ended December 31 is as follows:
The estimated net actuarial loss that will be amortized from accumulated other comprehensive loss during 2007 is $2.0 million.
Certain assumptions utilized in determining the net periodic benefit cost for the Salaried Plan for the years ended December 31 are as follows:
The accumulated benefit obligations at December 31, 2006 and 2005 for the Salaried Plan were $11.9 million and $10.8 million, respectively. The following table sets forth a reconciliation of the projected benefit obligation for the Salaried Plan for the years ended December 31:
The following table sets forth a reconciliation of the plans assets for the Salaried Plan for the years ended December 31:
In 2007, we anticipate providing approximately $1.3 million in contributions to the Salaried Plan.
The following table sets forth the funded status of the Salaried Plan and the amounts recognized in our Consolidated Balance Sheets at December 31:
The expected future benefits payments for the Salaried Plan are as follows:
Operational Plan
The weighted average asset allocation for our Operational Plan December 31 is as follows:
The amounts recognized in the Consolidated Balance Sheets before taxes are as follows at December 31:
As of December 31, 2006, included in accumulated other comprehensive loss was a net actuarial gain of $0.3 million.
A summary of the components of net periodic pension cost for the Operational Plan for the years ended December 31 is as follows:
The estimated net actuarial gain that will be amortized from accumulated other comprehensive loss during 2007 is $0.3 million.
Certain assumptions utilized in determining the net periodic benefit cost for the years ended December 31 are as follows:
The accumulated benefit obligations at December 31, 2006 and 2005 for the Operational Plan were $20.1 million and $18.2 million, respectively. The following table sets forth a reconciliation of the benefit obligation for the Operational Plan for the years ended December 31:
The following table sets forth a reconciliation of the plans assets for the Operational Plan for the years ended December 31:
In 2007, we anticipate providing approximately $1.8 million in contributions to the Operational Plan.
The following table sets forth the funded status of the plans and the amounts recognized for the Operational Plan in our Consolidated Balance Sheets at December 31:
The expected future benefits payments for the Operational Plan are as follows:
14. Postretirement Benefit Obligation
We sponsor a health care plan and life insurance plan that provides postretirement medical benefits and life insurance to substantially all our full-time U.S. and Canadian employees who have worked ten years after age 50 (52 for employees of our Altoona, Pennsylvania facility), and spouses of employees who die while employed after age 55 and have at least five years of service. This plan is contributory, with retiree contributions being adjusted annually. The plan was modified twice in 2005 to grant retiree coverage at active rates, without regard to the age requirement to one executive officer and to exclude employees who are not yet age 55 (age 57 for employees located in Altoona, Pennsylvania) or older as of February 28, 2006 from subsidized retiree medical coverage.
Net periodic postretirement benefit cost for the years ended December 31 includes the following components:
The change in benefit obligation for the years ended December 31 includes the following components:
The following table sets forth the Funded Status of the plans at December 31:
The following chart shows the estimated Future Benefit Payments for U.S. plans for the next 5 years, and the aggregate for the five fiscal years thereafter.
Expected Future Benefit Payments
The following table reconciles the beginning and ending balances of the fair value of plan assets for year 2006.
As indicated in Note 2, Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements, under SFAS 158 gains and losses, prior service costs and credits, and any remaining transition amounts under SFAS 106 that have not yet been recognized through net periodic benefit cost will be recognized in accumulated other comprehensive income, net of tax effects, until they are amortized as a component of net periodic cost.
The following chart sets forth the amounts recognized in Accumulated Other Comprehensive Income at December 31, 2006.
The following table sets forth the amounts in accumulated other comprehensive income expected to be recognized as components of net periodic benefit cost during fiscal year 2007.
The weighted average discount rate used in determining the postretirement benefit obligation was 5.31% at December 31, 2006 and 5.43% at December 31, 2005. The weighted average discount rate used to determine net periodic benefit cost was 5.30% at December 31, 2006 and 6.00% at December 31, 2005.
Our best estimate of contributions expected to be paid to the U.S. and Canadian plans during the fiscal year of 2007 is $1.4 million.
For purposes of determining the cost and obligation for pre-Medicare postretirement medical benefits, a 9.0% annual rate of increase in the per capita cost of covered benefits (i.e., health care trend rate) was assumed for our U.S. plan, grading down by 0.5% to an ultimate rate of 5.0% in 2015.
