Item 1. Business
Our Company
We are a global leader in the light and commercial vehicle replacement products and services industry, which is also referred to as the aftermarket. Our extensive aftermarket product offering consists principally of filtration, brake and chassis products. Our filtration products fit heavy and medium duty trucks, light vehicles, equipment in the off-highway market (i.e., construction, mining, forestry and agricultural) and equipment for industrial and marine applications. Our brake and chassis products fit light vehicles and heavy and medium duty trucks. In addition, we provide aftermarket products and distribution services in South America. We believe that the growth of the global aftermarket, from which we derived approximately 99% of our net sales in 2011, is predominantly driven by the size, age and use of the population of vehicles and equipment in operation. We design, manufacture, distribute and market a broad range of aftermarket products in North America, South America, Europe, and Asia and generate sales in over 70 countries. Based on management estimates and certain information from third parties, we believe that we hold the #1 market position in North American aftermarket filtration, chassis and brake products and the #2 market position in Brazilian aftermarket parts distribution by net sales for the year ended December 31, 2011. We believe historically that we held the #2 market position in North America in our aftermarket chassis products, which is mainly steering and suspension products. However, with the recent growth in our Chassis products we believe we have secured the #1 market position by a marginal percentage.
Our aftermarket products can be classified into two primary groups:
(1) Routine maintenance products, such as oil, fuel, air and other filters. The regular replacement cycle for these types of products provides a stable and recurring revenue stream. For example, we estimate that the oil filter will be replaced on an average heavy duty truck eight to ten times each year and on a typical light duty vehicle three to four times each year.
(2) Wear products that are designed to be replaced occasionally, such as brake and chassis products (e.g., pads, rotors, shoes, drums, shock absorbers, steering and other suspension products). For example, brake pads will be replaced multiple times over the life of a light vehicle and more frequently over the life of a typical severe use vehicle or heavy duty truck.
The aftermarket brake industry is a highly competitive, and price sensitive market. Over the past several years, we have addressed this by moving our manufacturing from high cost facilities, to state of the art low cost country manufacturing in China and India in particular. This transformation is now complete. There are any number of importers of brake products who do not design, manufacture, or for that matter warehouse and distribute on a mass scale, but strictly offer a short line of products to the industry. Affinia has developed the strategy over many years, of providing our customers with an extensive range of not only products, but services such as detailed product catalogs, e-catalogs, technical services and training, electronic data interchange, point of sale marketing materials, and direct shipments to jobber and retail outlets. These additional offerings help build customer loyalty and generate repeat business while differentiating us from our competitors. In pursuit of this strategy, and in response to the changing dynamics of the brake industry, we have made the decision to engage in a plan to sell the Brake North America and Asia group. We expect to sell the group during the first half of 2012.
We market our products under a variety of well-known brands, including WIX®, Raybestos®, Nakata®, Brake-Pro®, Filtron™, AIMCO®, McQuay-Norris®and ecoLAST®. Additionally, we provide private label products to large aftermarket distributors, including NAPA®, CARQUEST® and ACDelco®, as well as co-branded products for Federated Auto Parts (“Federated”) and Automotive Distribution Network (“ADN”). We believe that we have achieved our leading market positions due to the quality and reputation of our brands and products among professional installers, who are the primary decision makers for the purchase of the products we supply to the aftermarket. Professional installers are highly incentivized to order reliable, well-known aftermarket products when repairing a vehicle because the cost of the products is passed through to the end consumer and, once the repair is made, installers are expected to stand behind their work by replacing any malfunctioning products without charging for the replacement or for the additional labor required. We believe that the reputation of our brands and products for form, fit, function and quality promotes significant demand for our products from these installers and throughout the aftermarket supply chain. Our reputation for reliability has helped us penetrate retailers whose customers have become increasingly sophisticated about the quality of the products they install in their vehicles.
In addition to servicing the light vehicle population, we sell to medium and heavy duty truck fleets and repair facilities through many of our customers, such as NAPA, CARQUEST, the Alliance and other independent warehouse distributors. We also serve the off-highway market through our large customers and have successfully developed products for new non-vehicle related opportunities in stationary equipment and wind generation applications.
Our principal product areas are described below:
Product Area
Representative Brands
Product Description
Filtration
WIX, Filtron, NAPA, CARQUEST and ecoLAST
Oil, air, fuel, hydraulic and other filters for light, medium and heavy duty on and off-highway vehicle, industrial and marine applications
Brakes
Raybestos, Brake-Pro, AIMCO, NAPA, CARQUEST and ACDelco
Drums, rotors, calipers, friction and hydraulic components
Distribution - South America
Nakata and WIX
Steering, shock absorbers and other suspension and driveline components, brakes, fuel and water pumps and other aftermarket products
Chassis
Raybestos, Nakata, NAPA
Chassis, McQuay-Norris and
ACDelco
Steering, suspension and driveline components
Our net sales for 2011 were approximately $2.1 billion including our Brake North America and Asia group and $1.5 billion excluding our Brake North America and Asia group. The following charts illustrate our net sales on a continuing basis by geography and product type for the fiscal year ended December 31, 2011, excluding our Brake North America and Asia group, which is classified as discontinued operations (refer to Note 3. Discontinued Operation - Brake which is included in Item 8 of this report). For further information about our segments and our sales by geographic region, refer to “Note 20. Segment Information,” which is included in Item 8. Financial Statements and Supplementary Data.
History and Ownership
The registrant is a Delaware corporation formed on October 18, 2004 and controlled by affiliates of The Cypress Group L.L.C. (“Cypress”). The registrant’s direct wholly-owned subsidiary Affinia Group Inc., a Delaware corporation formed on June 28, 2004, entered into a stock and asset purchase agreement, as amended (the “Purchase Agreement”), with Dana Corporation (“Dana”) on July 8, 2004. The Purchase Agreement provided for the acquisition by Affinia Group Inc. of substantially all of Dana’s aftermarket business operations (the “Acquisition”). The Acquisition was completed on November 30, 2004.
All references in this report to “Affinia,” “Company,” “we,” “our,” and “us” mean, unless the context indicates otherwise, Affinia Group Intermediate Holdings Inc. and its subsidiaries on a consolidated basis.
As a result of the Acquisition, investment funds controlled by Cypress hold approximately 61% of the common stock of Affinia Group Holdings Inc. (“Holdings”), which directly owns 100% of our common stock, and therefore Cypress controls us. The other principal investors in Holdings are the following: OMERS Administration Corporation (formerly known as Ontario Municipal Employees Retirement Board), California State Teachers Retirement System, The Northwestern Mutual Life Insurance Company and Stockwell Capital.
On December 15, 2005, Holdings, our parent company, entered into stockholder and other agreements with certain officers, directors and key employees (collectively, the “Executives”) of the Company, pursuant to which those Executives purchased an aggregate of 9,520 shares of Holdings common stock for $100 per Share in cash. Holdings received aggregate proceeds of $952,000
as a result of the offering, which was made pursuant to the Affinia Group Holdings Inc. 2005 Stock Incentive Plan (“2005 Stock Plan”). Since 2005, Holdings has re-purchased some of those shares and has issued a small amount of additional shares, and a shareholder ceased to be an Executive of the Company, as a result of which there were 4,463 shares of Holdings common stock held by Executives outstanding as of December 31, 2011 (excluding shares that may be issued pursuant to our non-qualified deferred compensation plan).
On October 30, 2008, Holdings authorized 9.5% Class A Convertible preferred stock, with an initial issuance price of $1,000 per share, consisting of 150,000 shares. Holdings issued 51,475 shares of its preferred stock on October 31, 2008 to its investors and certain of our executives. As of December 31, 2011 there were 69,045 shares of Holdings preferred stock outstanding.
Overview
Our extensive product offering fits nearly every car, truck, off-highway and agricultural make and model on the road, allowing us to serve as a full line supplier to our customers for our product categories. These customers primarily comprise large aftermarket distributors and retailers selling to professional technicians or installers. Our customer base also includes original equipment service (“OES”) participants such as ACDelco. Many of our customers are leading aftermarket companies, including NAPA, CARQUEST, Aftermarket Auto Parts Alliance (“the Alliance”), Uni-Select Inc., O’Reilly Auto Parts, and Federated. As an active participant in the aftermarket for more than 60 years, we have many long-standing customer relationships.
We derived approximately 99% of our 2011 net sales from the on and off-highway replacement products and services industry, which is also referred to as the aftermarket. We believe that the aftermarket will continue to grow as a result of the increase in the light vehicle population and the average age of light vehicles. According to the Automotive Aftermarket Industry Association (“AAIA”), the U.S. motor vehicle aftermarket increased by 4.2% during 2010. In 2011, the industry was forecasted to increase by 4.1% and continue in 2012 with 4.1% growth.
Sales by Region
Our broad range of filtration, chassis and other products are primarily sold in North America, Europe and South America. We are also focusing on expanding manufacturing capabilities globally to position us to take advantage of global growth opportunities. With our new filtration plant in China we believe we are well positioned in Asia. In the future we plan to sell our broad product offering in China and other Asian markets. For information about our segments and our sales by geographic region, refer to “Note 20. Segment Information,” which is included in Item 8. Financial Statements and Supplementary Data.
Acquisitions
On December 16, 2010, the Company, through its subsidiary Affinia Products Corp LLC, acquired substantially all the assets of North American Parts Distributors, Inc. (“NAPD”), which is located in Ramsey, New Jersey. NAPD designs and engineers chassis products, which are manufactured by contractors in low labor cost countries. The NAPD acquisition expands our product offering of chassis parts to one of the broadest in the industry. We acquired NAPD’s assets and liabilities for cash consideration of $52 million. We accounted for this acquisition under the purchase method of accounting and the results of operations are included in our consolidated financial statements from the date of acquisition. This acquisition was considered immaterial for disclosure of supplemental pro forma information and revenues and earnings of the acquiree since the acquisition date. We financed this acquisition with available borrowings under our ABL Revolver, which borrowings were repaid with the proceeds from our completed offering on December 9, 2010 of the Additional Notes.
In December 2010, the Company acquired the remaining 50% ownership interest in Affinia India Private Limited (formerly known as Affinia MAT India Braking Private Limited), the Company’s India joint venture, for $24 million in cash, increasing our ownership interest from 50% to 100%. The acquisition was not subject to any post closing purchase price adjustments or earn-outs. We had a controlling financial interest in Affinia India Private Limited prior to the purchase of the remaining 50% interest. Since we had control prior to the purchase, we accounted for the transaction as an equity transaction consistent with ASC Topic 810, “Consolidation.” We financed this acquisition with available borrowings under our asset based revolving credit facility which provides for borrowings of up to $315 million (the “ABL Revolver”), which borrowings were repaid with proceeds from our completed offering on December 9, 2010 of an additional $100 million aggregate principal amount (the “Additional Notes”) of our 9% Senior Subordinated Notes due 2014 (the “Subordinated Notes”).
Restructuring
Comprehensive Restructuring
In 2005, we announced two restructuring plans: (i) a restructuring plan that we announced at the beginning of 2005 as part of the Acquisition, also referred to herein as the “acquisition restructuring” and (ii) a restructuring plan that we announced at the end of 2005, also referred to herein as the “comprehensive restructuring” (collectively, the “restructuring plans”). We have completed the acquisition restructuring and we have substantially completed the comprehensive restructuring. We have closed 36 facilities during the last six years and have shifted some of our manufacturing base to lower labor cost countries such as China, India, Ukraine and Mexico.
In connection with the comprehensive restructuring, we have recorded $169 million in restructuring costs to date and we expect to record less than $1 million in restructuring costs for the remainder of the comprehensive restructuring.
Other Restructuring
At the end of 2009, we approved the closure of our distribution operations located in Mississauga, Ontario, Canada. The operations closed at the end of the first quarter of 2010. The closure of this operation was part of the Company’s continuing effort to improve its distribution system and serve the replacement parts market effectively and efficiently. The charges were comprised of employee severance costs of approximately $1 million and other trailing liabilities of approximately $4 million. We incurred approximately $1 million in 2011, $4 million in 2010 and $1 million in 2009 related to the closure of this facility. We anticipate another $1 million in restructuring costs in 2012 related to the closure of the facility.
On May 3, 2010, we announced the closure of our manufacturing operations located in Maracay, Edo Aragua, Venezuela. The operations closed during the second quarter of 2010. We incurred pre-tax charges of approximately $7 million in 2010, of which approximately $4 million were cash expenditures. The charges were comprised of employee severance costs of $3 million, asset impairments of $3 million, and other trailing liabilities of $1 million. We will still continue to distribute brake products in Venezuela, which we import from other low cost manufacturing sources. Our Venezuelan filter operation was unaffected by the closure of the brake manufacturing operation.
On May 13, 2011, we announced the closure of our manufacturing operations located in Guelph, Ontario, Canada. The operations closed in the third quarter of 2011. We incurred pre-tax charges of $7 million in 2011 related to the closure of this facility. The charges were comprised of employee severance costs of $6 million and other trailing liabilities of $1 million.
Our Industry
Statements regarding industry outlook, our expectations regarding the performance of our business and other non-historical statements are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described under “Forward-Looking Statements.” Our actual results may differ materially from those contained in or implied by any forward-looking statements. You should read the following discussion together with “Forward-Looking Statements,” “Item 6. Selected Consolidated and Combined Financial Data” and “Item 8. Financial Statements and Supplementary Data.”
According to AAIA, there were approximately one billion light, medium and heavy duty vehicles registered worldwide in 2010. Approximately 249 million, or 26%, of these vehicles were registered in the United States. According to the AAIA, the overall size of the U.S. aftermarket was approximately $285.7 billion in 2010. We are one of the largest independent participants in the global aftermarket, based on our sales in over 70 countries and offer what we believe is the broadest line within our product categories. To facilitate efficient inventory management and timely vehicle owner customer service, many of our customers and professional installers rely on larger suppliers like us to have full line product offerings, consistent value-added services and timely delivery. There are important advantages to having meaningful size and scale in the aftermarket, including the ability to support significant distribution operations, offer sophisticated supply chain management capabilities and provide a broad line of quality products.
In general, aftermarket industry participants can be categorized into three major groups: (1) manufacturers of parts, (2) distributors of replacement parts (without manufacturing capabilities) and (3) installers, both professional and do-it-yourself (“DIY”) customers. Distributors purchase products from manufacturers and sell them to wholesale or retail operations, which in turn sell them to installers.
The distribution business is comprised of the (1) traditional, (2) retail and (3) OES channels. Typically, professional installers purchase their products through the traditional channel, and DIY customers purchase products through the retail channel. The traditional channel includes such well-known distributors as NAPA, CARQUEST, Federated, the Alliance, Uni-Select and ADN. Through a network of distribution centers, these distributors sell primarily to owned or affiliated stores, which in turn supply professional installers. The retail channel includes merchants such as AutoZone, O’Reilly Auto Parts, and Canadian Tire. The OES channel consists primarily of vehicle manufacturers’ service departments at new vehicle dealerships. The distribution business is illustrated by the chart below.
We believe that future growth in aftermarket product sales will be driven by the following key factors:
Growth in global vehicle population. AAIA estimates that the world’s total vehicle population in 2010 was approximately 1.0 billion. R.L. Polk & Co. (“Polk”) expects that the total vehicle populations of several key emerging markets will grow significantly over the next several years, as indicated by the forecasted compound annual growth rate (“CAGR”) in vehicle population from 2010 to 2015 for each of the following geographic areas:
•
Brazil - 7.4%
•
China - 15.7%
•
Eastern Europe - 4.0%
•
India - 10.2%
Growth in global commercial vehicle population. Polk estimates that there were approximately 241 million commercial vehicles worldwide in 2010 and expects the commercial vehicle population to continue to grow at a CAGR of 3.5% from 2010 to 2015. In particular, Polk expects that the U.S. commercial vehicle population will grow at a CAGR of 1.6% from 2010 to 2015 and that the commercial vehicle populations of several key emerging markets will grow significantly over the next several years, as indicated by the forecasted CAGRs in commercial vehicle population from 2010 to 2015 for the following geographic areas:
•
Brazil - 8.6%
•
China - 10.5%
•
Eastern Europe - 5.4%
•
India - 5.9%
Increase in total miles driven in the United States. In the United States, the total miles driven rose from 2.15 trillion in 1990 to 3.00 trillion in 2011, an increase of approximately 40%. Since 1980, annual miles driven in the United States have increased every year except for 2008 and 2011.
Increase in average age of light vehicles in the United States. As of 2010, the average light vehicle age in the United States was 10.6 years, compared to an average of 8.9 years in 2000. As the average light vehicle age continues to rise, we believe that the use of aftermarket products will generally increase as well.
Increase in vehicle related regulation and legislation. Increase in environmental and safety legislation that is being adopted on a global basis has led to an increase in demand for high value filtration and brake products.
Products
Our principal product areas are described below:
Filtration Products. We are a leading designer, manufacturer, marketer and distributor of a broad range of filtration products for the aftermarket and we are one of the few aftermarket suppliers of both heavy duty and light duty filters. Our filtration business includes manufacturing operations in Europe, South America and China. Our filtration product lines include oil, air, fuel, hydraulic and other filters for light, medium and heavy duty on and off-highway vehicle, industrial and marine applications.
Commercial Distribution South America Products. We manufacture and/or distribute products in Brazil, Argentina, Uruguay and Venezuela, including fuel and water pumps, universal joint kits, axle sets, shocks, steering, filtration products, brake products, suspension parts and other aftermarket products.
Chassis Products. We are a leading designer, manufacturer, marketer and distributor of a broad range of chassis products for the aftermarket. Our chassis products include steering, suspension and driveline products such as ball joints, tie rods, Pitman arms, idler arms, drag links, control arms, center links, stabilizers and other related parts.
Brake Products. We are a leading designer, manufacturer, marketer and distributor of a broad range of brake products for the aftermarket. We have an extensive offering of high quality, premium brake products. Our brake products include master cylinders, wheel cylinders, hardware and hydraulics, drums, shoes, linings, bonded/riveted segments, rotors, brake pads, calipers and castings. Excluding brake product sales in our Brake North America and Asia group we will still distribute approximately $22 million of brake products in South America.
Sales Channels and Customers
We distribute our products across several sales channels, including traditional, retail and OES channels. Approximately 26% and 8% of our 2011 net sales from continuing operations were derived from our two largest customers, NAPA and CARQUEST, respectively. See “Risk Factors-Our Business would be materially and adversely affected if we lost any of our larger customers.” During 2011, on a continuing operations basis, we derived approximately 49% of our net sales from the United States and approximately 51% of our net sales from other countries.
We have maintained long-standing relationships with many of our top customers. Some of our most significant customers include NAPA, CARQUEST, ACDelco, Federated, ADN, Uni-Select, Les Schwab, the Alliance and O’Reilly Auto Parts, each of which is a key player in the aftermarket.