An 8.5% annual rate of increase in the health care trend rate was assumed for our Canadian plan, and is expected to decrease 1% per year to an ultimate rate of 4.5%. Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans. A one percent change in the assumed health care cost trend rate would have had the following effects:
15. Environmental Matters
We are subject to extensive environmental regulations imposed by federal, state, provincial and local authorities in the U.S., Canada, China, Portugal and Mexico with respect to emissions to air, discharges to waterways, and the generation, handling, storage, transportation, treatment and disposal of waste materials. We have received various communications from regulatory authorities concerning certain environmental matters.
We have accrued undiscounted estimated environmental remediation costs of $0.8 million at December 31, 2006, consisting of $0.1 million for the Decatur facility and $0.7 million for the Ardmore facility. Based on information currently available, we believe that the costs of these matters are not reasonably likely to have a material effect on our business, financial condition or results of operations. However, actual costs related to environmental matters could differ materially from the amounts we estimated and accrued at December 31, 2006 if these environmental matters are not resolved as anticipated.
As result of the closure of the Montreal facility, our Company became subject to certain requirements of the Quebec Environmental Quality Act, which include performing a comprehensive Site Characterization and Rehabilitation Plan. This requires that Phase I and Phase II Environmental Site Assessments (ESA) be performed to determine the amount and extent of any contamination. A Site Rehabilitation Plan and Schedule, based upon the results of the Phase I & II ESAs, also must be submitted to the government for review and approval. Once approved, our Company will perform any required site remediation. The Phase I and Phase II ESAs began in January, 2007.
In 2006, we established an environmental accrual of $11.0 million for the Montreal facility. With the assistance of outside counsel and environmental consultants, our Company reevaluated environmental reports about the site prepared in 1993 to estimate the costs to meet the requirements of the Environmental Quality Act. The established accrual does not include costs associated with areas that could be contaminated but were not assessed.
We believe our operations are in substantial compliance with all applicable environmental laws and regulations as currently interpreted. We utilize an active environmental
auditing and evaluation process to facilitate compliance with applicable environmental laws and regulations. However, future regulations and/or changes in the text or interpretation of existing regulations may subject our operations to increasingly more stringent standards. While we cannot quantify the effect of any future potential changes on our business, compliance with such requirements may make it necessary, at costs which may be substantial, to retrofit existing facilities with additional pollution-control equipment and to undertake new measures in connection with the storage, transportation, treatment and disposal of by-products and wastes.
16. Litigation
Our facilities and operations are subject to extensive environmental laws and regulations, and we are currently involved in various proceedings relating to environmental matters (see Note 15, Environmental Remediation, of the Notes to Consolidated Financial Statements). We are not involved in any other legal proceedings that we believe could have a material adverse effect upon our business, operating results or financial condition.
17. Income Taxes
The components of income/(loss) from continuing operations before income taxes for the years ended December 31 are as follows:
The provision for income taxes for the years ended December 31 consists of the following:
Deferred income taxes included in our Consolidated Balance Sheets reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the carrying amount for income tax return purposes. Significant components of our deferred tax assets and liabilities are as follows at December 31:
Reconciliation of differences between the statutory U.S. federal income tax rate and our effective tax rate follows for the years ended December 31:
At December 31, 2006, we have U.S. federal, state and foreign net operating loss carryforwards of $105.0 million, $231.9 million and $42.3 million, respectively. These net operating loss carryforwards expire at various times beginning in 2007 through 2026. During 2006, we increased the valuation allowance for U.S. and foreign deferred tax assets from $20.0 million to $56.3 million because it was determined that it was more likely than not that some of these deferred tax assets related to U.S. and foreign net operating loss carryforwards would not be realized. Of this increase, $35.8 million resulted in a charge to operations, and the remainder was charged to other balance sheet accounts. The remaining deferred tax assets of $5.2 million have not been reserved since the company has tax planning strategies which should insure its realizability.
We also have $0.3 million in government tax credits which may be used to offset tax liabilities in Portugal through 2008. These credits are not reflected in deferred tax assets at December 31, 2006 or 2005. We believe in 2007 the remaining government tax credit will be utilized and our tax holiday will conclude and taxable income in Portugal will be subject to taxes at a rate of 25%.
Prior to the passage of the American Jobs Creation Act of 2004 (the Act), the undistributed earnings of our foreign subsidiaries were considered to be indefinitely reinvested, and in accordance with APB Opinion No. 23 (APB 23), Accounting for Income Taxes - Special Areas, no provision for U.S. federal or state income taxes had been provided on these undistributed earnings. The Act provided for a special 85% dividends received deduction on the repatriation of certain foreign earnings. As a result of the Act, we repatriated approximately $10.2 million in undistributed foreign earnings from our Chinese subsidiary during 2005. We took a tax charge for U.S. federal income taxes of approximately $0.5 million in the first quarter 2005 associated with the repatriation of these funds. At December 31, 2006, the undistributed earnings of our foreign subsidiaries amounted to approximately $60.8 million. Foreign withholding taxes of $3.6 million would also be payable upon remittance of any previously unremitted earnings at December 31, 2006. The exact amount of the charge depends on the pending technical corrections to the legislation and expected interpretive guidance to be issued by the Internal Revenue Service.
In December 2004, the FASB issued Staff Position No. FAS 109-1, Application of SFAS 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities provided by the American Jobs Creation Act of 2004 (FSP 109-1). FSP 109-1 states that qualified domestic production activities should be accounted for as a special deduction under SFAS 109, and not treated as a rate reduction. The provisions of FSP 109-1 are effective immediately. Our Company did not qualify for this benefit during 2006 and will continue to monitor its applicability in future years.
18. Accumulated Other Comprehensive Loss
The components of accumulated other comprehensive loss at December 31, are as follows:
19. Common Stock
All holders of common stock are entitled to receive dividends when and if declared by our Board of Directors (the Board), provided that all dividend requirements of the cumulative preferred stock have been paid. Additionally, the payment of dividends on our common stock is restricted under the terms of our various financing agreements. To date, no dividends have been paid to the holders of the common stock and there are no immediate plans to declare a dividend.
Our Company’s Stockholder Rights Plan, which was adopted by the Board in 1996, expired on February 23, 2006.
20. Stock-Based Compensation Plans
The 2003 Equity Incentive Plan (the 2003 Equity Plan) was adopted by the Board of Directors on March 25, 2003 and was approved by the stockholders on May 14, 2003, and was amended on July 24, 2003. The 2003 Equity Plan provides for the issuance of awards in the form of stock options, restricted shares, stock appreciation rights and other additional awards to key executives and employees. The maximum number of shares of common stock that may be issued under the plan is limited to 850,000 shares, provided that no more than 250,000 shares may be issued in the form of awards other than options or stock appreciation rights. The duration of the 2003 Equity Plan is ten years.
On March 22, 2001, the Board of Directors adopted the 2001 Stock Option Plan for Outside Directors (the 2001 Directors’ Plan) providing for the issuance of options for the purchase of up to 250,000 shares of our common stock. The 2001 Directors’ Plan allows us to compensate and reward our directors. The terms of the 2001 Directors’ Plan provides for the issuance of stock options to outside directors at the fair market value on the date of grant. The initial options granted at the time the Director joins the Board vest at 33.3% per year, but must be held one year before exercising. All subsequent grants vest immediately. All options terminate on the tenth anniversary of the date of grant.
The 1993 Equity Incentive Plan (the 1993 Equity Plan) provided for the issuance of stock options, restricted shares, stock appreciation rights, and other additional awards to key executives and employees. The maximum number of shares provided for under the 1993 Equity Plan was 2,075,000 at a price as determined by our Compensation Committee. All options granted under the plan were issued at the market value at the date of the grant. Options granted prior to 1999 under the 1993 Equity Plan vested 20% on each anniversary thereafter and terminate on the tenth anniversary of the date of grant. Options granted in 1999 and subsequent years under the 1993 Equity Plan vested 33.3% on each anniversary thereafter and terminate on the tenth anniversary of the date of grant. Options granted under prior plans remain outstanding but are governed by the provisions of the 1993 Equity Plan. The 1993 Equity Plan was terminated by its terms in 2003.
In the third quarter of 2001, we made available to our U.S. and Canadian stock option holders under the 1993 Equity Plan and the 1993 Directors’ Plan the right to exchange options whose
exercise price was $20.00 per share or greater, for new options to purchase one share for every two shares exchanged. We made the exchange offer available because a large number of stock options had exercise prices that were significantly higher than current trading prices of our common stock, and thus the stock options did not provide our employees and outside directors the incentive to acquire and maintain stock ownership in the Company and to participate in the Company’s long-term growth and success. As a result of this exchange of options, 836,860 shares with an average option price of $30.48 were canceled, 38,000 of which were under the 1993 Directors’ Plan. On April 11, 2002, six months and six business days after the date the options were cancelled, we granted 383,075 stock options, 19,000 of which were under the 1993 Directors’ Plan. New options granted under the 1993 Equity Plan have an exercise price of $8.60 per share, which was the closing price of our common stock on April 11, 2002. New options granted under the 1993 Directors’ Plan have an exercise price of $8.84 per share which was determined by the average market price of our stock on April 11, 2002 and the four preceding trading days. A stock option holder must have continued to have been employed by us or provide service to us through April 11, 2002 in order to have been eligible to receive the new options granted.