The following table provides a description of the primary sales channels to which we supply our products:
Primary Sales Channels
Description
Customers
Traditional
Warehouses and distribution centers that supply local distribution outlets, which sell to professional installers.
NAPA, CARQUEST, Federated, ADN, the Alliance and Uni-Select
Retail
Retail stores, including national chains that sell replacement parts directly to consumers (the DIY market) and to some professional installers.
O’Reilly Auto Parts and AutoZone
OES
Vehicle manufacturers and service departments at vehicle dealerships.
ACDelco, Robert Bosch, TRW Automotive and Chrysler
The traditional channel is important to us because it is the primary source of products for professional installers. We believe that the quality and reputation of our brands for form, fit, and function promotes significant demand for our products from these installers and throughout the aftermarket supply chain. We have many long-standing relationships with leading distributors in the traditional channel such as NAPA and CARQUEST, for whom we have manufactured products for approximately 40 and 20 years, respectively.
As retailers become increasingly focused on consolidating their supplier base, we believe that our broad product offering, product quality, sales and marketing support and customer service capabilities make us more valuable to these customers.
Customer Support
We believe that our emphasis on customer support has been a key factor in maintaining our leading market positions. We continuously seek to improve service, order turnaround time, product coverage and order accuracy. Our ability to replenish inventory quickly is important to customers as it enables them to maximize their sales while carrying reduced inventory levels. For these reasons, we ship the vast majority of orders within 24 to 48 hours of receipt.
In order to maintain the competitiveness of our existing customers and maximize new sales opportunities, we have extensive product coverage. In turn, this has allowed our customers to develop a reputation for carrying the parts their customers need, especially for newer vehicles for which warranties may not have expired and aftermarket parts are not generally available.
In addition, as the aftermarket becomes more electronically integrated, customers often prefer to receive their application information electronically as well as in print form. We provide both printed and electronic catalog media. We also provide products which are problem solvers for professional installers, such as alignment products that allow installers to properly align a vehicle, even though the vehicle was not equipped with adjustment features. We provide many other support features, such as technical support hot lines and training and electronic systems which interface with customers and conform to aftermarket industry standards.
Intellectual Property
We strategically manage our portfolio of patents, trade secrets, copyrights, trademarks and other intellectual property.
As of December 31, 2011, we maintain and have pending in excess of 250 patents and patent applications on a worldwide basis. These patents expire over various periods up to the year 2030. We do not materially rely on any single patent or group of patents. In addition, we believe that the expiration of any single patent or group of patents will not materially affect our business. We have proprietary trade secrets, technology, know-how, processes and other intellectual property rights that are not registered.
Trademarks are important to our business activities. We have a robust worldwide program of trademark registration and enforcement to maintain and strengthen the value of the trademarks and prevent the unauthorized use of our trademarks. The Raybestos and WIX trade names are highly recognizable to the public and are valuable assets. Additionally, we use numerous other trademarks which are registered worldwide or for which we claim common law rights. As of December 31, 2011, we had in excess of 750 active trademark registrations and applications worldwide.
Raw Materials and Manufactured Components
We use a broad range of manufactured components and raw materials in our products, including steel, steel-related components, filtration media, aluminum, brass, iron, rubber, resins, plastics, paper and packaging materials. We purchase raw materials from a wide variety of domestic and international suppliers, and we have not, in recent years, experienced any significant shortages of these items and normally do not carry inventories of these items in excess of those reasonably required to meet our production and shipping schedule. Raw materials comprise the largest component of our manufactured goods cost structure. With our commitment to globalization, we are subject to increases in freight costs due to increased oil prices. We experienced price volatility in fiscal year 2011 with raw material prices trending higher. We will continue to review our purchasing and sourcing strategies for opportunities to reduce costs.
Seasonality
In a typical year, we build inventory during the first and second quarters to accommodate our peak sales during the second and third quarters. Our working capital requirements therefore tend to be highest from March through August. In periods of weak sales, inventory can increase beyond typical levels, as our product delivery lead times are less than two days while certain components we purchase from overseas require lead times of approximately 90 days.
Backlog
Substantially all of the orders on hand at December 31, 2011 are expected to be filled during 2012. We do not view our backlog as being insufficient, excessive or problematic, or a significant indication of 2012 sales.
Research and Development Activities
We provide information regarding our research and development activities in “Note 2. Summary of Significant Accounting Policies” to our consolidated financial statements, which is included in “Item 8. Financial Statements and Supplementary Data.”
Competition
The light duty filter aftermarket is comprised of several large U.S. manufacturers that compete with us, including United Components, Inc. under the brand name Champ, FRAM Group, LLC under the brand name FRAM and Purolator Filters NA LLC under the brand name Purolator, along with several international light duty filter suppliers. The heavy duty filter aftermarket is comprised of several manufacturers that compete with us, including Cummins, Inc. under the brand name Fleetguard, CLARCOR Inc. under the brand name Baldwin and Donaldson Company Inc. under the brand name Donaldson. The brake aftermarket is comprised of several large manufacturers that compete with us, including Federal Mogul Corp. under the brand name Wagner, Honeywell International Inc. under the brand name Bendix and Cardone Industries, Inc. under the brand name A1 Cardone. The chassis aftermarket is comprised primarily of one large U.S. manufacturer that competes with us, Federal Mogul Corp. under the brand name Moog, along with some international chassis suppliers. The Commercial Distribution South America products competitors include, Dpk Distribuidora de Pecas, Ltda, Pacaembu Autopeças, Polipeças Comercial e Importadora Ltda and Comdip Comercial Distribuidora de Peças Ltda. We compete on, among other things, quality, price, service, brand reputation, delivery, technology and product offerings.
Employees
As of December 31, 2011, we had 11,458 employees (including the Brake North America and Asia group), of whom 5,726 were employed in North America, 2,854 were employed in Asia, 1,675 were employed in South America and 1,203 were employed in Europe. The Brake North America and Asia group had 5,641 employees as of December 31, 2011. Approximately 23% of our employees are salaried and the remaining approximately 77% of our employees are hourly. As of December 31, 2011, approximately 5% of our 4,263 U.S. employees and approximately 2% of our 121 Canadian employees were represented by unions all of whom are part of our discontinued operation. We consider our relations with our employees to be good.
We are party to a collective bargaining agreement in the United States that covers 226 employees and expires in October 2014. We are party to a collective bargaining agreement in Canada that covers 3 employees and expires in March 2013.
Environmental Matters
We are subject to a variety of federal, state, local and foreign environmental laws and regulations, including those governing the discharge of pollutants into the air or water, the emission of noise and odors, the management and disposal of hazardous substances or wastes, the clean-up of contaminated sites and human health and safety. Some of our operations require environmental permits and controls to prevent or reduce air and water pollution, and these permits are subject to modification, renewal and revocation by issuing authorities. Contamination has been discovered at certain of our owned properties, which is currently being monitored and/or remediated. We are not aware of any contaminated sites which we believe will result in material liabilities; however, the discovery of additional remedial obligations at these or other sites could result in significant liabilities. ASC Topic 410, “Asset Retirement and Environmental Obligations,” requires that a liability for the fair value of an Asset Retirement Obligation (“ARO”) be recognized in the period in which it is incurred if it can be reasonably estimated, with the offsetting associated asset retirement costs capitalized as part of the carrying amount of the long-lived asset.
In addition, many of our current and former facilities are located on properties with long histories of industrial or commercial operations. Because some environmental laws can impose liability for the entire cost of clean-up upon any of the current or former owners or operators, regardless of fault, we could become liable for investigating or remediating contamination at these properties if contamination requiring such activities is discovered in the future. We have incurred environmental remediation costs associated with the comprehensive restructuring and the acquisition restructuring.
We are also subject to the U.S. Occupational Safety and Health Act and similar state and foreign laws regarding worker safety. We believe that we are in substantial compliance with all applicable environmental, health and safety laws and regulations. Historically, our costs of achieving and maintaining compliance with environmental and health and safety requirements have not been material to our operations.
Internet Availability
Available free of charge through our internet website, www.affiniagroup.com, under the investor relations tab are our recent filings of forms 10-K, 10-Q, 8-K and amendments to those reports filed with the Securities and Exchange Commission. These reports can be found on our internet website as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”). The information contained on or connected to our website is not incorporated by reference into this Annual Report on Form 10-K and should not be considered part of this or any other report filed with the SEC.
Item 1A.
Item 1A. Risk Factors
If any of the following events discussed in the following risks were to occur, our results of operations, financial conditions, or cash flows could be materially affected. Additional risks and uncertainties not presently known by us may also constrain our business operations.
Risks Relating to Our Industry and Our Business
Continued volatility in and disruption to the global economy, including the global capital and credit markets, has affected and may continue to materially and adversely affect our business, financial condition and results of operations, as well as our ability to access credit and has affected and may continue to materially and adversely affect the financial soundness of our customers and suppliers.
The global economy, including the global capital and credit markets, has been experiencing a period of significant uncertainty, characterized by very weak or negative economic growth, high unemployment, reduced spending by consumers and businesses, the bankruptcy, failure, collapse or sale of various financial institutions and a considerable level of intervention from the United States federal government and various foreign governments. Downgrades of long-term sovereign debt issued by the United States and various European countries by Standard & Poor’s, Moody’s and other rating agencies could also affect global and domestic financial markets and economic conditions. These recessionary conditions have materially and adversely affected the demand for our products and services and, therefore, reduced purchases by our customers, which has negatively affected our revenue growth and caused a decrease in our profitability. Although many vehicle maintenance and repair expenses are non-discretionary, difficult economic conditions may reduce miles driven and thereby increase periods between maintenance and repairs. In addition, interest rate fluctuations, financial market volatility or credit market disruptions may limit our access to capital, and may also negatively affect our customers’ and our suppliers’ ability to obtain credit to finance their businesses on acceptable terms. As a result, our customers’ need for and ability to purchase our products or services may decrease, and our suppliers may increase their prices, reduce their output or change their terms of sale. If our customers’ or suppliers’ operating and financial performance deteriorates, or if they are unable to make scheduled payments or obtain credit, our customers may not be able to pay, or may delay payment of, accounts receivable owed to us, and our suppliers may restrict credit or impose different payment terms. Any inability of customers to pay us for our products and services, or any demands by suppliers for different payment terms, may materially and adversely affect our earnings and cash flow.
If these economic conditions do not improve or continue to deteriorate, our results of operations or financial condition could limit our ability to take actions pursuant to certain covenants in our debt agreements that are tied to ratios based on our financial performance. Such covenants include our ability to incur additional indebtedness, make investments or pay dividends.
Our business would be materially and adversely affected if we lost any of our larger customers.
For the year ended December 31, 2011, approximately 26% and 8% of our net sales from continuing operations were to NAPA and CARQUEST, respectively. To compete effectively, we must continue to satisfy these and other customers’ pricing, service, technology and increasingly stringent quality and reliability requirements. Additionally, our revenues may be affected by decreases in NAPA’s or CARQUEST’s business or market share. Consolidation among our customers may also negatively impact our business. We cannot provide any assurance as to the amount of future business with these or any other customers. While we intend to continue to focus on retaining and winning these and other customers’ business, we may not succeed in doing so. Although business with any given customer is typically split among numerous contracts, the loss of, or significant reduction in purchases by, one of those major customers could materially and adversely affect our business, financial condition and results of operations.
Increased crude oil and gasoline prices could reduce global demand for and use of automobiles and increase our costs, which could have a material and adverse effect on our business, financial condition and results of operations.
Material increases in the price of crude oil have historically been a contributing factor to the periodic reduction in the global demand for and use of automobiles. An increase in the price of crude oil could reduce global demand for and use of automobiles and continue to shift customer demand away from larger cars and light trucks (including sport utility vehicles (“SUVs”), which we believe have more frequent replacement intervals for our products, which could have a material and adverse effect on our business, financial condition and results of operations. Demand for traditional SUVs and vans has declined in the past due, in part, to higher gasoline prices. If this trend were to continue, or if total miles driven were to decrease for a number of years, it could have a material and adverse effect on our business, financial condition and results of operations. Further, as higher gasoline prices result in a reduction in discretionary spending for auto repair by the end users of our products, our results of operations have been, and could continue to be, impacted. Additionally, higher gasoline prices have a material and adverse impact on our freight expenses.
The shift in demand from premium to economy brands may require us to produce value products at the expense of premium products, resulting in lower prices, thereby reducing our margins and decreasing our net sales.
We estimate that a majority of our net sales are currently derived from products we consider to be premium products. There has been, and may continue to be, a shift in demand from premium products, on which we can generally command premium pricing and generate enhanced margins, to value products. If such a trend continues, we may be forced to expand our production and/or purchases of value products at competitive prices. In addition, we could be forced to further reduce our prices to remain competitive, in which case our margins will decrease unless we make corresponding reductions in our cost structure.
We are subject to increasing pricing pressure from imports, particularly from lower labor cost countries.
Price competition from other aftermarket manufacturers particularly those based in lower labor cost countries, such as China, have historically played a role and may play an increasing role in the aftermarket sectors in which we compete. Pricing pressures have historically been more prevalent with respect to our brake products than our other products. While aftermarket manufacturers in these locations have historically competed primarily in markets for less technologically advanced products and manufactured a limited number of products, many are expanding their manufacturing capabilities to produce a broad range of lower labor cost, higher quality products and provide an expanded product offering. In the future, competitors in Asia or other lower labor cost sources may be able to effectively compete in our premium markets and produce a wider range of products which may force us to move additional manufacturing capacity offshore and/or lower our prices, reducing our margins and/or decreasing our net sales.
Increasing costs for manufactured components, raw materials and energy prices may materially and adversely affect our business, financial condition and results of operations.
We use a broad range of manufactured components and raw materials in our products, including raw steel, steel-related components, filtration media, aluminum, brass, iron, rubber, resins, plastics, paper and packaging materials. Materials comprise the largest component of our manufactured goods cost structure. Increases in the price of these items could materially increase our operating costs and materially and adversely affect our profit margins. In addition, in connection with passing through steel and other raw material price increases to our customers, there has typically been a delay of up to several months in our ability to increase prices, which has temporarily impacted profitability. In the future, it may be difficult to pass further price increases on to our customers, especially if we experience additional cost increases soon after implementing price increases. In addition, we have experienced longer than typical lead times in sourcing some of our steel-related components and certain finished products, which has caused us to buy from non-preferred vendors at higher costs.
If our customers seek more expansive return policies or practices, such as extended payment terms, our cash flows and results of operations could be materially and adversely affected.
We are subject to product returns from customers, some of which manage their excess inventory by returning product to us. Our contracts with our customers typically include provisions that permit our customers to return specified levels of their purchases. Returns have historically represented approximately 2% of our sales. If returns from our customers significantly increase, our business, financial condition and results of operations may be materially and adversely affected. In addition, some customers in the aftermarket are pursuing ways to shift their costs of working capital, including extending payment terms. To the extent customers extend payment terms, our cash flows and results of operations may be materially and adversely affected.
We are subject to other risks associated with our non-U.S. operations.
We have significant manufacturing operations outside the United States, including joint ventures and other alliances. In 2011, approximately 51% of our net sales from continuing operations originated outside the United States. Risks inherent in international operations include:
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multiple regulatory requirements that are subject to change and that could restrict our ability to manufacture, market or sell our products;
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inflation, recession, fluctuations in foreign currency exchange and interest rates and discriminatory fiscal policies;
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trade protection measures; including increased duties and taxes, and import or export licensing requirements;
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price controls;
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exposure to possible expropriation or other government actions;
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differing local product preferences and product requirements;
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difficulty in establishing, staffing and managing operations;
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differing labor regulations;
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potentially negative consequences from changes in or interpretations of tax laws;
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political and economic instability and possible terrorist attacks against American interests;
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enforcement of remedies in various jurisdictions; and
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diminished protection of intellectual property in some countries.
These and other factors may have a material and adverse effect on our international operations or on our business, financial condition and results of operations. In addition, we may experience net foreign exchange losses due to currency fluctuations.
We are exposed to risks related to our receivables factoring arrangements.
We have entered into agreements with third-party financial institutions to factor on a non-recourse basis certain receivables. The terms of the factoring arrangements provide for the factoring of certain U.S. Dollar-denominated or Canadian Dollar-denominated receivables, which are purchased at the face amount of the receivable discounted at the annual rate of LIBOR plus a bank-determined spread on the purchase date. The amount factored is not contractually defined by the factoring arrangements and our use will vary each month based on the amount of underlying receivables and our cash flow needs. We began factoring certain of our receivables during 2010. For the year ended December 31, 2011, the total amount of receivables factored was $408 million and the cost incurred on factoring was $4 million. For the year ended December 31, 2010, the total amount of receivables factored was $156 million and the cost incurred on factoring was $2 million. Receivables factored by us will be accounted for as a sale and removed from the balance sheet at the time of factoring and the cost of the factoring will be accounted for in other income. If any of the financial institutions we have factoring arrangements with experience financial difficulties or are otherwise unable or unwilling to honor the terms of, or otherwise terminates, our factoring arrangements, we may experience material and adverse economic losses due to the impact of such failure on our liquidity, which could have a material and adverse effect upon our financial condition, results of operations and cash flows.
We may incur material losses and costs as a result of product liability and warranty and recall claims that may be brought against us.
We may be exposed to product liability and warranty claims in the event that our products actually or allegedly fail to perform as expected or the use of our products results, or is alleged to result, in bodily injury and/or property damage. Accordingly, we could experience material warranty or product liability losses in the future and incur significant costs to defend these claims.
In addition, if any of our products are, or are alleged to be, defective, we may be required to participate in a recall of that product if the defect or the alleged defect relates to vehicle safety. Our costs associated with providing product warranties could be material. Product liability, warranty and recall costs may have a material and adverse effect on our business, financial condition and results of operations. Our insurance may not be sufficient to cover such costs.
As a result of the consolidation driven by improved logistics and data management, distributors have reduced their inventory levels, which have reduced and could continue to reduce our sales.
Warehouse distributors have consolidated through acquisition and rationalized inventories, while streamlining their distribution systems through more timely deliveries and better data management. The corresponding reduction in purchases by distributors has negatively impacted our sales. Further consolidation or improvements in distribution systems could have a similar material and adverse impact on our sales.
We are subject to costly regulation, particularly in relation to environmental, health and safety matters, which could materially and adversely affect our business, financial condition and results of operations.