Our stock option plans are summarized as follows:
There were no options outstanding at December 31, 2006 that were issued prior to August 1993. The number of options outstanding, weighted average exercise price, weighted average remaining contractual life, vested options and the weighted average exercise price of vested options outstanding at December 31, 2006 were 1,784,318, $9.15, 5.5 years, 1,629,270 and $9.60, respectively.
At December 31, 2005, we had stock-based employee and outside director compensation plans. Effective January 1, 2006, the Company adopted SFAS 123(R) utilizing the modified prospective method. SFAS 123(R) requires the measurement and recognition of compensation expense for all stock-based payment awards made to employees and directors, including stock options based on their fair values. The Company’s financial statements for the fourth quarter and twelve months ended December 31, 2006 reflect the impact of SFAS 123(R).
In 2005, the Company accelerated the vesting of all out-of-the-money, unvested, non-qualified stock options held by officers and employees in anticipation of the impact of SFAS 123(R). All options priced above $7.42, the closing market price of the Company’s common stock on October 18, 2005, were considered to be out-of-the-money. The primary purpose of the accelerated vesting was to avoid recognizing compensation expense associated with these options upon adoption by the Company of SFAS 123(R). Without the acceleration, the Company estimates that pre-tax charges under SFAS 123(R) relating to these options would have been $0.7 million and $0.2 million in fiscal 2006 and 2007, respectively.
Upon adoption of SFAS 123(R), the Company elected to value its stock-based payment awards granted beginning in fiscal year 2006 using the Black-Scholes option-pricing model (Black-Scholes model), which was previously used for pro forma information. The Black-Scholes model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. The Black-Scholes model requires the input of certain assumptions. The determination of fair value of stock-based payment awards on the date of grant using the Black-Scholes model is affected by our stock price as well as the input of other subjective assumptions, including: expected stock price volatility, the expected pre-vesting forfeiture rate and the expected option term (the amount of time from the grant date until the options are exercised or expire). Expected volatility is determined based upon actual historical stock price movements over the expected option term. Expected pre-vesting forfeitures are estimated based on actual historical pre-vesting forfeitures for the expected option term. The expected option term is calculated using the “simplified” method permitted by Staff Accounting Bulletin No. 107, which the Company has applied in its adoption of SFAS 123(R). Our options have characteristics significantly different from those of traded options, and changes in the assumptions can materially affect the fair value estimates.
The adoption of SFAS 123(R) resulted in stock-based compensation expense for the year ended December 31, 2006 of approximately $0.3 million, all of which was recorded in selling, general and administrative expenses. This expense increased the loss per share by $0.02 per basic share for the year ended December 31, 2006.
The Company recorded stock-based compensation expense for the year ended December 31, 2006 and December 31, 2005 as follows:
Prior to the adoption of SFAS 123(R), the Company presented any tax benefits of deductions resulting from the exercise of stock options within operating cash flows in the Condensed Consolidated Statement of Cash Flows. SFAS 123(R) requires tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options to be classified and reported as both an operating cash outflow and a financing cash inflow upon adoption of SFAS 123(R).
As of December 31, 2006, the Company had not yet recognized compensation expense on the following non-vested awards:
The determination of the fair value of the stock option awards granted during the year ended December 31, 2006, using the Black-Scholes model, incorporated the assumptions set forth in the following table. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant. Expected volatility is based on historical volatility. Expected life is based on historical experience and consideration of changes in option terms.
The following table summarizes stock options outstanding and changes during the year ended December 31, 2006:
The range of exercise prices of the exercisable options and outstanding options at December 31, 2006 are as follows:
Restricted stock award activity for the year ended December 31, 2006 is summarized below:
21. Commitments
We lease certain assets such as motorized vehicles, distribution and warehousing space, computers, office equipment and production testing equipment. Terms of the leases, including purchase options, renewals and maintenance costs, vary by lease. Minimum future rental commitments under our operating leases having non- cancelable lease terms in excess of one year totaled approximately $2.8 million as of December 31, 2006 and are payable as follows: $1.4 million in 2008, $1.0 million in 2009 and $0.3 million in 2010. Rental expense for operating leases was $4.4 million in 2006, $3.9 million in 2005 and $3.8 million in 2004.
At December 31, 2006, we had commitments of $0.1 million for capital expenditures.
At December 31, 2006, we had commitments to purchase approximately 49.3 million pounds of copper in 2007 from suppliers to be priced at COMEX at either the date of shipment or average for the month plus an average premium of approximately $0.04 per pound. Based upon a copper price of $2.75 per pound, this commitment totals approximately $137.6 million.
22. Industry Segments and Foreign Operations
Our reportable segments are based on our three product lines: commercial products, wholesale products and rod, bar and other products. Commercial products consist primarily of high value-added products sold directly to original equipment manufacturers. Wholesale products are commodity-type plumbing tube products, which are primarily sold to plumbing wholesalers and distributors. Rod, bar and other products consists of products sold to a variety of customers and includes our European distribution business.
The accounting policies for each of the reportable segments are the same as those described in Note 2, Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements. We evaluate the performance of our operating segments based on sales and gross profit; however, we do not allocate asset amounts and items of income and expense below gross profit.
Summarized financial information concerning our reportable segments is shown in the following table:
Our manufacturing operations are primarily conducted in the U.S. and Canada. We also have manufacturing facilities in Shanghai, China, Esposende, Portugal and Monterrey, Mexico.
In 2006, 2005 and 2004, no customer accounted for as much as 10% of our net sales.
Sales to unaffiliated customers and long-lived assets are based on our Company’s location providing the products:
Information concerning enterprise-wide revenues by product line is shown in the following table:
Included in “Other Products” in Commercial Products above, are our Company’s metal joining and copper alloy product lines as individually each of those product lines represent less than 10% of our Company’s total sales for each year.
23. Restructuring and Other Charges
On September 13, 2006, we announced the planned closure of our manufacturing facilities located in Jackson, Tennessee and Montreal, Quebec. In addition, we also announced moving our U.S. wholesale distribution facility into the Decatur, Alabama plant location. These actions constituted the first phase of Wolverine’s restructuring and rationalization program, as a part of our strategic planning process and in conjunction with our “Path to Profitability” initiatives, which focus on reducing our Company’s North American footprint while continuing to serve and support our customers globally. According to plan, the operations at the Montreal,
Quebec and Jackson, Tennessee facilities were phased out by the end of the year. The consolidation of the U.S. wholesale distribution facility was also completed by the end of 2006.
We continue to serve most of our customers previously supplied by these closed facilities through alternate means. Customers of the Jackson plant are now serviced through our global value added strategic sourcing programs. Production of wholesale and industrial copper tube formerly manufactured in our Montreal facility was successfully transferred to our other facilities, including operations in London, Ontario and Decatur, Alabama.
The closing of the two production facilities and the consolidation of the U.S. wholesale distribution facilities required our Company to take restructuring and impairment charges before tax totaling $57.6 million ($44.0 million after tax), of which $38.4 million was non-cash and $19.2 million required cash outlays. The two facilities that were closed employed approximately 400 persons at the time of announcement. The annual pre-tax benefit associated with these actions is estimated to be approximately $6.0 million. Additionally, we recorded $7.4 million of professional advisory fees in conjunction with our strategic planning and balance sheet restructuring efforts.
Restructuring expenses / (credits) for the years ended December 31, 2006, 2005, and 2004 are as follows:
The following set forth the major types of costs associated with each of the 2006 restructuring activities:
Montreal, Quebec Closing
Jackson, Tennessee Closing
Wholesale Distribution Relocation
In 2006, we recorded a credit of $47 thousand which represents the difference between actual and reserved amounts in 2005. At December 31, 2006 and 2005, we had $2.6 million and $0.8 million of remaining accruals related to the above activities on the balance sheet.
24. Earnings/(Loss) Per Share
The following table sets forth the computation of earnings/(loss) per share for the years ended December 31:
(1)
To the extent that stock options and unvested restricted stock are anti-dilutive, they are excluded from the calculation of diluted earnings/(loss) per share in accordance with SFAS 128.
In 2006, we recognized $65.1 million in restructuring and other charges associated with the closure of our Montreal, Quebec, Jackson, Tennessee, and U.S. commodity depot facilities and non-recurring advisory fees and expenses. The effect these charges had on basic earnings per share is a loss of $3.62.
We had additional stock options outstanding of approximately 1.8 million, 1.5 million and 0.9 million at December 31, 2006, 2005, and 2004, respectively, which were not included in the computation of potentially dilutive securities, because the options’ exercise prices were greater than the average market price of the common shares.