We are subject to a substantial number of costly regulations. In particular, we are required to comply with frequently changing and increasingly stringent requirements of federal, state and local environmental and occupational safety and health laws and regulations in the United States and other countries, including those governing emissions to air, discharges to air and water, and the creation and emission of noise and odor; the generation, handling, storage, transportation, treatment and disposal of waste materials; and the cleanup of contaminated properties and occupational health and safety. We could incur substantial costs, including cleanup costs, fines and civil or criminal sanctions, third-party property damage or personal injury claims, or costs to upgrade or replace existing equipment, as a result of violations of or liabilities under environmental, health and safety laws or non-compliance with environmental permits required at our facilities. In addition, many of our current and former facilities are located on properties with long histories of industrial or commercial operations. Because some environmental laws can impose joint and several liability for the entire cost of cleanup upon any of the current or former owners or operators, regardless of fault, we could become liable for investigating and/or remediating contamination at these properties if contamination requiring such activities is discovered in the future. We cannot assure that we have been, or will at all times be, in complete compliance with all environmental requirements, or that we will not incur material costs or liabilities in connection with these requirements in excess of amounts we have reserved. In addition, environmental requirements are complex, change frequently and have tended to become more stringent over time. These requirements may change in the future in a manner that could have a material and adverse effect on our business, financial condition and results of operations. We have made and will continue to make expenditures to comply with environmental requirements. These requirements, responsibilities and associated expenses and expenditures, if they continue to increase, could have a material and adverse effect on our business and results of operations. While our costs to defend and settle claims arising under environmental laws in the past have not been material, we cannot assure you that this will remain the case in the future. For more information about our environmental compliance and potential environmental liabilities, see “Item 1. Business-Environmental Matters” and “Item 3. Business-Legal Proceedings.”
Our operations would be materially and adversely affected if we are unable to purchase raw materials, manufactured components or equipment from our suppliers.
Because we purchase from suppliers various types of raw materials, finished goods, equipment and component parts, we may be materially and adversely affected by the failure of those suppliers to perform as expected. This non-performance may consist of delivery delays or failures caused by production issues or delivery of non-conforming products. The risk of non-performance may also result from the insolvency or bankruptcy of one or more of our suppliers. Our suppliers’ ability to supply products to us is also subject to a number of risks, including availability of raw materials, such as steel, destruction of their facilities or work stoppages. In addition, our failure to promptly pay, or order sufficient quantities of inventory from, our suppliers may increase the cost of products we purchase or may lead to suppliers refusing to sell products to us at all. Our efforts to protect against and to minimize these risks may not always be effective.
Our intellectual property portfolio could be subject to legal challenges and we may be subject to certain intellectual property claims.
We have developed and actively pursue developing a considerable amount of proprietary technology in the replacement products industry and rely on intellectual property laws of the United States and other countries to protect such technology. In doing so, we incur ongoing costs to enforce and defend our intellectual property. We have from time to time been involved in litigation regarding patents and other intellectual property. We may be subject to material intellectual property claims in the future or we may incur significant costs or losses related to such claims, including payments for licenses that may not be available on reasonable terms, if at all. Our proprietary rights may be challenged, invalidated or circumvented. Moreover, third parties may independently develop technology or other intellectual property that is comparable with or similar to our own, and we may not be able to prevent the use of it.
Our success depends in part on our development of improved products, and our efforts may fail to meet the needs of customers on a timely or cost-effective basis.
Our continued success depends on our ability to maintain advanced technological capabilities, machinery and knowledge necessary to adapt to changing market demands as well as to develop and commercialize innovative products. We cannot assure you that we will be able to develop new products as successfully as in the past or that we will be able to keep pace with technological developments by our competitors and the industry generally. In addition, we may develop specific technologies and capabilities in anticipation of customers’ demands for new innovations and technologies. If such demand does not materialize, we may be unable to recover the costs incurred in such programs. If we are unable to recover these costs or if any such programs do not progress as expected, our business, financial condition or results of operations could be materially and adversely affected.
The introduction of new and improved products and services may reduce our future sales.
Improvements in technology and product quality may extend the longevity of vehicle component parts and delay aftermarket sales. In particular, in our oil filter business the introduction of oil change indicators and the use of synthetic motor oils may further extend oil filter replacement cycles. The introduction of electric, fuel cell and hybrid automobiles may pose a long-term risk to our business because these vehicles may alter demand for our primary product lines. In addition, the introduction by OEMs of increased warranty and maintenance service initiatives, which are gaining popularity, have the potential to decrease the demand for our products in the traditional and retail sales channels.
We may not be able to achieve the cost savings that we expect from the restructuring of our operations.
At the end of 2005 we announced the comprehensive restructuring through which we seek to lower costs and improve profitability by rationalizing manufacturing operations and to focus on low-cost sourcing opportunities. We have realized approximately $100 million in cost savings as a result of the comprehensive restructuring to date. The majority of our comprehensive restructuring relates to our discontinued operations and we have substantially completed the comprehensive restructuring plan. We may not be able to achieve the level of benefits that we expected to realize or we may not be able to realize these benefits within the timeframes we currently expect. Our expectations regarding cost savings are also predicated upon maintaining our sales levels and maintaining our operations as continuing. The planned divestiture of our Brake North America and Asia Group could have a negative effect on our ability to achieve the anticipated savings.
Work stoppages, labor disputes or similar difficulties could significantly disrupt our operations.
As of December 31, 2011, 226 of our U.S. employees and 3 of our Canadian employees were represented by unions. These employees are part of our Brake North America and Asia group, which is classified in discontinued operations. It is possible that our workforce will become more unionized in the future. We may be subject to work stoppages and may be affected by other labor disputes. A work stoppage at one or more of our plants may have a material and adverse effect on our business. Unionization activities could also increase our costs, which could have an adverse effect on our business, financial condition and results of operations.
Additionally, a work stoppage at one of our suppliers could materially and adversely affect our operations if an alternative source of supply were not readily available. Stoppages by employees of our customers also could result in reduced demand for our products.
Any acquisitions or dispositions we make could disrupt our business and materially and adversely affect our business, financial condition and results of operations.
We may, from time to time, consider acquisitions of complementary companies, products or technologies or dispositions of existing lines of business. For example, we recently announced that we are committed to evaluating strategic options for selling our Brake North America and Asia group. Acquisitions and dispositions involve numerous risks, including the diversion of our management’s attention from other business concerns and potential adverse effects on existing business relationships with current customers and suppliers. In addition, any acquisitions could present difficulties in the assimilation of the acquired business and involve the incurrence of substantial additional indebtedness. We cannot assure that we will be able to successfully integrate any acquisitions that we pursue or that such acquisitions will perform as planned or prove to be beneficial to our operations and cash flow. We cannot assure that we will be able to realize higher values for our brake related businesses through the evaluation of strategic alternatives or that we will be able to consummate any proposals for strategic alternatives for the brake related business at all or within a specified time period, due to market, regulatory and other factors. Any of these factors could materially and adversely affect our business, financial condition and results of operations.
Cypress controls us and may have conflicts of interest with us or the holders of our notes in the future.
Cypress beneficially owns 61% of the outstanding shares of our common stock. As a result, Cypress has control over our decisions to enter into any corporate transaction and has the ability to prevent any transaction that requires the approval of stockholders regardless of whether or not other stockholders or note holders believe that any such transactions are in their own best interests. Additionally, Cypress is in the business of making investments in companies and may from time to time acquire and hold interests in businesses that compete directly or indirectly with us. Cypress may also pursue, for its own account, acquisition opportunities that may be complementary to our business, and, as a result those acquisition opportunities may not be available to us. So long as Cypress continues to own a significant amount of the outstanding shares of our common stock, even if such amount is less than 50%, it will continue to be able to strongly influence or effectively control our decisions including director and officer appointments, potential mergers and acquisitions, asset sales and other significant corporate transactions.
Our ability to maintain our ongoing operations could be impaired.
To be successful and achieve our objectives under our strategic plan, we must retain qualified personnel. Our potential sale of the Brake North America and Asia operations may create uncertainty for our employees and this uncertainty may adversely affect our ability to retain key employees, including our senior management, and to hire new talent necessary to maintain our ongoing operations which could have a material adverse effect on our business. Accordingly, we may fail to maintain our ongoing operations, or execute our strategic plan if we are unable to manage such changes effectively.
We may be required to recognize impairment charges for our long-lived assets, which includes fixed assets, intangible assets, and goodwill.
At December 31, 2011, the net carrying value of long-lived assets (property, plant and equipment) totaled $118 million. Additionally, we have $122 million of property, plant and equipment on our consolidated balance sheet classified in current assets of discontinued operations as of December 31, 2011. In accordance with GAAP, we periodically assess our long-lived assets to determine if they are impaired. Significant negative industry or economic trends, disruptions to our business, unexpected significant changes or planned changes in use of the assets, divestitures and market capitalization declines may result in charges to long-lived asset impairments. Future impairment charges could significantly affect our results of operations in the periods recognized. Impairment charges would also reduce our consolidated net worth and increase our debt to total capitalization ratio, which could negatively impact our access to the public debt and equity markets.
We have $122 million of recorded intangible assets and goodwill on our consolidated balance sheet as of December 31, 2011. Additionally, we have $78 million of recorded intangible assets and goodwill on our consolidated balance sheet classified in current assets of discontinued operations as of December 31, 2011. These assets may become impaired with the loss of significant customers or a decline of profitability. In assessing the recoverability of goodwill, projections regarding estimated future cash flows and other factors are made to determine the fair value of the respective reporting unit. If these estimates or related projections change in the future, we may be required to record impairment charges for goodwill at that time. If our trade names carrying values exceed fair value we will be required to record an impairment charge.
While our intangibles with definite lives may not be impaired, the useful lives are subject to continual assessment, taking into account historical and expected losses of relationships that were in the base at time of acquisition. This assessment may result in a reduction of the remaining useful life of these assets, resulting in potentially significant increases to non-cash amortization expense that is charged to our consolidated statement of operations. An intangible asset or goodwill impairment charge, or a reduction of amortization lives, could have a material and adverse effect on our results of operations.
The Company determined that the net carrying value of the Brake North America and Asia group may not be recoverable through the sale process. As a result, an impairment charge of $165 million was recorded within discontinued operations in 2011 to reduce the carrying value of the business to expected realizable value. A tax benefit to the Company of $57 million was recorded relating to the impairment.
Business disruptions could materially and adversely affect our future sales and financial condition or increase our costs and expenses.
Our business may be disrupted by a variety of events or conditions, including, but not limited to, threats to physical security, acts of terrorism, raw material shortages, natural and man-made disasters, information technology failures and public health crises. Any of these disruptions could affect our internal operations or services provided to customers, and could impact our sales, increase our expenses or materially and adversely affect our reputation.
Foreign exchange rate fluctuations could cause a decline in our financial condition, results of operations and cash flows.
As a result of our international operations, we are subject to risk because we generate a significant portion of our revenues and incur a significant portion of our expenses in currencies other than the U.S. Dollar. Our international presence is most significant in Brazil, Canada, China, Mexico and Poland. To the extent that we have significantly more costs than revenues generated in a foreign currency, we are subject to risk if the foreign currency appreciates because the appreciation effectively increases our cost in that country to a greater extent than our revenues. To the extent that we are unable to match revenues received in foreign currencies with costs paid in the same currency, foreign exchange rate fluctuations in that currency could have a material and adverse effect on our financial condition, results of operations and cash flows. In addition, the financial condition, results of operations and cash flows of some of our operating entities are reported in foreign currencies and then translated into U.S. Dollars at the applicable foreign exchange rate for inclusion in our consolidated financial statements. As a result, appreciation of the U.S. Dollar against these foreign currencies generally will have a negative impact on our reported sales and profits.
For example, on January 11, 2010, the Venezuelan government devalued the country’s currency, Bolivar Fuerte (“VEF”), and changed to a two-tier exchange structure. The official exchange rate moved from 2.15 VEF per U.S. Dollar to 2.60 VEF for essential goods and 4.30 VEF for non-essential goods and services, with our products falling into the non-essential category. A Venezuelan currency control board is responsible for foreign exchange procedures, including approval of requests for exchanges of VEF for U.S. Dollars at the official, government established exchange rate. We use the parallel market rate, which ranged between 5.30 to 7.70 VEF to the U.S. Dollar during 2010 and remained at 5.30 VEF to the U.S. Dollar for 2011, to translate the financial statements of our Venezuelan subsidiary because we expect to obtain U.S. Dollars at the parallel market rate for future dividend remittances. The one-time devaluation had a $2 million negative impact on our pre-tax net income in 2010. Further depreciation of the VEF, or depreciation of the currencies of other countries in which we do business, could materially and adversely affect our business, financial condition, results of operations and cash flows. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Business Environment.”
We use a combination of natural hedging techniques and financial derivatives to protect against certain foreign currency exchange rate risks. Such hedging activities may be ineffective or may not offset more than a portion of the adverse financial impact resulting from foreign currency variations. Gains or losses associated with hedging activities also may negatively impact operating results.
Entering new markets poses new competitive threats and commercial risks.
In recent years we have sought to expand our manufacturing and sales into new markets. Expanding into new markets requires investments and resources that may not be available as needed. We cannot guarantee that we will be successful in leveraging our capabilities to compete favorably in new markets or that we will be able to recoup our significant investments in expansion projects. If our customers in new markets experience reduced demand for their products or financial difficulties, our future prospects will be negatively affected as well.
The mix of profits and losses in various jurisdictions may have an impact on our overall tax rate, which in turn, may materially and adversely affect our profitability.
Tax expenses and benefits are determined separately for each of our taxpaying entities or groups of entities that is consolidated for tax purposes in each jurisdiction. Losses in such jurisdictions may provide no current financial statement tax benefit. As a result, changes in the mix of projected profits and losses between jurisdictions, among other factors, could have a significant impact on our overall effective tax rate.
The value of our deferred tax assets could become impaired, which could materially and adversely affect our operating results.
As of December 31, 2011, we had $167 million in net deferred income tax assets. These deferred tax assets include net operating loss carryforwards that can be used to offset taxable income in future periods and reduce income taxes payable in those future periods. We periodically determine the probability of the realization of deferred tax assets, using significant judgments and estimates with respect to, among other things, historical operating results, expectations of future earnings and tax planning strategies. If we determine in the future that there is not sufficient positive evidence to support the valuation of these assets, due to the factors described above or other factors, we may be required to further adjust the valuation allowance to reduce our deferred tax assets. Such a reduction could result in material non-cash expenses in the period in which the valuation allowance is adjusted and could have a material and adverse effect on our results of operations.
Our ability to utilize our net operating loss carryforwards may be limited and delayed. As of December 31, 2011, we had U.S. net operating loss carryforwards of $319 million. Certain provisions of the Internal Revenue Code of 1986, as amended (the “Code”) could limit our annual utilization of the net operating loss carryforwards. There can be no assurance that we will be able to utilize all of our net operating loss carryforwards and any subsequent net operating loss carryforwards in the future.
We must successfully maintain and/or upgrade our information technology systems.
We rely on various information technology systems to manage our operations. We are currently implementing modifications and upgrades to our systems, including making changes to legacy systems, replacing legacy systems with successor systems with new functionality and acquiring new systems with new functionality. These types of activities subject us to inherent costs and risks associated with replacing and changing these systems, including impairment of our ability to fulfill customer orders, potential disruption of our internal control structure, substantial capital expenditures, additional administration and operating expenses, retention of sufficiently skilled personnel to implement and operate the new systems, demands on management time, and other risks and costs of delays or difficulties in transitioning to new systems or of integrating new systems into our current systems. Our system implementations may not result in productivity improvements at a level that outweighs the costs of implementation, or at all. In addition, the implementation of new technology systems may cause disruptions in our business operations and have an adverse effect on our business and operations, if not anticipated and appropriately mitigated.
Our international operations are subject to political and economic risks of developing countries and special risks associated with doing business in corrupting environments.
We design, manufacture, distribute and market a broad range of aftermarket products in various regions, some of which are less developed, have less stability in legal systems and financial markets and are generally recognized as potentially more corrupt business environments than the United States, and therefore present greater political, economic and operational risks. We have in place certain policies, procedures and certain ongoing training of employees with regard to business ethics and many key legal requirements, such as applicable anti-corruption laws, including the U.S. Foreign Corrupt Practices Act (the “FCPA”), which make it illegal for us to give anything of value to foreign officials in order to obtain or retain any business or other advantages; however, there can be no assurance that our employees will adhere to our code of business conduct and ethics or any other of our policies, applicable anti-corruption laws, including the FCPA, or other legal requirements. If we fail to enforce our policies and procedures properly or fail to maintain adequate record-keeping and internal accounting practices to accurately record our transactions, we may be subject to regulatory sanctions. In the event that we believe or have reason to believe that our employees have or may have violated applicable anti-corruption laws, including the FCPA, or other laws or regulations, we are required to investigate or have outside counsel investigate the relevant facts and circumstances, and if violations are found or suspected could face civil and criminal penalties, and significant costs for investigations, litigation, fees, settlements and judgments, which in turn could have a material and adverse effect on our business.
Risks Relating to Our Indebtedness
Our substantial leverage could harm our business by limiting our available cash and our access to additional capital and, to the extent of our variable rate indebtedness, exposing us to interest rate risk.
As a result of the Acquisition in 2004, the refinancing in 2009 and the issuance of additional Subordinated Notes in 2010, we are highly leveraged. This leverage may limit our ability to obtain additional financing for working capital, capital expenditures, product development, debt service requirements, acquisitions, restructuring and general corporate or other purposes, limit our ability to adjust to changing market conditions and place us at a competitive disadvantage compared to our less leveraged competitors. Further volatility in the credit markets could adversely impact our ability to obtain favorable terms on financing in the future. In addition, a substantial portion of our cash flows from operations must be dedicated to the payment of principal and interest on our indebtedness and is not available for other purposes, including our operations, capital expenditures and future business opportunities. We may be more vulnerable than a less leveraged company to a downturn in the general economic conditions or in our business, or we may be unable to carry out capital spending that is important to our growth. We may be vulnerable to interest rate increases, as certain of our borrowings, including those under our ABL Revolver, are at variable rates. We can give no assurance that our business will generate sufficient cash flow from operations, that revenue growth or operating improvements will be realized, or that future borrowings will be available under our ABL Revolver in an amount sufficient to enable us to service our indebtedness or to fund other liquidity needs.
We may not be able to generate sufficient cash to service all of our indebtedness and may be forced to take other actions to satisfy our obligations under our indebtedness, which actions may not be successful.
Our ability to make scheduled payments or to refinance our debt obligations depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We may not be able to maintain a level of cash flow from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources.”
If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets, seek additional capital or seek to restructure or refinance our indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to sell material assets or operations to attempt to meet our debt service and other obligations. Our ABL Revolver and the indentures governing our notes restrict our ability to use the proceeds from asset sales. We may not be able to consummate those asset sales to raise capital or sell assets at prices that we believe are fair, and proceeds that we do receive may not be adequate to meet any debt service obligations then due.
Despite our current indebtedness levels, we may still be able to incur substantially more debt, which could further exacerbate the risks associated with our substantial leverage.
We and our subsidiaries may be able to incur substantial additional indebtedness in the future. Although the terms of the agreements governing our debt instruments contain restrictions on the incurrence of additional indebtedness, these restrictions are subject to a number of qualifications and exceptions, and the indebtedness incurred in compliance with these restrictions could be substantial. As of December 31, 2011, we had $166 million of borrowing capacity available under the ABL Revolver after giving effect to $13 million in outstanding letters of credit, none of which was drawn against, and $3 million for borrowing base reserves. If we incur additional debt above the levels currently in effect, the risks associated with our leverage, including those described above, would increase.
The terms of our debt covenants could limit how we conduct our business and our ability to raise additional funds.
The agreements that govern the terms of our debt, including the indentures governing our notes and the credit agreement that governs our ABL Revolver, contain, and the agreements that govern our future indebtedness may contain, certain covenants that, among other things, limit or restrict our ability and the ability of our subsidiaries to (subject to certain qualifications and exceptions):
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incur and guarantee additional indebtedness, issue disqualified stock or issue certain preferred stock;
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repay subordinated indebtedness prior to its stated maturity;
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pay dividends, make other distributions on, redeem or repurchase stock or make certain other restricted payments;
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make certain investments or acquisitions;
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create certain liens or encumbrances;
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sell assets;
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enter into transactions with affiliates;
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issue capital stock;
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change our line of business;
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consolidate, merge, sell or otherwise dispose of all or substantially all of our assets;
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designate subsidiaries as unrestricted subsidiaries;
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make capital expenditures; and
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restrict dividends, distributions or other payments from our subsidiaries.
There are limitations on our ability to incur the full $315 million of commitments under the ABL Revolver. The borrowers organized in the United States are limited to $295 million and the borrower organized in Canada may borrow up to the remaining $20 million. In each case, borrowings under our ABL Revolver are limited by a specified borrowing base consisting of a percentage of eligible accounts receivable and inventory, less customary reserves. Subject to certain conditions, the commitments under the ABL Revolver may be increased by up to $160 million.
In addition, under the ABL Revolver, a covenant trigger would occur if excess availability under the ABL Revolver is at any time less than the greater of 12.5% of the total revolving loan commitments at such time and $39.5 million, and shall continue until
such time thereafter as excess availability shall have exceeded a threshold amount at all times during a 60 consecutive day period. If the covenant trigger were to occur, we would be required to satisfy and maintain a fixed charge coverage ratio of at least 1.10x, measured for the last twelve-month period. Our ability to meet the required fixed charge coverage ratio can be affected by events beyond our control, and we cannot assure you that we will meet this ratio. A breach of any of these covenants could result in a default under the ABL Revolver.
Moreover, the ABL Revolver provides the lenders considerable discretion to impose reserves, which could materially impair the amount of borrowings that would otherwise be available to us. There can be no assurance that the lenders under the ABL Revolver will not impose such actions during the term of the ABL Revolver.
A breach of the covenants or restrictions under the indentures governing our notes or the credit agreement that governs the ABL Revolver could result in a default under the applicable indebtedness. Such default may allow the creditors to accelerate the related debt and may result in the acceleration of any other debt to which a cross-acceleration or cross-default provision applies. In addition, an event of default under our ABL Revolver would permit the lenders under our ABL Revolver to terminate all commitments to extend further credit under that facility. Furthermore, if we were unable to repay the amounts due and payable under our ABL Revolver, those lenders could proceed against the collateral granted to them to secure that indebtedness. In the event our lenders and noteholders accelerate the repayment of our borrowings, we cannot assure that we and our subsidiaries would have sufficient assets to repay such indebtedness. As a result of these restrictions, we may be:
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limited in how we conduct our business;
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unable to raise additional debt or equity financing to operate during general economic or business downturns; or
•
unable to compete effectively or to take advantage of new business opportunities.
These restrictions may affect our ability to grow in accordance with our plans.
Our variable rate indebtedness exposes us to interest rate risk, which could cause our debt costs to increase significantly.
A portion of our borrowings is at variable rates of interest and exposes us to interest rate risks. We are exposed to the risk of rising interest rates to the extent that we fund our operations with short-term or variable-rate borrowings. As of December 31, 2011, the Company’s $718 million of aggregate debt outstanding, which includes $20 million classified in current liabilities of discontinued operations for our Brake North America and Asia group, consisted of $142 million of floating-rate debt and $576 million of fixed-rate debt. Fixed rate debt comprised approximately 80% of our total debt as of December 31, 2011. Based on the amount of floating-rate debt outstanding at December 31, 2011 a 1% rise in interest rates would result in approximately $1 million in incremental interest expense. If the LIBOR rates increase in the future then the floating-rate debt could have a material effect on our interest expense.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
Our principal executive offices are located in Ann Arbor, Michigan; our operations include numerous manufacturing, research and development and warehousing facilities as well as offices. The table below summarizes the number of facilities by geographical region for our manufacturing, distribution and warehouse, other and discontinued operations facilities. Discontinued operations includes the Brake North America and Asia group facilities.
The other facilities around the globe include five facilities that have been closed as part of our restructuring programs, seven sales and administration offices and one non-operational storage site. Of our manufacturing facilities approximately 67% are filtration production facilities, approximately 8% are chassis production facilities and approximately 25% relates to other production facilities from continuing operations. Of the total number of principal manufacturing facilities from continuing operations, approximately 75% of are owned and approximately 25% are leased.
Item 3.
Item 3. Legal Proceedings
Various claims, lawsuits and administrative proceedings are pending or threatened against us and our subsidiaries, arising from the ordinary course of business with respect to commercial, intellectual property, product liability and environmental matters. We believe that the ultimate resolution of the foregoing matters will not have a material effect on our financial condition or results of operations.
On March 31, 2008, a class action lawsuit was filed by S&E Quick Lube Distributors, Inc. of Utah against several auto parts manufacturers for allegedly conspiring to fix prices for replacement oil, air, fuel and transmission filters. Several auto parts companies are named as defendants, including Champion Laboratories, Inc., Purolator Filters NA LLC, Honeywell International Inc., Cummins Filtration Inc., Donaldson Company, Baldwin Filters Inc., Bosch USA., Mann + Hummel USA Inc., ArvinMeritor Inc., United Components Inc. and Wix Filtration Corp LLC (“Wix Filtration”), one of our subsidiaries. The lawsuit is currently pending as a consolidated Multi-District Litigation (“MDL”) Proceeding in Chicago, IL because of multiple “tag-along” filings in several jurisdictions. Two suits have also been filed in the Canadian provinces of Ontario and Quebec. Wix Filtration, along with other named defendants, has filed various motions to dismiss plaintiffs’ complaints, which were denied by the court in December 2009. Several defendants, including Wix Filtration, refiled motions to dismiss based upon plaintiffs’ most recent amended complaint. The court denied those motions in September 2010. Discovery in the action continues. In June 2011, the U.S. Department of Justice indicted the plaintiffs’ main witness, William Burch, for making false statements in connection with the litigation. Burch pleaded guilty, was sentenced to two years in prison and the parties are now considering the implications. Three defendants to the action, Baldwin Filters Inc., Cummins Filtration Inc. and Donaldson Company settled the claims against them for minimal payments in the fall of 2011. In January 2012, all parties to the lawsuit participated in a settlement conference with the Court without success. Shortly afterwards, defendants Wix Filtration, Honeywell and Champion, were able to combine their contributions toward settlement to reach an agreement with plaintiffs to avoid the cost of further litigation. The parties have signed a memorandum of understanding regarding the settlement.
On September 30, 2011, we entered into a settlement agreement with Satisfied for $10 million to settle our claims against Satisfied for their theft of our trade secrets. Upon execution of the settlement agreement, $2.5 million was due immediately and up to an additional $7.5 million is to be provided after liquidation of Satisfied’s business. On September 30, 2011, we have recorded a gain of $2.5 million in our consolidated financial statements included elsewhere in this report. We will record the rest of the income from settlement once the realization is assured beyond a reasonable doubt, which we anticipate will occur if and when we receive the cash.
We have various accruals for civil liability, including product liability, and other costs. If there is a range of equally probable outcomes, we accrue at the lower end of the range. The Company had $2 million and $4 million accrued as of December 31, 2010 and 2011, respectively. There are no recoveries expected from third parties.
Item 4.
Item 4. Mine Safety Disclosures
None.
PART II.
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Shares
No trading market for our common stock currently exists. As of March 16, 2012, our parent, Holdings, was the sole holder of our common stock. The Company has never declared or paid any cash dividends on its common stock. We intend to retain all current and foreseeable future earnings to support operations. Our senior credit facilities and our notes indentures restrict our ability to pay cash dividends on our common stock. For information in respect of securities authorized under our equity compensation plan, see “Item 11. Executive Compensation.”
Item 6.
Item 6. Selected Consolidated and Combined Financial Data
The financial statements included in this report are the consolidated financial statements of Affinia Group Intermediate Holdings Inc. The selected financial data are derived from our financial statements. The financial data as of December 31, 2010 and 2011 and for the years ended December 31, 2009, 2010, and 2011 are derived from the audited financial statements contained under “Item 8. Financial Statements and Supplementary Data.” The selected financial data as of December 31, 2007, December 31, 2008 and December 31, 2009; and for the years ended December 31, 2007 and 2008, are derived from our financial statements.
You should read the following data in conjunction with “Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Statements in the discussion and analysis regarding industry outlook, our expectations regarding the performance of our business and other non-historical statements in the discussion and analysis are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described under “Forward-Looking Statements.” Our actual results may differ materially from those contained in or implied by any forward-looking statements. You should read the following discussion together with “Forward-Looking Statements,” “Item 6. Selected Consolidated and Combined Financial Data” and “Item 8. Financial Statements and Supplementary Data.”
Company Overview
We are a global leader in the light and commercial vehicle replacement products and services industry, which also is referred to as the aftermarket. Our extensive aftermarket product offering consists principally of filtration, brake and chassis products. Our filtration products fit heavy and medium duty trucks, light vehicles, equipment in the off-highway market (i.e., construction, mining, forestry and agricultural) and equipment for industrial and marine applications. Our brake and chassis products fit light vehicles and heavy and medium duty trucks. In addition, we provide aftermarket products and distribution services in South America. We believe that the growth of the global aftermarket, from which we derived approximately 99% of our net sales in 2011, is predominantly driven by the size, age and use of the population of vehicles and equipment in operation. We design, manufacture, distribute and market a broad range of aftermarket products in North America, South America, Europe and Asia and generate sales in over 70 countries. Our product groupings consist of Filtration products, South America products, Chassis products and Brake North America and Asia products.
The aftermarket brake industry is a highly competitive, and price sensitive market. Over the past several years, we have addressed this by moving our manufacturing from high cost facilities, to state of the art low cost country manufacturing in China and India in particular. This transformation is now complete. There are any number of importers of brake products who do not design, manufacture, or for that matter warehouse and distribute on a mass scale, but strictly offer a short line of products to the industry. Affinia has developed the strategy over many years, of providing our customers with an extensive range of not only products, but services such as detailed product catalogs, e-catalogs, technical services and training, electronic data interchange, point of sale marketing materials, and direct shipments to jobber and retail outlets. These additional offerings help build customer loyalty and generate repeat business while differentiating us from our competitors. In pursuit of this strategy, and in response to the changing dynamics of the brake industry, we have committed to a plan to sell the Brake North America and Asia group. We expect to sell the group during the first half of 2012.
The net sales by product grouping for our continuing operations, together with major brands and the concentration of on and off-highway replacement product sales and OEM sales for the year ended December 31, 2011 are illustrated in the chart below.
We market our continuing products under a variety of well-known brands, including WIX®, Raybestos®, Nakata®, Filtron™, ecoLast® and McQuay-Norris®. Additionally, we provide private label products to large aftermarket distributors, including NAPA®, CARQUEST® and ACDelco®, as well as co-branded products for Federated and ADN. We believe that we have achieved our leading market positions due to the quality and reputation of our brands and products among professional installers, who are the primary decision makers for the purchase of the products we supply to the aftermarket.
We provide many of our customers with an extensive range of value added services which help build customer loyalty and generate repeat business while differentiating us from our competitors. These services include e-catalogs, technical services, electronic data interchange, direct shipments of products and point-of-sale marketing materials. The depth of our value added services has led to numerous customer awards.
Transformation
Our Filtration, South America and Chassis product groups fit with our strategic initiatives of growth and profitability. As shown in the chart below these product groups have grown significantly since our acquisition in 2004.
Our Filtration products group has seen significant growth in Europe and other parts of the world as we have successfully entered new markets and grown existing market share. We believe we hold the #1 market position in North America for filtration products and we also have a strong presence in Eastern Europe, which includes the #1 market position for filtration products in Poland.
Our South America products group has experienced rapid growth in its distribution operations as we have invested and made a concerted effort to grow this business. Based on management estimates and certain information from third parties, we believe that we hold the #2 market position in Brazilian aftermarket parts distribution by net sales for the year ended December 31, 2011.
Our Chassis products group has experienced significant growth in the last two years as we gained premium chassis business. With the recent growth in Chassis product sales we believe we have gained the #1 market position for chassis products by a marginal percentage in North America.
The following are major transformation projects we have completed or in the process of being completed in our continuing operations:
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Second quarter of 2011 - During April we completed the construction of a filtration manufacturing facility in China, in which we have an 85% ownership interest. This facility manufactures products in China and distributes these products in Asia and North America. We began shipping products from this facility during the third quarter of 2011.
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Second quarter of 2011 - We completed a new filtration facility in Poland and began shipping products in the second quarter of 2011. The facility was constructed to handle our increased production volumes in Poland and other European countries where we distribute products.
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2010 and 2011 - Our Brazilian distribution company opened one new branch in 2010 and a new warehouse in January 2011. The new warehouse more than triples our distribution company’s warehouse and distribution capacity in Brazil. The new branch has contributed to the growth of our Brazilian distribution business.
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Fourth quarter of 2010 - We purchased substantially all the assets of NAPD, a chassis distributor with strong foreign name plate capabilities.
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Fourth quarter of 2010 - We initiated filter product distribution capabilities in Russia.
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Third quarter of 2007 - We opened our first filter manufacturing operation in Mexico. During 2008, the manufacturing operation was brought up to its full capabilities. This operation serves markets in both North America and Central America. We expanded our distribution capabilities at this operation to increase our sales in the Mexican market.
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Second quarter of 2007 - We opened a new filter manufacturing plant in Ukraine on April 1, 2007 to help meet increased demand for filtration products in Eastern Europe. The plant became fully operational in 2009.
Since our acquisition in 2004, we have executed a significant restructuring plan that has transformed our company and positioned us for growth. During 2011, we experienced a record for sales and operating profit from continuing operations as shown by the charts below.
Strategic Focus
With the sale of the Commercial Distribution Europe group in 2010 and the anticipated sale of the Brake North America and Asia group in 2012, we have positioned ourselves to be a global filtration, chassis and distribution business. With the realignment of our company we will be able to better focus on expanding our global manufacturing and distribution capabilities throughout the world.
Acquisitions and New Technology
On December 16, 2010, the Company, through its subsidiary Affinia Products Corp LLC, acquired substantially all the assets of NAPD, which is located in Ramsey, New Jersey. NAPD designs and engineers chassis products, which are manufactured by contractors in low labor cost countries. The NAPD acquisition expands our product offering of chassis parts to one of broadest in the industry. More specifically, the acquisition provides us with broad range of European branded product coverage. We acquired NAPD’s assets and liabilities for cash consideration of $52 million.
In January 2011, we introduced ecoLAST® oil filters, a revolutionary line of heavy duty oil filters that has proven to double oil life. WIX ecoLAST oil filters capture dirt and soot like a traditional filter, while utilizing media to sequester the acids in the oil. WIX’s ecoLAST oil filters are a direct replacement with no changes or modification required to the vehicle.
Disposition
On February 2, 2010, as part of our strategic plan, we sold our Commercial Distribution Europe business unit for approximately $11 million. Our Commercial Distribution Europe business unit, also known as Quinton Hazell, is a diverse aftermarket manufacturer and distributor of automotive components throughout Europe. Quinton Hazell’s financial performance did not meet our strategic financial metrics, as evidenced by a 2009 pre-tax loss of $84 million, of which $75 million related to an impairment of assets.
Nature of Business
We typically conduct business with our customers pursuant to short-term contracts and purchase orders. However, our business is not characterized by frequent customer turnover due to the critical nature of long-term relationships in our industry. The expectation of quick turnaround times for car repairs and the broad proliferation of available part numbers require a large investment in inventory and strong fulfillment capabilities in order to deliver high fill rates and quick cycle times. Large aftermarket distributors typically source their product lines at a particular price point and product category with one “full-line” supplier, such as us, which covers substantially all of their product requirements. Switching to a new supplier typically requires that a distributor or supplier make a substantial investment to purchase, or “changeover” to, the new supplier’s products. In addition, the end user of our products, who is most frequently a professional installer, requires consistently high quality products because it is industry practice to replace, free of any labor or service charge, malfunctioning parts.
Business Environment
Our Markets. We believe that future growth in aftermarket product sales will be driven by the following key factors: (1) growth in global vehicle population; (2) growth in global commercial vehicle population; (3) increase in total miles driven in the United States and other key countries around the world; (4) increase in average age of light vehicles in the United States and other key countries around the world and (5) increase in vehicle related regulation and legislation.
Raw Materials and Manufactured Components. Our variable costs are proportional to sales volume and mix and are comprised primarily of raw materials, labor and certain overhead costs. Our fixed costs are not significantly influenced by volume in the short term and consist principally of selling, general and administrative expenses, depreciation and other facility-related costs.
We use a broad range of manufactured components and raw materials in our products, including raw steel, steel-related components, filtration media, aluminum, brass, iron, rubber, resins, plastics, paper and packaging materials. We purchase raw materials from a wide variety of domestic and international suppliers, and we have not, in recent years, experienced any significant shortages of these items and normally do not carry inventories of these items in excess of those reasonably required to meet our production and shipping schedules.
Seasonality. Our working capital requirements are significantly impacted by the seasonality of the aftermarket. In a typical year, we build inventory during the first and second quarters to accommodate our peak sales during the second and third quarters. Our working capital requirements therefore tend to be highest from March through August. In periods of weak sales, inventory can increase beyond typical seasonal levels, as our product delivery lead times are less than two days while certain components we purchase from overseas require lead times of approximately 90 days.
Global Developments. The aftermarket has also experienced increased price competition from manufacturers based in China and other lower labor cost countries. We responded to this challenge by acquiring an 85% controlling interest in Haimeng, one of the largest drum and rotor manufacturers in the world and by expanding our manufacturing capacity in China, India, Mexico, Poland and Ukraine. Additionally, we are meeting this challenge through restructuring and outsourcing initiatives, as well as through ongoing cost reduction programs.
Results of Operations
In accordance with ASC Topic 360, “Property, Plant, and Equipment,” the Brake North America and Asia group and Commercial Distribution Europe segment qualified as discontinued operations. Previously reported consolidated statements of operations for all periods presented have been adjusted to reflect the discontinued operations.