25. Quarterly Results of Operations (Unaudited)
The following is a summary of the unaudited quarterly results of operations for the years ended December 31, 2006 and 2005:
26. Condensed Consolidating Financial Information
The following tables present condensed consolidating financial information for: (a) Wolverine Tube, Inc. (the Parent) on a stand-alone basis; (b) on a combined basis, the guarantors of the 10.5% Senior Notes and 7.375% Senior Notes (Subsidiary Guarantors), which include TF Investor, Inc.; Tube Forming, L.P.; Wolverine Finance, LLC; Wolverine China Investments, LLC; Small Tube Manufacturing, LLC; Wolverine Joining Technologies, LLC; WT Holding Company, Inc. and Tube Forming Holdings, Inc.; and (c) on a combined basis, the Non-Guarantor Subsidiaries, which include Wolverine Tube (Canada) Inc.; 3072452 Nova Scotia Company; 3072453 Nova Scotia Company; 3072996 Nova Scotia Company; Wolverine Tube Canada Limited Partnership; Wolverine Tube (Shanghai) Co., Limited; Wolverine European
Holdings BV; Wolverine Tube Europe BV; Wolverine Tube, BV; Wolverine Tubagem (Portugal), Lda; Wolverine Joining Technologies Canada, Inc.; Wolverine Europe; Wolverine Asia, Limited; WLVN de Latinoamerica, S. de R.L. de C.V.; and WLV Mexico, S. de R.L. de C.V. Each of the Subsidiary Guarantors is 100% owned by Wolverine Tube, Inc. The guarantees issued by each of the Subsidiary Guarantors are full, unconditional, joint and several. Accordingly, separate financial statements of the 100% owned Subsidiary Guarantors are not presented because the Subsidiary Guarantors are jointly, severally and unconditionally liable under the guarantees, and we believe separate financial statements and other disclosures regarding the Subsidiary Guarantors are not material to investors. Furthermore, there are no significant legal restrictions on the Parent’s ability to obtain funds from its subsidiaries by dividend or loan.
The Parent is comprised of Alabama, Oklahoma, Tennessee, and Mississippi manufacturing operations and certain corporate management, sales and marketing, information services and finance functions.
Wolverine Tube, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations
For the Year Ended December 31, 2006
Wolverine Tube, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations
For the Year Ended December 31, 2005
Wolverine Tube, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations
For the Year Ended December 31, 2004
Wolverine Tube, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
December 31, 2006
Wolverine Tube, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
December 31, 2005
Wolverine Tube, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
For the Year Ended December 31, 2006
Wolverine Tube, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
For the Year Ended December 31, 2005
Wolverine Tube, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
For the Year Ended December 31, 2004
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Wolverine Tube, Inc.;
We have audited the accompanying consolidated balance sheets of Wolverine Tube, Inc. and subsidiaries (the Company) as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity and comprehensive income (loss), and cash flows for each of the years in the three year period ended December 31, 2006. In connection with our audits of the consolidated financial statements, we also have audited the accompanying financial statement schedule II. These consolidated financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and 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, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Wolverine Tube, Inc. and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 2006 in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related 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.
As discussed in note 2 to the consolidated financial statements, effective January 1, 2006, the Company changed its method of accounting for share-based payments and, as discussed in note 13 to the consolidated financial statements, effective December 31, 2006, the Company changed its method of accounting for defined pension and postretirement benefit plans.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Wolverine Tube, Inc.’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 14, 2007 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.
/s/ KPMG LLP
Birmingham, Alabama
March 14, 2007
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders Wolverine Tube, Inc.:
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that Wolverine Tube, Inc. maintained effective internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Management of Wolverine Tube, Inc. 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 opinion.
A company’s internal control over financial reporting is a process designed 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 its inherent limitations, internal control over financial reporting 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.
In our opinion, management’s assessment that Wolverine Tube, Inc. maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by the COSO. Also, in our opinion, Wolverine Tube, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal Control-Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Wolverine Tube, Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity and comprehensive income (loss), and cash flows each of the years in the three year period ended December 31, 2006, and our report dated March 14, 2007 expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
Birmingham, Alabama
March 14, 2007
Wolverine Tube, Inc. and Subsidiaries
Schedule II-Valuation and Qualifying Accounts
(1)
Reduction of reserve, net of translation adjustments, for actual sales returns and allowances.
(2)
Uncollectible accounts written off from both continuing and discontinued operations, net of translation adjustments and recoveries.
Exhibit Index