Year Ended December 31, 2010 Compared to the Year Ended December 31, 2011
Net sales. Consolidated net sales increased by $119 million in 2011 in comparison to 2010 due to increased sales to new and existing customers and favorable currency translation effects. The following table summarizes the consolidated net sales results for the years ended December 31, 2010 and December 31, 2011:
(1) The currency effect was calculated by comparing the local currency net sales for all international locations for both periods, each at the current year exchange rate, to determine the impact of the currency between periods. These currency effects provide a clearer understanding of the operating results of our foreign entities because they exclude the varying effects that changes in foreign currency exchange rates may have on those results.
On and Off-highway segment products sales increased due to the following:
(1) Filtration products sales increased in 2011 in comparison to 2010 due mainly to increased sales of $35 million related to our Polish, Russian and Venezuelan operations, which includes $7 million of favorable currency translation effects.
(2) Commercial Distribution South America products sales increased in 2011 in comparison to 2010 due to favorable currency translation effects and the impact of price increases on certain products. Our Brazilian distribution company accounted for the majority of the increase in sales.
(3) Chassis products sales increased in 2011 in comparison to 2010 by $44 million. During the fourth quarter of 2010, we began shipping new premium Chassis business, which accounted for a $34 million increase in sales in 2011compared to 2010. We also benefited from $15 million in additional sales related to NAPD, which we acquired during the fourth quarter of 2010.
South America other segment products sales for 2011 increased in comparison to 2010 due to favorable currency translation effects.
The following table summarizes the consolidated results for the years ended December 31, 2010 and December 31, 2011:
(1) We recorded $2 million of restructuring costs in cost of sales for 2010.
(2) We recorded $10 million and $1 million of restructuring costs in selling, general and administrative expenses for 2010 and 2011, respectively.
(3) We recorded in our discontinued operations $12 million and $11 million of restructuring costs for 2010 and 2011, respectively.
NM (Not Meaningful)
Gross profit/Gross margin. Gross profit increased by $26 million and the gross margin remained at 23% in 2011. The increase in gross profit is consistent with the increase in sales. Our freight costs and operating costs increased during the year and as a result we increased prices, the full effect of which will be reflected in 2012, and we have made productivity improvements to offset these cost increases. In 2011, we built up inventory in anticipation of increased demand. However, due to a decrease in miles driven and other factors we built inventory at a higher pace than actual sales increased and as a result our inventory carrying costs increased.
Selling, general and administrative expenses. Our selling, general and administrative expenses for 2011 increased by $7 million from 2010 due to an increase in advertising costs, legal and professional costs, and information technology costs offset by a reduction in restructuring costs.
Operating profit/Operating margin. Operating profit increased by $19 million and the operating margin increased marginally in 2011 compared to 2010. In 2011 our operating profit in the South America other segment improved by $7 million due to lower restructuring costs in 2011. Additionally, the corporate costs were reduced by $12 million in 2011.
Other income, net. Other income, net increased in 2011 in comparison to 2010 due to the gain on a sale of Venezuelan facility in the fourth quarter of 2011.
Interest expense. Interest expense increased by $2 million in 2011 in comparison to 2010 due to higher debt levels in 2011offset by lower short term rates. The higher debt levels related to higher inventory levels to support increased sales.
Income tax provision. The income tax provision was $30 million and $38 million for 2010 and 2011, respectively. The effective tax rate was similar for both 2010 and 2011.
Income (loss) from discontinued operations, net of tax. As part of our strategic plan, we committed to a plan to sell our Brake North America and Asia group during the fourth quarter of 2011. Brake North America and Asia group incurred a loss of $113 million in 2011 of which $7 million related to a loss from operations, $165 million related to an impairment charge to reduce the carrying value of the business to expected realizable value, and offsetting these amounts was $57 million, which related to a tax benefit for the impairment. In 2010, Brake North America and Asia group incurred income from operations of $1 million.
Net income (loss). The decrease in net income was driven by the loss from discontinued operations, net of tax, offset by an increase in sales and gross profit in 2011 in comparison to 2010.
Net income attributable to noncontrolling interest, net of tax. Our net income attributable to noncontrolling interest, net of tax decreased due to our increase in ownership of our two most significant noncontrolling interests. We increased our ownership in Affinia Acquisition LLC from 5% to 40% effective on June 1, 2009 and to 100% effective on September 1, 2010. We acquired the remaining 50% interest in Affinia India Private Limited on December 3, 2010.
Year Ended December 31, 2009 Compared to the Year Ended December 31, 2010
Net sales. Consolidated net sales increased by $152 million in 2010 in comparison to 2009 due mainly to favorable foreign currency translation effects of $17 million, improved market conditions and increased business from new and existing customers. The following table summarizes the consolidated net sales results for the years ended December 31, 2009 and December 31, 2010:
(1) The currency effect was calculated by comparing the local currency net sales for all international locations for both periods, each at the current year exchange rate to determine the impact of the currency between periods. These currency effects provide a more clear understanding of the operating results of our foreign entities because they exclude the varying effects that changes in foreign currency exchange rates may have on those results.
On and Off-highway segment products sales increased due to the following:
(1) Filtration products sales increased in 2010 in comparison to 2009 due in part to increased sales in our Polish operation and due to improving markets. Sales increased $43 million due to the improving U.S. and Canadian markets, $23 million due to our Polish operation gaining market share in Western and Eastern Europe and due to $1 million in additional volumes in other countries. The increased sales were offset by $21 million of unfavorable currency translations which were comprised of unfavorable currency translation effects in Venezuela of $31 million, favorable currency translation effects of $4 million related to Poland and an additional $6 million of favorable currency effects in three other countries.
(2) Commercial Distribution South America products sales increased in 2010 in comparison to 2009 partially due to favorable foreign currency translation effects of $45 million. The Brazilian Real weakened significantly in the first half of 2009 and then strengthened in the last half of the year and has remained strong in 2010. Excluding currency effects, sales grew by 16% in 2010 in comparison to 2009. This growth was due to improved market conditions, growth in our Brazilian distribution company and the introduction of motorcycle applications, heavy duty applications and related accessories. Our Brazilian distribution company sales grew significantly in 2010 and have grown since 2005 by 135%.
(3) Chassis products sales increased in 2010 in comparison to 2009 due to an improvement in general market conditions, new business and favorable currency translation effects of $3 million related to the Canadian Dollar. Additionally, sales increased due to new business with new customers and existing customers. During the fourth quarter we began shipping premium Chassis product to one of our largest customers, which accounted for an $8 million increase in sales in 2010.
South America other segment products sales for 2010 decreased in comparison to 2009 due to the devaluation of the Venezuelan currency, which resulted in a decrease in sales of $10 million for 2010, offset partially by additional volumes in Venezuela and Uruguay.
The following table summarizes the consolidated results for the years ended December 31, 2009 and December 31, 2010:
(1) We recorded $2 million of restructuring costs in cost of sales for 2010.
(2) We recorded $5 million and $10 million of restructuring costs in selling, general and administrative expenses for 2009 and 2010, respectively.
(3) We recorded in our discontinued operations $9 million and $12 million of restructuring costs in 2009 and 2010, respectively.
NM (Not Meaningful)
Gross profit/Gross margin. Gross profit increased by $39 million during 2010 in comparison to 2009. The increase in gross profit during 2010 was primarily due to an increase in sales volume and currency effects. The comprehensive restructuring began at the end of 2005 and was substantially completed by the end of 2010. The improvement in gross profit included $11 million of favorable currency translation effects.
Selling, general and administrative expenses. Our selling, general and administrative expenses for 2010 increased $4 million from 2009 due mainly to restructuring expenses. The restructuring costs increased $5 million in 2010 in comparison to 2009, which was mainly related to our Venezuela operations. There were additional increases in advertising costs and insurance costs in 2010 in comparison to 2009. Offsetting these increases in 2010 was a reduction in the management fee charged by Cypress from $3 million in 2009 to no charge in 2010.
Operating profit/Operating margin. Our operating profit increased in 2010 in comparison to 2009 due to an improvement in gross profit and an increase in sales volume. On and Off-highway segment operating profit increased in 2010 in comparison to 2009 due to the improved gross profit and increased sales. South America other segment operating loss increased in 2010 due to the restructuring costs related to the closure of our Maracay, Venezuela manufacturing plant. In 2010, Corporate, eliminations and other operating loss decreased by $9 million due to lower general and administrative expenses and due to Cypress not charging us a management fee.
Gain (loss) on extinguishment of debt. In June of 2009 Affinia Group Holdings Inc. purchased in the open market approximately $33 million principal amount of the Subordinated Notes and thereafter contributed such notes to Affinia Group Intermediate Holdings Inc., who contributed such notes to Affinia Group Inc. Affinia Group Inc. promptly surrendered such purchased notes for cancellation which resulted in a pre-tax gain on the extinguishment of debt of $8 million in 2009. The retirement of $22.5 million of Secured Notes on December 31, 2010 resulted in a pre-tax loss on extinguishment of debt of $1 million.
Interest expense. Interest expense decreased by $3 million in 2010 in comparison to 2009 due to lower refinancing costs in 2010 and offset by higher interest rates on our new debt structure. During 2009, we recognized $10 million in refinancing costs related to replacing our former term loan facility, revolving credit facility and accounts receivable facility and the termination of our interest rate swap agreements. The refinancing consisted of the ABL Revolver and the $225 million in aggregate principal amount of 10.75% Senior Secured Notes due 2016 (the “Secured Notes”), the proceeds of which were used to repay outstanding borrowings under our former term loan facility, revolving credit facility and accounts receivable facility, as well as to settle interest rate derivatives and to pay fees and expenses related to the refinancing. During 2010, we issued additional notes and amended the ABL Revolver, which resulted in payment of deferred financing costs of $5 million.
Income tax provision. The income tax provision increased by $18 million in 2010 from 2009 due mainly to a higher level of income from continuing operations. The effective tax rate was higher in 2010 due to higher foreign taxes from increased withholding taxes related to dividends in our international companies.
Income (loss) from discontinued operations, net of tax. Included within discontinued operations is our Commercial Distribution Europe segment and our Brake North America and Asia group. As part of our strategic plan we committed to a plan to sell our Commercial Distribution Europe business unit during the fourth quarter of 2009 and our Brake North America and Asia group in the fourth quarter of 2011. Commercial Distribution Europe incurred a loss of $61 million in 2009 and nil in 2010. Brake North America and Asia had income from operations of $3 million and $1 million in 2009 and 2010, respectively. The Commercial Distribution Europe loss in 2009 consisted of a $10 million loss on operations and a $75 million impairment charge to reduce the carrying value of the business to expected realizable value offset by a tax benefit of $24 million. Brake North America and Asia group net income decreased in 2010 in comparison to 2009 due to higher restructuring costs, payroll, information and technology costs, travel costs and legal and professional fees.
Net income (loss). Net income increased in 2010 in comparison to 2009 due mainly to the decrease in the loss from discontinued operations, net of tax and the increase in gross profit in 2010.
Net income attributable to noncontrolling interest, net of tax. Our net income attributable to noncontrolling interest, net of tax decreased due to our increase in ownership of our two most significant noncontrolling interests. We increased our ownership in Affinia Acquisition LLC from 5% to 40% effective on June 1, 2009 and to 100% effective on September 1, 2010. We acquired the remaining 50% interest in Affinia India Private Limited on December 3, 2010.
Results by Geographic Region
Net sales by geographic region were as follows:
United States. Net sales increased in 2011 in comparison to 2010 mainly due to increased sales in our chassis products. The chassis products sales increase was primarily due to new premium chassis business and additional sales related to NAPD, which we acquired during the fourth quarter of 2010. Net sales increased in 2010 in comparison to 2009 due to improving market conditions and new business from both new customers and existing customers.
Foreign. Net sales increased in 2011 in comparison to 2010 due to improving market conditions, increased sales to new and existing customers and favorable currency translation effects. Our sales increased by $40 million in South America and $18 million in Europe for 2011 in comparison to 2010. Net sales increased in 2010 in comparison to 2009 due to increased sales in Brazil and Poland, the majority of which related to gains in market share by our Brazilian distribution company and our Polish operation in 2010. Additionally, our Brazilian and Polish subsidiaries’ sales were higher in 2010 due to favorable currency translation effects of $46 million and $4 million, respectively.
Income from continuing operations before income tax provision, equity in income and noncontrolling interest by geographic region was as follows:
United States. Loss from continuing operations before income tax provision, equity in income and noncontrolling interest decreased in 2011 in comparison to 2010 due to an increase in gross profit. Loss from continuing operations before income tax provision, equity in income and noncontrolling interest decreased in 2010 in comparison to 2009 due to our open-market purchase of approximately $33 million principal amount of the Subordinated Notes in June 2009 and the subsequent cancellation of those notes, which resulted in a pre-tax gain on the extinguishment of debt of $8 million in 2009 and an increase in operating profit.
Foreign. Income from continuing operations before income tax provision, equity in income and noncontrolling interest increased in 2011 in comparison to 2010. The majority of the increase was due to an improvement in gross profit, which was driven by an increase in sales volume and favorable currency translation effects. Foreign sales increased by 9% in 2011 in comparison to 2010. Income from continuing operations before income tax provision, equity in income and noncontrolling interest increased in 2010 in comparison to 2009 due to an improvement in gross profit, which was driven by an increase in sales volume and favorable currency translation effects. Foreign sales increased by 19% in 2010 in comparison to 2009. The improvement in gross profit included $11 million of favorable currency translation effects.
The foreign income from continuing operations before income tax provision, equity in income and noncontrolling interest compared to the United States was higher due to interest expense in domestic operations, higher restructuring costs in the United States and higher profitability of some of our foreign operations. The majority of our debt relates to our United States operations and as a consequence almost all of the associated interest expense is allocated to our domestic operations. During 2011, our United States operations had $66 million of interest expense and our foreign operations had $1 million of interest expense and during 2010, our United States operations had $64 million of interest expense and our foreign operations had $1 million in interest expense.
Liquidity and Capital Resources
Our primary source of liquidity is cash flow from operations and available borrowings from our ABL Revolver. Our primary liquidity requirements are significant and are expected to be primarily for debt servicing, working capital, restructuring obligations and capital spending.
We are significantly leveraged as a result of the Acquisition, the refinancing that occurred in 2009 and the issuance of Additional Notes in 2010. Affinia Group Inc. issued the Subordinated Notes in connection with the Acquisition and issued the Secured Notes and entered into the ABL Revolver in connection with the refinancing. As of December 31, 2011, we had $718 million in aggregate indebtedness, which includes $20 million classified in current liabilities of discontinued operations. As of December 31, 2011, we had an additional $166 million of borrowing capacity available under our ABL Revolver after giving effect to $13 million in outstanding letters of credit, none of which was drawn against, and $3 million for borrowing base reserves. In addition, we had cash and cash equivalents of $55 million and $54 million as of December 31, 2010 and December 31, 2011, respectively.
We spent $52 million and $55 million in capital expenditures during 2010 and 2011, respectively. The cash flow from operations on an annual basis has historically been adequate to meet our liquidity needs. However, during the first half of the year, cash flows from operations are typically not sufficient to meet our liquidity needs, and we therefore utilize our ABL Revolver to bridge our financing needs until the second half of the year. During the first half of 2011 we had a use of cash of $52 million and in the second half of 2011 we had a source of cash of $66 million. Based on the current level of operations, we believe that cash flow from operations and available cash, together with available borrowings under our ABL Revolver, will be adequate to meet our short term and long term liquidity needs.
Our ABL Revolver matures in November 2015, our Subordinated Notes mature in November 2014 and our Secured Notes mature in August 2016. Furthermore, if we were to undertake a significant acquisition or capital improvement plan, we may need additional sources of liquidity. We expect to meet such liquidity needs by entering into new or additional credit facilities and/or offering new or additional debt or equity securities, but whether such sources of liquidity will be available to us at any given point in the future will depend on a number of factors that are outside of our control, including general market conditions.
Asset Based Credit Facilities
Overview. Affinia Group Intermediate Holdings Inc., Affinia Group Inc. and certain of its subsidiaries entered into a four-year $315 million ABL Revolver maturing in 2015 (subject to early termination under certain limited circumstances). There was $110 million outstanding on the ABL Revolver at December 31, 2011. The ABL Revolver includes (i) a revolving credit facility of up to $295 million for borrowings solely to the U.S. domestic borrowers (the “U.S. Facility”), including (a) a $40 million sub-limit for letters of credit and (b) a $30 million swingline facility and (ii) a revolving credit facility of up to $20 million for Canadian Dollar denominated revolving loans solely to a Canadian borrower (the “Canadian Facility”). Availability under the ABL Revolver is based upon monthly (or more frequent under certain circumstances) borrowing base valuations of Affinia Group Inc.’s eligible inventory and accounts receivable for continuing and discontinued operations and is reduced by certain reserves in effect from time to time.
Guarantees and Collateral. The indebtedness, obligations and liabilities under the U.S. Facility are unconditionally guaranteed jointly and severally on a senior secured basis by Affinia Group Intermediate Holdings Inc. and certain of its current and future U.S. subsidiaries, and are secured by a first-priority lien on accounts receivable, inventory, cash, deposit accounts, securities accounts and proceeds of the foregoing and certain assets related thereto and a second-priority lien on the collateral securing the Secured Notes on a first-priority basis (collectively, the “U.S. Collateral”).
The indebtedness, obligations and liabilities under the Canadian Facility are unconditionally guaranteed jointly and severally on a senior secured basis by Affinia Group Intermediate Holdings Inc., certain of its current and future U.S. subsidiaries and certain of its Canadian subsidiaries and are also secured by the U.S. Collateral and by a first-priority lien on substantially all of the Canadian borrower’s and the Canadian guarantors’ existing and future assets, including, but not limited to, accounts receivable and inventory (but excluding owned real property and the capital stock of any non-U.S. and non-Canadian subsidiaries of the Canadian borrower or the Canadian guarantors).
Mandatory Prepayments. If at any time the outstanding borrowings under the ABL Revolver (including outstanding letters of credit and swingline loans) exceed the lesser of (i) the borrowing base as in effect at such time and (ii) the aggregate revolving commitments as in effect at such time, the borrowers will be required to prepay an amount equal to such excess and/or cash collateralize outstanding letters of credit.
Voluntary Prepayments. Subject to certain conditions, the ABL Revolver allows the borrowers to voluntarily reduce the amount of the revolving commitments and to prepay the loans without premium or penalty other than customary breakage costs for LIBOR rate contracts.
Covenants. The ABL Revolver contains certain covenants that, among other things, limit or restrict the ability of Affinia Group Intermediate Holdings Inc. and its subsidiaries to (subject to certain qualifications and exceptions):
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create liens and encumbrances;
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incur additional indebtedness;
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merge, dissolve, liquidate or consolidate;
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make acquisitions and investments;
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dispose of or transfer assets;
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pay dividends or make other payments in respect of the borrowers’ capital stock;
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amend certain material governance documents;
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change the nature of the borrowers’ business;
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make any advances, investments or loans;
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engage in certain transactions with affiliates;
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issue or dispose of equity interests;
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change the borrowers’ fiscal periods; and
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restrict dividends, distributions or other payments from Affinia Group Intermediate Holdings Inc.’s subsidiaries.
In addition, commencing on the day that an event of default occurs or availability under the ABL Revolver is less than the greater of (i) 12.5% of the total revolving loan commitments and (ii) $39.5 million, Affinia Group Intermediate Holdings Inc. is required to maintain a fixed charge coverage ratio of at least 1.10x measured for the last 12-month period.
Interest Rates and Fees. Outstanding borrowings under the U.S. Facility will accrue interest at an annual rate of interest equal to (i) a base rate plus the applicable spread or (ii) a LIBOR rate plus the applicable spread. Swingline loans will bear interest at a base rate plus the applicable spread. Outstanding borrowings under the Canadian Facility will accrue interest at an annual rate of interest equal to (i) the Canadian prime rate plus the applicable spread or (ii) the BA rate (the average discount rate of bankers’ acceptances as quoted on the Reuters Screen CDOR page) plus the applicable spread. We will pay a commission on letters of credit issued under the U.S. Facility at a rate equal to the applicable spread for loans based upon the LIBOR rate.
The borrowers will pay certain fees with respect to the ABL Revolver, including (i) an unused commitment fee of 0.50% per annum on the undrawn portion of the credit facility (subject to a step-down to 0.375% in the event more than 50% of the commitments (excluding swingline loans) under the credit facility are utilized) and (ii) customary annual administration fees and fronting fees in respect of letters of credit equal to 0.125% per annum on the stated amount of each letter of credit outstanding during each month. During an event of default, the fee payable under clause (i) will be increased by 2% per annum.
Cash Dominion. If availability under the ABL Revolver is less than the greater of (i) 15% of the total revolving loan commitments and (ii) $47.5 million, or if there exists an event of default, amounts in Affinia Group Intermediate Holdings Inc.’s deposit accounts and the deposit accounts of the subsidiary guarantors (other than certain excluded accounts) will be transferred daily into a blocked account held by the administrative agent and applied to reduce the outstanding amounts under the ABL Revolver.
Senior Notes
Overview. In November 2004, Affinia Group Inc. issued $300 million aggregate principal amount of the Subordinated Notes, which bear interest at a rate of 9% and mature on November 30, 2014, pursuant to an indenture dated as of November 30, 2004 (the “senior subordinated indenture”). On December 9, 2010, Affinia Group Inc. issued $100 million of Additional Notes. In connection with our refinancing in August 2009, Affinia Group Inc. issued $225 million aggregate principal amount of the Secured Notes (together with the Subordinated Notes, the “Senior Notes”), which bear interest at a rate of 10.75% and mature on August 15, 2016, pursuant to an indenture dated as of August 13, 2009 (the “senior secured indenture” and, together with the senior subordinated indenture, the “senior indentures”). On December 31, 2010, Affinia Group Inc. redeemed $22.5 million aggregate principal amount of the Secured Notes pursuant to their terms at a redemption price equal to 103% of the principal amount of such notes being redeemed, plus accrued and unpaid interest to the redemption date. As of December 31, 2011, $367 million principal amount of the Subordinated Notes was outstanding and $201 million principal amount of the Secured Notes was outstanding, net of a $2 million issue discount which is being amortized until the Secured Notes mature.
Guarantees and Collateral. The Subordinated Notes are unconditionally guaranteed jointly and severally on a senior subordinated basis by substantially all of our wholly-owned domestic subsidiaries. The Secured Notes are unconditionally guaranteed jointly and severally on a senior secured basis by substantially all of our wholly-owned domestic subsidiaries.
The Secured Notes and the related guarantees are secured on a first-priority lien basis by substantially all of the assets (other than accounts receivable, inventory, cash, deposit accounts, securities accounts and proceeds of the foregoing and certain assets related thereto) of Affinia Group Inc. and the guarantors and on a second-priority lien basis by the accounts receivable, inventory, cash, deposit accounts, securities accounts and proceeds of the foregoing and certain assets related thereto of Affinia Group Inc. and the guarantors.
Interest Payments. Interest on the Subordinated Notes is payable on May 30 and November 30 of each year and interest on the Secured Notes is payable on February 15 and August 15 of each year.
Optional Redemption. We may redeem some or all of the Senior Notes at any time at redemption prices described or set forth in the applicable senior indenture.
Change of Control. Upon the occurrence of certain change of control events specified in the applicable senior indenture, each holder of the Subordinated Notes or Secured Notes has the right to require us to repurchase such holder’s Subordinated Notes or Secured Notes, as applicable, at a purchase price in cash equal to 101% of the principal amount thereof, plus accrued and unpaid interest to the repurchase date.
Covenants. The senior indentures contain certain covenants that, among other things, limit or restrict the ability of Affinia Group Inc. and its restricted subsidiaries to (subject to certain qualifications and exceptions):
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incur and guarantee additional indebtedness, issue disqualified stock or issue certain preferred stock;
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pay dividends, make other distributions on, redeem or repurchase stock or make certain other restricted payments;
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create certain liens or encumbrances;
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sell assets;
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issue capital stock;
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make certain investments or acquisitions;
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make capital expenditures;
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restrict dividends, distributions or other payments from our subsidiaries;
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change their line of business;
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enter into transactions with affiliates;
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consolidate, merge, sell or otherwise dispose of all or substantially all of their assets; and
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designate subsidiaries as unrestricted subsidiaries.
Cash Flows
Net cash provided by (used in) operating, investing and financing activities including continuing and discontinued operations is summarized in the tables below for the years ended 2009, 2010 and 2011:
Net Cash Provided by Operating Activities
Net cash provided by operating activities is summarized in the table below for the years ended 2009, 2010 and 2011:
Net income (loss) - Net income increased in 2010 in comparison to 2009 due to the decrease in the loss from discontinued operations, net of tax. We recorded a $75 million impairment related to our Commercial Distribution Europe segment in 2009, which was sold on February 2, 2010. Net income decreased in 2011 in comparison to 2010 due to the loss from discontinued operations, net of tax, offset by an increase in sales and gross profit. We recorded a $165 million impairment related to our Brake North America and Asia group in 2011, offset by a tax benefit to the Company of $57 million.
Loss (gain) on extinguishment of debt - The retirement of $33 million of Subordinated Notes during the second quarter of 2009 resulted in a pre-tax gain on the extinguishment of debt of $8 million. The retirement of $22.5 million of Secured Notes during the fourth quarter of 2010 resulted in a pre-tax loss on the extinguishment of debt of $1 million.
Write-off of debt issuance costs - We recorded a write-off of $5 million in 2009 to interest expense for unamortized deferred financing costs associated with the retirement of the term loan facility, revolving credit facility and the accounts receivable facility. We wrote off $1 million in deferred costs in 2010 related to the extinguishment of $22.5 million of Secured Notes during the fourth quarter of 2010.
Change in trade accounts receivable - Our accounts receivable decreased in 2009 and increased in 2010 mainly due to the timing of payments in the United States. Our accounts receivable decreased in 2011 due to timing of payments. The change in trade accounts receivable was due in part to entering into factoring programs in the third quarter of 2010 that have continued through to 2011.
Change in inventories - The change in inventories was an $8 million source of cash in 2011, a $77 million use of cash in 2010 and a $42 million source of cash in 2009. The reduction in inventory in 2009 was due to a concerted effort to reduce inventories due to the economic downturn. In 2008, our inventory increased mainly due to increases in Brazil and other international locations. Our Brazilian operations were experiencing record sales in 2008 and, as a result, built up inventory to keep up with demand. In the second half of 2010 we began building up inventory, which we continued until the second quarter of 2011, in anticipation of increased demand. However, due to a decrease in miles driven and other factors we built inventory at a higher pace than actual sales increased. We began focusing on reducing inventory levels during second half of 2011 which resulted in an $81 million decrease from the second quarter of 2011 until the end of 2011.
Change in other current operating liabilities - The change in other current operating liabilities was a $47 million use of cash in 2011, a $39 million source of cash in 2010 and a $42 million use of cash in 2009. The changes over the last three years were primarily due to accounts payable, which was a $54 million use of cash in 2011, a $38 million source of cash in 2010 and a $54 million use of cash in 2009. Accounts payable fluctuates from quarter to quarter due to the timing of payments.
Net cash used in investing activities
Net cash used in investing activities is summarized in the table below for the years ended 2009, 2010 and 2011:
The changes in investing activities are mainly comprised of the following:
Investments in companies, net of cash acquired -The NAPD business was acquired for an original payment of $51 million in 2010 and a $1 million payment in 2011 for a working capital settlement.
Additions to property, plant and equipment - The additions increased significantly in 2010 and 2011 due to the expansion in China for new friction and filtration facilities and for the expansion of our Polish and Brazilian operations. The total additions to property, plant and equipment in China, Poland and Brazil increased $21 million in 2010 from 2009 and, in addition, China also increased $11 million in 2011 from 2010.
Proceeds from sale of affiliates - We sold our Commercial Distribution Europe segment for $11 million during 2010.
Proceeds from sales of assets - The proceeds from sales of assets increased in 2011 to $9 million mainly due to the sale of Venezuelan and Canadian facilities, which were part of our restructuring plans.
Net cash provided by (used in) financing activities
Net cash provided by (used in) financing activities is summarized in the table below for the years ended 2009, 2010 and 2011:
The changes in financing activities are mainly comprised of the following:
On December 9, 2010, we completed an offering of the Additional Notes. The issuance of the Additional Notes and the amendment of the ABL Revolver in 2010 resulted in payment of deferred financing costs of $5 million. We utilized the ABL Revolver to finance our purchase of the NAPD business and the remaining 50% interest in Affinia India Private Limited but subsequently we used the proceeds of this note offering to repay the ABL Revolver borrowings that we incurred to finance these acquisitions. The proceeds of the note offering were also used to redeem $22.5 million in Secured Notes on December 31, 2010.
In the third quarter of 2009, we refinanced a portion of our then-existing debt. We settled the former term loan facility by paying $287 million. The refinancing included sources of cash of $222 million from the Secured Notes. We also had $90 million of net borrowings on the new ABL Revolver and $22 million of fees and other associated financing costs.
Effective June 1, 2009, Affinia Group Inc. acquired an additional 35% ownership interest in Affinia Acquisition LLC for a purchase price of $25 million, which increased its ownership to 40%. The $25 million reduced our noncontrolling interest balance in 2009. During the fourth quarter of 2010, we acquired the remaining 50% ownership interest in Affinia India Private Limited, our India joint venture, for $24 million in cash, increasing our ownership interest from 50% to 100%. The $24 million reduced our noncontrolling interest balance in 2010.
Capital contributions-The $3 million and $2 million source of cash in 2010 and 2011, respectively, related to contributions from Mr. Zhang Haibo, who owns 15% of Affinia Hong Kong Limited. The 2010 contribution was used to facilitate the purchase of land for a new filtration company in China with the intention to manufacture products in China and distribute filtration products principally in Asia. The 2011 contributions were to provide additional funding for the new filtration company in China and to facilitate the establishment of a new friction company in China with the intention to manufacturing friction products and distributing these products in Asia and North America.
Net increase (decrease) in other short-term debt - During 2011, our Chinese operation was able to decrease its short term debt due to a reduction in purchases of inventory.
Proceeds from other debt - The change in 2011 was due to our Polish subsidiary increasing its debt by $20 million.
Net proceeds from ABL Revolver -We had $20 million additional outstanding at the end of 2011 on our ABL Revolver compared to 2010. The additional borrowings in 2011 were needed to fund the additional operational needs related to increased levels of capital spending and higher levels of working capital.
Contractual Obligations and Commitments
Under various agreements, we are obligated to make future cash payments in fixed amounts. These include payments under debt obligations at maturity, under operating lease agreements, and under purchase commitments for property, plant, and equipment. The following table summarizes our fixed cash obligations over various future periods as of December 31, 2011:
* Excludes the $2 million reserve for income taxes under ASC Topic 740, “Income Taxes,” as we are unable to reasonably predict the ultimate timing of settlement of our reserves for income taxes.
** Includes $20 million of notes payable in our Brake North America and Asia group, which is classified above in payments due in less than 1 year. Excludes $2 million discount on the Secured Notes.
*** The ABL Revolver includes a margin on LIBOR borrowings that varies from 2.25% to 2.75% based on availability under the facility. At December 31, 2011, the margin was 2.50%.
**** Operating leases include future minimum rental commitments under non-cancelable operating leases of $35 million in our Brake North America and Asia group.
***** Includes $6 million of purchase commitments for property, plant and equipment in our Brake North America and Asia group.
Commitments and Contingencies
We are party to various pending judicial and administrative proceedings arising in the ordinary course of business. These include, among others, proceedings based on product liability claims and alleged violations of environmental laws.
We have various accruals for contingent liability costs associated with pending judicial and administrative proceedings (excluding environmental liabilities described below). We had $2 million and $4 million accrued at December 31, 2010 and 2011, respectively. There are no recoveries expected from third parties. If there is a range of equally probable outcomes, we accrue the lower end of the range.
The fair value of an ARO is required to be recognized in the period in which it is incurred if it can be reasonably estimated, with the offsetting associated asset retirement costs capitalized as part of the carrying amount of the long-lived asset. The ARO is subsequently allocated to expense using a systematic and rational method over its useful life. Changes in the ARO liability resulting from the passage of time are recognized as an increase in the carrying amount of the liability and an accretion to expense. Changes resulting from revisions to the timing or amount of the original estimate of cash flows are recognized as an increase or a decrease in both the asset and liability. Our ARO liability recorded at December 31, 2010 and December 31, 2011 was $2 million and the accretion for 2010 and 2011 was less than $1 million.
Critical Accounting Estimates
The critical accounting estimates that affect our financial statements and that use judgments and assumptions are listed below. These estimates are subject to a range of amounts because of inherent imprecision that may result from applying judgment to the estimation process. The expenses and accrued liabilities or allowances related to certain of these policies are initially based on our best estimate at the time of original entry in our accounting records. Adjustments are recorded when actual results differ from the expected forecasts underlying the estimates. These adjustments could be material if our results were to change significantly in a short period of time. We make frequent comparisons of actual results and expected forecasts in order to mitigate the likelihood of material adjustments. The Company determined that the net carrying value of the Brake North America and Asia group may not be recoverable through the sales process. As a result, an impairment charge of $165 million was recorded within discontinued operations in 2011 to reduce the carrying value of the business to expected realizable value. A tax benefit to the Company of $57 million was recorded relating to the impairment. The impairment was determined by comparing the carrying value of the Brake North America and Asia group to its fair value less costs to sell.
Asset impairment. We perform impairment analyses, which are based on the guidance found in ASC Topic 350, “Intangibles -Goodwill and Other” and ASC Topic 360, “Property, Plant, and Equipment.” Management also evaluates the carrying amount of our inventories on a recurring basis for impairment due to lower of cost or market issues, and for excess or obsolete quantities. Goodwill and intangibles with indefinite lives are tested for impairment as of December 31 of each year or more frequently as necessary. The factors that would cause a more frequent test for impairment include, among other things, a significant negative change in the estimated future cash flows of the reporting unit that has goodwill or other intangibles because of an event or a combination of events. If the carrying amount of the asset is determined not to be recoverable, a write-down to fair value is recorded. Fair values are determined based on quoted market values, discounted cash flows, or external appraisals, as applicable. We review long-lived assets for impairment at the individual asset or the asset group level for which the lowest level of independent cash flows can be identified.
Goodwill. The impairment test involves an optional qualitative assessment before a two-step testing process. If we determine, on the basis of qualitative factors, that it is not more likely than not that the fair value of a reporting unit is less than the carrying amount, the two-step impairment test would not be required. If we elected to or if we determined that it is more likely than not that the fair value of a reporting unit is less than the carry amount, then we perform step 1 of the impairment test process which is a comparison of the fair value of the applicable reporting unit with the aggregate carrying values, including goodwill. If the carrying amount of a reporting unit exceeds the reporting unit’s fair value, we perform the second step of the goodwill impairment test to determine the amount of impairment loss. The second step includes comparing the implied fair value of the affected reporting unit’s goodwill with the carrying value of that goodwill. The reporting unit’s current fair value is in excess of the reporting unit’s carrying value.
We primarily determine the fair value of our reporting units using a discounted cash flow model (“DCF model”), and supplement this with observable valuation multiples for comparable companies, as applicable. The completion of the DCF model requires that we make a number of significant assumptions to produce an estimate of future cash flows. These assumptions include projections of future revenue, costs and working capital changes. In addition, we make assumptions about the estimated cost of capital and other relevant variables, as required, in estimating the fair value of our reporting units. The projections that we use in our DCF model are updated annually and will change over time based on the historical performance and changing business conditions for each of our reporting units. The determination of whether goodwill is impaired involves a significant level of judgment in these assumptions, and changes in our business strategy, or economic or market conditions could significantly impact these judgments. We will continue to monitor market conditions and other factors to determine if interim impairment tests are necessary in future periods. If impairment indicators are present in future periods, the resulting impairment charges could have a material impact on our results of operations.
Trade names. The fair value for each trade name is estimated based upon management’s estimates using a royalty savings approach, which is based on the principle that, if the business did not own the asset, it would have to license it in order to earn the returns that it was earning. The fair value is calculated based on the present value of the royalty stream that the business was saving by owning the asset. The projections that we use in our model are updated annually and will change over time based on the historical performance and changing business conditions for each of our reporting units. The determination of whether trade names are impaired involves a significant level of judgment in these assumptions, and changes in our business strategy, or economic or market conditions could significantly impact these judgments.
Other intangibles. Finite-lived intangibles are amortized over their estimated useful lives. Impairment tests for these intangible assets are only performed when a triggering event occurs that indicates that the carrying value of the intangible may not be recoverable based on the undiscounted future cash flows of the intangible. If the carrying amount of the intangible is determined not to be recoverable, a write-down to fair value is recorded. Fair values are determined based on a DCF model.
Inventories. Inventories are valued at the lower of cost or market. Cost is determined on the first in first out (“FIFO”) basis for all inventories or average cost basis for non-U.S. inventories. Where appropriate, standard cost systems are utilized for purposes of determining cost; the standards are adjusted as necessary to ensure they approximate actual costs. Estimates of inventory value are determined on a product line basis. These estimates are based upon current economic conditions, historical sales quantities and patterns and, in some cases, the specific risk of loss on specifically identified inventories.
We also evaluate inventories on a regular basis to identify inventory on hand that may be obsolete or in excess of current and future projected market demand principally based on historical market demand. For inventory deemed to be obsolete, we provide a reserve on the full value of the inventory. Inventory that is in excess of current and projected use, which is generally defined as inventory quantities in excess of 24 months of historical sales, is adjusted for certain allowances such as new part number introductions and product repacking opportunities.
Revenue recognition. Sales are recognized when products are shipped or received depending on terms and whether risk of loss has transferred to the customer. The Company estimates and records provisions for warranty costs, sales returns and other allowances based on experience when sales are recognized. The Company assesses the adequacy of its recorded warranty and sales returns and allowances liabilities on a regular basis and adjusts the recorded amounts as necessary. While management believes that these estimates are reasonable, actual returns and allowances and warranty costs may differ from estimates. Inter-company sales have been eliminated.
Sales returns and rebates. The amount of sales returns accrued at the time of sale is estimated on the basis of the history of the customer and the history of products returned. Other factors considered in establishing the accrual include consideration of current economic conditions and changes in trends in returns, as well as adjusting for the impact of extraordinary returns that may result from individual negotiations with a customer in an unusual situation. The level of sales returns are recorded as a reduction of gross sales in our financial statements at the time of sale. In addition, we periodically perform studies to determine a scrap factor to be applied to the returns on a product-by-product basis, since a portion of the goods historically returned by customers have not been in saleable condition. Estimates of returned goods that are not in saleable condition are included in cost of sales.
We customize rebate programs with individual customers. Under certain rebate programs, a customer may earn a rebate that will increase as a percentage of the sale amount based on the achievement of specified sales levels. In order to estimate the amount of a rebate under this type of arrangement, we project the amount of sales that the customer will make over the specified rebate period in order to calculate an overall rebate to be accrued at the time that each sale is made. Gross sales are reduced at the time of sale. These estimates may need to be adjusted based on actual customer purchases compared to the projected purchases. Adjustments to the accrual are made as new information becomes available. In other cases a customer may earn a specific rebate for a specific period of time, based upon the sales of certain product types within the specified timeframe. Rebates are recorded as a reduction of gross sales.
Warranty. Estimated costs related to product warranty are accrued at the time of sale and included in cost of sales. Estimated costs are based upon past warranty claims and sales history. In certain situations the estimated cost of the warranty includes a salvage factor where a portion of the inventory returned proves to be saleable. These costs are then adjusted, as required, to reflect subsequent experience.
Income taxes. We account for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to be in effect for the year in which those temporary differences are expected to be recovered or settled. Deferred tax assets are recognized for temporary differences that will result in deductible amounts in future years and for carryforwards. A valuation allowance is recognized if, based on the weight of available evidence, it is more likely than not that some portion or all of a deferred tax asset will not be realized. All available evidence, both positive and negative, is considered when determining the need for a valuation allowance. Judgment is used in considering the relative impact of negative and positive evidence. The weight given to the potential effect of negative and positive evidence is commensurate with the extent to which it can be objectively verified. Accounting for income taxes involves matters that require estimates and the application of judgment. Our income tax estimates are adjusted in light of changing circumstances, such as the progress of tax audits and our evaluation of the realizability of our tax assets.
Contingency reserves. We have historically been subject to a number of loss exposures, such as environmental claims, product liability and litigation. Establishing loss reserves for these matters requires the use of estimates and judgment with regard to risk exposure and ultimate liability. We expect to estimate losses relating to such contingent liabilities using consistent and appropriate methods. Changes to assumptions we use could materially affect the recorded liabilities.
Restructuring. The company defines restructuring charges to include costs related to business operation consolidation and exit and disposal activities. In 2005, we announced two restructuring plans: (i) a restructuring plan that we announced at the beginning of 2005 as part of the Acquisition, also referred to as the acquisition restructuring and (ii) a restructuring plan that we announced at the end of 2005, also referred to as the comprehensive restructuring. We have completed the acquisition restructuring and we have substantially completed the comprehensive restructuring. We currently estimate that we will incur in the aggregate approximately $169 million of cash and non cash restructuring costs for the comprehensive restructuring. With the comprehensive restructuring coming to a close we anticipate from time to time further refinement to the Company through continued restructuring. Establishing a reserve requires the estimate and judgment of management with respect to employee termination benefits, environmental costs and other exit costs. We had a $4 million and $3 million reserve recorded as of December 31, 2010 and 2011, respectively.
Recent Accounting Pronouncements
In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs”. Key provisions of the amendments in ASU 2011-04 include: (1) a prohibition on grouping financial instruments for purposes of determining fair value, except in limited cases; (2) an extension of the prohibition against the use of a blockage factor to all fair value measurements; and (3) a requirement that for recurring Level 3 fair value measurements, entities disclose quantitative information about unobservable inputs, a description of the valuation process used and qualitative details about the sensitivity of the measurements. For items not carried at fair value but for which fair value is disclosed, entities will be required to disclose the level within the fair value hierarchy that applies to the fair value measurement disclosed. This ASU is effective for annual periods beginning after December 15, 2011. The adoption of ASU 2011-04 is not expected to have a significant effect on our fair value measurements utilized and the related disclosures.
In June 2011, the FASB amended ASC 220, “Comprehensive Income” with ASU 2011-05, “Comprehensive Income (Topic 220) - Presentation of Comprehensive Income,” which revises the manner in which comprehensive income is presented in an entity’s financial statements. This update requires the presentation of the components of comprehensive income in either a continuous
statement of comprehensive income or in two separate but consecutive financial statements. The option to present comprehensive income on the statement of stockholders’ equity has been eliminated. The provisions of this update are effective as of January 1, 2012. The implementation of this update will result in presentation changes only.
In September 2011, the FASB amended ASC 350, “Intangibles - Goodwill and Other” with ASU 2011-08, “Intangibles - Goodwill and Other (Topic 350): Testing Goodwill for Impairment.” Under the revised guidance, entities testing goodwill for impairment have the option of performing a qualitative assessment before calculating the fair value of a reporting unit in step 1 of the goodwill impairment test. If entities determine, on the basis of qualitative factors, that the fair value of a reporting unit is not more likely than not less than the carrying amount, the two-step impairment test would not be required. Otherwise, further testing would be needed. The amendments are effective for all entities for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. We adopted ASU 2011-08 for the fiscal year ending December 31, 2011 as early adoption is permitted.
In September 2011, the FASB amended ASC 715-80, “Compensation - Retirement Benefits - Multiemployer Plans” with ASU 2011-09, “Compensation-Retirement Benefits-Multiemployer Plans (Subtopic 715-80): Disclosures about an Employer’s Participation in a Multiemployer Plan.” The revised guidance requires that employers provide additional separate disclosures for multiemployer pension plans and multiemployer other postretirement benefit plans. The additional quantitative and qualitative disclosures will provide users with more detailed information about an employer’s involvement in multiemployer pension plans. The new disclosure requirements are effective for nonpublic entities for the fiscal years ending after December 15, 2012. We are still evaluating the impact of these new requirements on our disclosures.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to various market risks, such as currency exchange and interest rate fluctuation. Where necessary to minimize such risks we may enter into financial derivative transactions, however we do not enter into derivatives or other financial instruments for trading or speculative purposes.
Currency risk
We conduct business throughout the world. Although we manage our businesses in such a way as to reduce a portion of the risks associated with operating internationally, changes in currency exchange rates may adversely impact our results of operations and financial position.
The results of operations and financial position of each of our operations are measured in their respective local (functional) currency. Business transactions denominated in currencies other than an operation’s functional currency produce foreign exchange gains and losses, as a result of the re-measurement process, as described in ASC Topic 830, “Foreign Currency Matters.” To the extent that our business activities create monetary assets or liabilities denominated in a non-local currency, changes in an entity’s functional currency exchange rate versus each currency in which an entity transacts business have a varying impact on an entity’s results of operations and financial position, as reported in functional currency terms. Therefore, for entities that transact business in multiple currencies, we seek to minimize the net amount of cash flows and balances denominated in non-local currencies. However, in the normal course of conducting international business, some amount of non-local currency exposure will exist. Therefore, management monitors these exposures and may engage in business activities or execute financial hedge transactions intended to mitigate the potential financial impact related to changes in the respective exchange rates.
Our consolidated results of operations and financial position, as reported in U.S. Dollars, are also affected by changes in currency exchange rates. The results of operations of non-U.S. Dollar functional entities are translated into U.S. Dollars for consolidated reporting purposes each period at the average currency exchange rate experienced during the period. To the extent that the U.S. Dollar may appreciate or depreciate over time, the contribution of non-U.S. Dollar denominated results of operations to our U.S. Dollar reported consolidated earnings will vary accordingly. Therefore, changes in the various local currency exchange rates, as applied to the revenue and expenses of our non-U.S. Dollar operations may have a significant impact on our sales and, to a lesser extent, consolidated net income trends. In addition, a significant portion of our consolidated financial position is maintained at foreign locations and is denominated in functional currencies other than the U.S. Dollar. The non-U.S. Dollar denominated monetary assets and liabilities are translated into U.S. Dollars at each respective currency’s exchange rate then in effect at the end of each reporting period. The financial impact of the translation process is reflected within the other comprehensive income component of shareholder’s equity. Accordingly, the amounts shown in our consolidated shareholder’s equity account will fluctuate depending upon the cumulative appreciation or depreciation of the U.S. Dollar versus each of the respective functional currencies in which we conduct business. Management seeks to lessen the potential financial impact upon our consolidated results of operations due to exchange rate changes by engaging in business activities or by executing financial derivative transactions intended to mitigate specific transactional underlying currency exposures. We do not engage in activities solely intended to counteract the impact that changes in currency exchange rates may have upon our U.S. Dollar reported statement of financial condition nor do we engage in currency transactions for speculative purposes.
Our foreign currency exchange rate risk management efforts primarily focus upon operationally managing the net amount of non-functional currency denominated monetary assets and liabilities. In addition, we routinely execute short-term currency exchange rate forward contracts intended to mitigate the earnings impact related to the re-measurement process. At December 31, 2011, we had currency exchange rate derivatives with an aggregate notional value of $62 million and fair values of $1 million in assets and less than $1 million in liabilities.
Interest rate risk
We are exposed to the risk of rising interest rates to the extent that we fund operations with short-term or variable-rate borrowings. At December 31, 2011, the Company’s $718 million of aggregate debt outstanding, which includes $20 million classified in current liabilities of discontinued operations for our Brake North America and Asia group, consisted of $142 million of floating-rate debt and $576 million of fixed-rate debt.
Pursuant to our written interest rate risk management policy we actively monitor and manage our fixed versus floating rate debt composition within a specified range. At year-end, fixed rate debt comprised approximately 80% of our total debt. Based on the amount of floating-rate debt outstanding at December 31, 2011 a 1% rise in interest rates would result in approximately $1 million in incremental interest expense.
Commodity Price Risk Management
We are exposed to adverse price movements or surcharges related to commodities that are used in the normal course of business operations. Management actively seeks to negotiate contractual terms with our customers and suppliers to limit the potential financial impact related to these exposures.
Item 8.
Item 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholder of
Affinia Group Intermediate Holdings Inc.
Ann Arbor, Michigan
We have audited the accompanying consolidated balance sheets of Affinia Group Intermediate Holdings Inc. and subsidiaries (the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements of operations, shareholder’s equity, and cash flows for each of the three years in the period ended December 31, 2011. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Affinia Group Intermediate Holdings Inc. and subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ DELOITTE & TOUCHE LLP
Detroit, Michigan
March 16, 2012
Affinia Group Intermediate Holdings Inc.
Consolidated Statements of Operations
The accompanying notes are an integral part of the consolidated financial statements.
Affinia Group Intermediate Holdings Inc.
Consolidated Balance Sheets
The accompanying notes are an integral part of the consolidated financial statements.
Affinia Group Intermediate Holdings Inc.
Consolidated Statements of Shareholder’s Equity
The accompanying notes are an integral part of the consolidated financial statements.
Affinia Group Intermediate Holdings Inc.
Consolidated Statements of Cash Flows
The accompanying notes are an integral part of the consolidated financial statements.
Affinia Group Intermediate Holdings Inc.
Notes to Consolidated Financial Statements
Note 1. Organization and Description of Business
Affinia Group Intermediate Holdings Inc. is a global leader in the light and commercial vehicle replacement products and services industry. We derive approximately 99% of our sales from this industry and, as a result, are not directly affected by the market cyclicality of the automotive original equipment manufacturers. Our broad range of brake, filtration, chassis and other products are sold in North America, Europe, South America and Asia. Our brands include WIX®, Raybestos®, Nakata®, Brake-Pro®, FiltronTM AIMCO®, McQuay-Norris® and ecoLAST®. Additionally, we provide private label products for NAPA, CARQUEST and ACDelco and other customers and co-branded offerings for Federated Auto Parts and Automotive Distribution Network. Affinia Group Inc. is wholly-owned by Affinia Group Intermediate Holdings Inc., which, in turn, is wholly-owned by Affinia Group Holdings Inc., a company controlled by affiliates of The Cypress Group L.L.C.
Affinia Group Inc., the Company’s direct, wholly-owned subsidiary and a Delaware corporation formed on June 28, 2004, entered into a stock and asset purchase agreement on November 30, 2004, as amended (the “Purchase Agreement”), with Dana Corporation (“Dana”). The Purchase Agreement provided for the acquisition by Affinia Group Inc. of substantially all of Dana’s aftermarket business operations (the “Acquisition”).
The accompanying Consolidated Financial Statements include the accounts of the Company and its subsidiaries. In these Notes to the Consolidated Financial Statements, the terms “the Company,” “we,” “our” and “us” refer to Affinia Group Intermediate Holdings Inc. and its subsidiaries on a consolidated basis.
Note 2. Summary of Significant Accounting Policies
Principles of Consolidation
In accordance with ASC Topic 810, “Consolidation,” the consolidated financial statements include the accounts of Affinia and its wholly owned subsidiaries, majority-owned subsidiaries and variable interest entities (“VIE”) for which Affinia (or one of its subsidiaries) is the primary beneficiary. All intercompany transactions have been eliminated. Equity investments in which we exercise significant influence but do not control are accounted for using the equity method. Investments in which we are not able to exercise significant influence over the investee are accounted for under the cost method. Affinia India Private Limited reports financial results on a one-month reporting lag. Prior to 2011, Affinia Hong Kong Limited reported their financial results on a one-month reporting lag.
Starting January 1, 2011, Affinia Hong Kong Limited (formerly Haimeng) reported its financial results without a one-month reporting lag. The previously existing one-month reporting lag was eliminated as it was no longer required to achieve a timely consolidation due to the Company’s investments in systems and personnel to enhance our financial statement close process. In accordance with ASC 850-10-45-13, “A Change in the Difference Between Parent and Subsidiary Fiscal Year-Ends,” the elimination of this previously existing reporting lag is considered a voluntary change in accounting principle in accordance with ASC 250-10-50, “Change in Accounting Principle.” The Company believes that this change in accounting principle is preferable because it will result in timelier reporting of the operations of Affinia Hong Kong Limited. A change in accounting principle is to be reported through retrospective application of the new principle to all prior financial statement periods presented. The change in accounting principle was not material to the previously reported annual and interim periods and therefore we have not adjusted those prior period consolidated financial statements. The impact was also not material to the year ended December 31, 2011. To eliminate the lag, the Company’s operations for the year ended December 31, 2011 include the results of Affinia Hong Kong Limited for the thirteen months of December 2010 to December 2011. The inclusion of the results of the thirteenth month increased net income from discontinued operations by $0.4 million.
Use of Estimates
The preparation of these consolidated financial statements requires estimates and assumptions that affect the amounts reported in these consolidated financial statements and accompanying notes. Some of the more significant estimates include valuation of deferred tax assets and inventories; workers compensation; sales return, rebate and warranty accruals; restructuring, environmental and product liability accruals; valuation of postemployment and postretirement benefits and allowances for doubtful accounts. Actual results may differ from these estimates and assumptions.
Concentration of Credit Risk
The primary type of financial instruments that potentially subject the Company to concentrations of credit risk are trade accounts receivable. The Company limits its credit risk by performing ongoing credit evaluations of its customers and, when deemed necessary, requires letters of credit, guarantees or collateral. The majority of the Company’s accounts receivable is due from replacement parts wholesalers and retailers serving the aftermarket.
The Company’s net sales to its two largest customers as a percentage of total net sales from continuing operations for the year ended December 31, 2011, were 26%, and 8%; for the year ended December 31, 2010, were 27% and 6%; and for the year ended December 31, 2009, were 29% and 6%. Net sales represent the amounts invoiced to customers after adjustments related to rebates, returns and discounts. The Company provides reserves for rebates, returns and discounts at the time of sale which are subsequently applied to the account of specific customers based upon actual activity including the attainment of targeted volumes. The Company’s two largest customers’ accounts receivable, which includes continuing and discontinued operations, as of December 31, 2011 represented approximately 32% and 9%, and as of December 31, 2010 represented 37% and 10% of the total accounts receivable.
Foreign Currency Translation
Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Revenue and expenses are translated at average rates of exchange prevailing during the year. Translation adjustments resulting from this process are charged or credited to Other Comprehensive Income.
Included in net income (loss) are the gains and losses arising from foreign currency transactions. The impact on income from continuing operations before income tax provision, equity in income and noncontrolling interest of foreign currency transactions including the results of our foreign currency hedging activities amounted to a loss of $1 million, $2 million and $1 million in 2009, 2010 and 2011, respectively.
Cash and Cash Equivalents
Cash and cash equivalents include all cash balances and highly liquid investments with original maturities of three months or less.
Restricted Cash
Restricted cash relates to deposits requested by banks for notes payables issued to Haimeng’s suppliers in relation to its purchases.
Accounts receivable
We record trade accounts receivable when revenue is recorded in accordance with our revenue recognition policy and relieve accounts receivable when payments are received from customers. Generally, we do not require collateral for our accounts receivable.
Allowance for doubtful accounts
The allowance for doubtful accounts is established through charges to the provision for bad debts. We evaluate the adequacy of the allowance for doubtful accounts on a periodic basis. The evaluation includes historical trends in collections and write-offs, management’s judgment of the probability of collecting accounts, and management’s evaluation of business risk. This evaluation is inherently subjective, as it requires estimates that are susceptible to revision as more information becomes available. The allowance for doubtful accounts was $2 million and $1 million at December 31, 2010 and 2011, respectively.
Inventories
Inventories are valued at the lower of cost or market. Cost is determined on the FIFO basis for all domestic inventories or average cost basis for non-U.S. inventories.
Goodwill
Goodwill is not amortized, but instead the Company evaluates goodwill for impairment, as of December 31 of each year, unless conditions arise that would require a more frequent evaluation. In assessing the recoverability of goodwill, we perform a qualitative or quantitative assessment to test for impairment annually. If we determine, on the basis of qualitative factors, that quantitative impairment test is required estimated future cash flows and other factors are made to determine the fair value of the respective reporting unit. If these estimates or related projections change in the future, we may be required to record impairment charges for goodwill at that time.
Intangibles
We have trade names with indefinite lives and other intangibles with definite lives. We test trade names for impairment on an annual basis as of December 31 of each year, unless conditions arise that would require a more frequent evaluation. Trade names are tested for impairment by comparing the fair value to their carrying values.
Our intangibles with definite lives consist of customer relationships, patents and developed technology. These assets are amortized on a straight-line basis over estimated useful lives ranging from 5 to 20 years. Certain conditions may arise that could result in a change in useful lives or require us to perform a valuation to determine if the definite lived intangibles are impaired.
Deferred Financing Costs
Deferred financing costs are incurred to obtain long-term financing and are amortized using the effective interest method over the term of the related debt. The amortization of deferred financing costs is classified in interest expense in the statement of operations.
Properties and Depreciation
Fixed assets are being depreciated over their estimated remaining lives using primarily the straight-line method for financial reporting purposes and accelerated depreciation methods for federal income tax purposes. Major additions and improvements are capitalized and depreciated over their estimated useful lives, and repairs and maintenance are charged to expense in the period incurred. We review long-lived assets for impairment and general accounting principles require recognition of an impairment loss only if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows. If the long-lived asset is not recoverable, we measure an impairment loss as the difference between the carrying amount and fair value of the asset.
Useful lives for buildings and building improvements, machinery and equipment, tooling and office equipment, furniture and fixtures principally range from 20 to 30 years, five to ten years, three to five years and three to ten years, respectively. Upon retirement or other disposal of fixed assets, the cost and related accumulated depreciation are eliminated from the asset and accumulated depreciation accounts, respectively. The difference, if any, between the net asset value and the proceeds is recorded as a gain or loss on disposition.
Revenue Recognition
Sales are recognized when products are shipped or received, depending on the contractual terms, and risk of loss has transferred to the customer. The Company estimates and records provisions for warranty costs, sales returns, rebates and other allowances based on experience and other relevant factors, when sales are recognized. The Company assesses the adequacy of its recorded warranty, sales returns, rebates and allowances liabilities on a regular basis and adjusts the recorded amounts as necessary. While management believes that these estimates are reasonable, warranty costs, actual returns, rebates and allowances may differ from estimates. Shipping and handling fees billed to customers are included in sales and the costs of shipping and handling are included in cost of sales. Inter-company sales have been eliminated.
Income Taxes
Income taxes are recognized during the period in which transactions enter into the determination of financial statement income, with deferred income taxes being provided for the tax effect of temporary differences between the carrying amount of assets and liabilities and their tax basis. Deferred income taxes are provided on the undistributed earnings of foreign subsidiaries and affiliated companies except to the extent such earnings are considered to be permanently reinvested in the subsidiary or affiliate. In cases where foreign tax credits will not offset U.S. income taxes, appropriate provisions are included in the combined or consolidated statement of operations.
The Company accounts for uncertain tax positions in accordance with ASC Topic 740, “Income Taxes.” The Company adopted the provisions of general accounting principles relating to uncertain tax positions (referred to as FIN 48) on January 1, 2007. Accordingly, the Company reports a liability for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax expense.
Financial Instruments
The reported fair values of financial instruments, consisting of cash and cash equivalents, trade accounts receivable and long-term debt, are based on a variety of factors. Where available, fair values represent quoted market prices for identical or comparable instruments. Where quoted market prices are not available, fair values are estimated based on assumptions concerning the implied market volatilities, amount and timing of estimated future cash flows and assumed discount rates reflecting varying degrees of credit and market risk. Fair values may not represent actual values of the financial instruments that could be realized as of the balance sheet date or that will be realized in the future. As of December 31, 2010 and 2011, the book value of some of our financial instruments, consisting of cash and cash equivalents and trade accounts receivable, approximated their fair values. The fair value of long-term debt is disclosed in “Note 10. Debt.”
Environmental Compliance and Remediation
Environmental expenditures that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to existing conditions caused by past operations which do not contribute to current or future revenue generation are expensed. Liabilities are recorded when environmental assessments and/or remedial efforts are probable and the costs can be reasonably estimated. Estimated costs are based upon current laws and regulations, existing technology and the most probable method of remediation. The costs are not discounted and exclude the effects of inflation. If the cost estimates result in a range of equally probable amounts, the lower end of the range is accrued.
Pension Plans
The Company maintains six defined benefit pension plans associated with its Canadian operations. The annual net periodic pension costs are determined on an actuarial basis.
Advertising Costs
Advertising expenses included in continuing operations were $16 million, $19 million and $26 million for the years 2009, 2010, and 2011, respectively. The advertising expenses included in discontinued operations, were $10 million, $8 million and $7 million for the years 2009, 2010, and 2011, respectively. Advertising costs are recognized as selling expenses at the time advertising is incurred.
Promotional Programs
Cooperative advertising programs conducted with customers that promote the Company’s products are accrued as a rebate based on anticipated total amounts to be rebated to customers over the period of the agreement with the customer. Aftermarket distributors typically source their product lines at a particular price point and product category with one “full-line” supplier, such as our company, which covers substantially all of their product requirements. Switching to a new supplier typically requires that a distributor or supplier make a substantial investment to purchase, or “changeover” to, the new supplier’s products. The changeover costs and other incentives incurred in connection with obtaining new business are recognized as selling expense in the period in which the changeover from a competitor’s product to the Company’s product occurs. Infrequently, we enter into a contract with a customer for a set period of time that requires the reimbursement of the incentive by the customer if the future conditions of the contract are not met. In these infrequent cases the incentive is recorded as a reduction of revenue over the life of the contract.
Insurance
We use a combination of insurance and self-insurance for a number of risks, including workers’ compensation, general liability, vehicle liability and the company-funded portion of employee-related health care benefits. Liabilities associated with these risks are estimated in part by considering historical claims experience, demographic factors, severity factors and other actuarial assumptions.
Research and Development Costs
Research and development expenses included in continuing operations are charged to operations as incurred. The Company incurred $1 million, less than $1 million and $1 million for the years ended 2009, 2010 and 2011, respectively.
Free-Standing Derivatives
The Company is subject to various financial risks during the normal course of business operations, including but not limited to, adverse changes to interest rates, currency exchange rates, counterparty creditworthiness, and commodity prices. Pursuant to prudent risk management principles, the Company may utilize appropriate financial derivative instruments in order to mitigate the potential impact of these factors. The Company’s policies strictly prohibit the use of derivatives for speculative purposes.
In 2010 and 2011, the Company’s derivative instrument usage was limited to standard currency forward transactions intended to offset the earnings impact related to the periodic revaluation of specific non-functional currency denominated monetary working capital accounts and intercompany financing arrangements.
The Company does not seek hedge accounting treatment for its currency derivative transactions because the earnings impact from both the underlying exposures and the hedge transactions are recognized in each accounting period.
Stock-Based Compensation
We account for the employee stock options under the fair value method of accounting using a Black-Scholes model to measure stock-based compensation expense at the date of grant. The compensation expense for the year was $1 million for 2009, less than $1 million in 2010 and nil in 2011.
On July 20, 2005, Affinia Group Holdings Inc. adopted the 2005 Stock Plan. The 2005 Stock Plan was amended on August 25, 2010 and on December 2, 2010 to increase the maximum shares of common stock that may be subject to awards. The 2005 Stock Plan permits the grant of non-qualified stock options, incentive stock options, stock appreciation rights, restricted stock and other stock-based awards to employees, directors or consultants of the Company and its affiliates. A maximum of 350,000 shares of common stock may be subject to awards under the 2005 Stock Plan. The number of shares issued or reserved pursuant to the 2005 Stock Plan (or pursuant to outstanding awards) is subject to adjustment on account of mergers, consolidations, reorganizations, stock splits, stock dividends and other dilutive changes in the common stock. Shares of common stock covered by awards that terminate or lapse and shares delivered by a participant or withheld to pay the minimum statutory withholding rate, in each case, will again be available for grant under the 2005 Stock Plan. Refer to “Note 12. Stock Incentive Plan” for further information on and discussion of our stock options.
On August 25, 2010 and December 23, 2011, Affinia Group Holdings Inc. commenced an offer to certain eligible holders of stock options to exchange their existing options to purchase shares of Affinia Group Holdings Inc. common stock for restricted stock unit awards (“RSUs”). The RSUs granted in connection with the option exchange are governed by the 2005 Stock Plan and a new Restricted Stock Unit Agreement. The RSUs are subject to performance-based and market-based vesting restrictions, which differ from the performance and time-based vesting restrictions applicable to the exchanged stock options. We will estimate the fair value of restricted stock unit awards using the value of Affinia Group Holdings Inc.’s common stock on the date of grant, reduced by the present value of Affinia Group Holdings Inc.’s common stock prior to vesting. The fair value of the RSUs will be expensed either pro rata over the requisite service term or in full if the requisite service period has passed when the RSUs vest in accordance with the performance conditions listed above. Stock-based compensation expense, which would be recorded in selling, general and administrative expenses, and tax related income tax benefits was not recorded for 2010 or 2011 as the performance condition had not been met.
Deferred Compensation Plan
We started a deferred compensation plan in 2008 that permits executives to defer receipt of all or a portion of the amounts payable under our non-equity incentive compensation plan. All amounts deferred are treated solely for purposes of the plan to have been notionally invested in the common stock of Affinia Group Holdings Inc. As such, the accounts under the plan will reflect investment gains and losses associated with an investment in Affinia Group Holdings Inc.’s common stock. We match 25% of the deferral with an additional notional investment in common stock of Affinia Group Holdings Inc., which is subject to vesting as provided in the plan.
New Accounting Pronouncements
In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs”. Key provisions of the amendments in ASU 2011-04 include: (1) a prohibition on grouping financial instruments for purposes of determining fair value, except in limited cases; (2) an extension of the prohibition against the use of a blockage factor to all fair value measurements; and (3) a requirement that for recurring Level 3 fair value measurements, entities disclose quantitative information about unobservable inputs, a description of the valuation process used and qualitative details about the sensitivity of the measurements. For items not carried at fair value but for which fair value is disclosed, entities will be required to disclose the level within the fair value hierarchy that applies to the fair value measurement disclosed. This ASU is effective for annual periods beginning after December 15, 2011. The adoption of ASU 2011-04 is not expected to have a significant effect on our fair value measurements utilized and the related disclosures.
In June 2011, the FASB amended ASC 220, “Comprehensive Income” with ASU 2011-05, “Comprehensive Income (Topic 220) - Presentation of Comprehensive Income,” which revises the manner in which comprehensive income is presented in an entity’s financial statements. This update requires the presentation of the components of comprehensive income in either a continuous statement of comprehensive income or in two separate but consecutive financial statements. The option to present comprehensive income on the statement of stockholders’ equity has been eliminated. The provisions of this update are effective as of January 1, 2012. The implementation of this update will result in presentation changes only.
In September 2011, the FASB amended ASC 350, “Intangibles - Goodwill and Other” with ASU 2011-08, “Intangibles - Goodwill and Other (Topic 350): Testing Goodwill for Impairment.” Under the revised guidance, entities testing goodwill for impairment have the option of performing a qualitative assessment before calculating the fair value of a reporting unit in step 1 of the goodwill impairment test. If entities determine, on the basis of qualitative factors, that the fair value of a reporting unit is not more likely than not less than the carrying amount, the two-step impairment test would not be required. Otherwise, further testing would be needed. The amendments are effective for all entities for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. We adopted ASU 2011-08 for the fiscal year ending December 31, 2011 as early adoption is permitted.
In September 2011, the FASB amended ASC 715-80, “Compensation - Retirement Benefits - Multiemployer Plans” with ASU 2011-09, “Compensation-Retirement Benefits-Multiemployer Plans (Subtopic 715-80): Disclosures about an Employer’s
Participation in a Multiemployer Plan.” The revised guidance requires that employers provide additional separate disclosures for multiemployer pension plans and multiemployer other postretirement benefit plans. The additional quantitative and qualitative disclosures will provide users with more detailed information about an employer’s involvement in multiemployer pension plans. The new disclosure requirements are effective for nonpublic entities for the fiscal years ending after December 15, 2012. We are still evaluating the impact of these new requirements on our disclosures.
Note 3. Discontinued Operation - Brake
In the fourth quarter of 2011, we committed to a plan to sell the Brake North America and Asia group. In accordance with ASC Topic 205, “Presentation of Financial Statements,” the Brake North America and Asia group qualified as a discontinued operation. The consolidated statements of operations for all periods presented have been adjusted to reflect this group as a discontinued operation. The consolidated statements of cash flows for all periods presented were not adjusted to reflect this group as a discontinued operation. The table below summarizes the Brake North America and Asia group’s net sales, income (loss) before income tax provision, income tax provision, income (loss) from discontinued operations, net of tax, net income attributable to noncontrolling interest, net of tax and income (loss) attributable to the discontinued operations.
The aftermarket brake industry is a highly competitive, and price sensitive market. Over the past several years, we have addressed this by moving our manufacturing from high cost facilities, to state of the art low cost country manufacturing in China and India in particular. This transformation is now complete. There are any number of importers of brake products who do not design, manufacture, or for that matter warehouse and distribute on a mass scale, but strictly offer a short line of products to the industry. Affinia has developed the strategy over many years, of providing our customers with an extensive range of not only products, but services such as detailed product catalogs, e-catalogs, technical services and training, electronic data interchange, point of sale marketing materials, and direct shipments to jobber and retail outlets. These additional offerings help build customer loyalty and generate repeat business while differentiating us from our competitors. In pursuit of this strategy, and in response to the changing dynamics of the brake industry, we have made the decision to engage in a plan to sell the Brake North America and Asia group. We expect to sell the group during the first half of 2012.
In accordance with ASC Topic 360, “Property, Plant, and Equipment,” intangibles and other long-lived assets are assessed for recoverability whenever events or changes in circumstances indicate that their carrying value may not be recoverable through the estimated undiscounted future cash flows resulting from the use of the assets. The Company determined that the net carrying value of the Brake North America and Asia group may not be recoverable through the sales process.
The fair value of the Brake North America and Asia group assets held for sale were determined based on current market data, discounted cash flow model and observable valuation multiples for comparable companies. As a result, an impairment charge of $165 million was recorded within discontinued operations in 2011 to reduce the carrying value of the business to expected realizable value. A tax benefit to the Company of $57 million was recorded relating to the impairment.
The amounts for 2010 related to the Brake North America and Asia group are not reclassified to discontinued operations on the balance sheet. The following table shows an analysis of assets and liabilities held for sale as of December 31, 2011:
(1) During the fourth quarter of 2011, we had a change in estimate in our caliper core products that adjusted the carrying amount of finished goods inventory. The change results from new information as defined in ASC 250, “Accounting Changes and Error Corrections.” Due to the recent addition of new controls and reporting processes related to certain remanufactured inventory components we were able to more closely determine the cost of the caliper core products. The financial impact of this change in estimate increased inventory in 2011 and decreased cost of sales by $4 million in 2011 and it is expected to have the same financial impact in 2012.
Note 4. Discontinued Operation - Quinton Hazell
In the fourth quarter of 2009 we committed to a plan to sell the Commercial Distribution Europe segment. In accordance with ASC Topic 205, “Presentation of Financial Statements,” the Commercial Distribution Europe segment qualified as a discontinued operation. The consolidated statements of operations for all periods presented have been adjusted to reflect this segment as a discontinued operation. The consolidated statements of cash flows for all periods presented were not adjusted to reflect this segment as a discontinued operation. The table below summarizes the Commercial Distribution Europe segment’s net sales, loss before income tax provision, income tax provision and loss from discontinued operations, net of tax.
We entered into a Sale and Purchase Agreement with Klarius Group Limited (“KGL”) and Auto Holding Paris S.A.S. (“AHP”) (collectively, the “Purchaser”) on February 2, 2010 (the “Agreement”), pursuant to which KGL purchased the shares of Quinton Hazell Automotive Limited and Quinton Hazell Italia SpA and AHP purchased the shares of Quinton Hazell Deutschland GmbH and Affinia Holding S.A.S. (collectively, the “Group Companies”) for $12 million as of the end of 2009. We settled with KGL on a working capital adjustment in February 2011 and as a result the purchase price was lowered by $1 million effective for 2010. Consequently, the net purchase price after the settlement was $11 million. The Agreement also called for the Purchaser to assume debt of $2.6 million. We also retained the cash in the Group Companies. The business of the Group Companies and their subsidiaries consist of manufacturing and distribution facilities in eight countries in Europe.
In accordance with ASC Topic 360, “Property, Plant, and Equipment,” intangibles and other long-lived assets are assessed for recoverability whenever events or changes in circumstances indicate that their carrying value may not be recoverable through the estimated undiscounted future cash flows resulting from the use of the assets. The Company determined that the net carrying value of the Commercial Distribution Europe segment may not be recoverable through the sales process. As a result, an impairment charge of $75 million was recorded within discontinued operations in 2009 to reduce the carrying value of the business to expected realizable value. A tax benefit to the Company of $24 million was recorded resulting from this transaction. The sale was consummated on February 2, 2010 and the estimated loss has subsequently decreased $2 million offset by the one month of operating losses of $1 million resulting in net income from discontinued operations and $1 million loss on post closing adjustments.
Note 5. Acquisition
On December 16, 2010, the Company, through its subsidiary Affinia Products Corp LLC, acquired substantially all the assets of North American Parts Distributors, Inc. (“NAPD”). NAPD, located in Ramsey, New Jersey, was an automobile parts and supplies wholesaler. The NAPD acquisition expanded our product offering of chassis parts to one of the broadest in the industry. NAPD’s purchased assets and assumed liabilities were acquired for cash consideration of $52 million. The initial purchase price was $51 million and was paid in 2010. Subsequently, in 2011 the working capital adjustment was settled for $1 million. The working capital adjustment was based on the difference between targeted working capital and working capital at the closing date. This acquisition was considered immaterial for disclosure of supplemental pro forma information and revenues and earnings of the acquiree since the acquisition date. We financed this acquisition with the available borrowings under our ABL Revolver, which borrowings were repaid with our completed offering on December 9, 2010 of the Additional Notes.
The aforementioned acquisition has been accounted for under the purchase method of accounting, in accordance with ASC Topic 805, “Business Combinations.” We engaged independent appraisers to assist in determining the fair values of inventory and intangible assets acquired; including non-competition agreements, developed technology and customer relationships. Purchase price allocations are subject to adjustment until all pertinent information regarding the acquisition is obtained and fully evaluated. Based on our preliminary valuations and purchase accounting adjustments, we recorded $22 million as goodwill at the end of 2010. The Company completed the final allocation of the purchase price as of September 30, 2011. There were no changes to the preliminary allocation of the purchase price of the fair value of the underlying assets acquired and liabilities assumed. We expect the goodwill will be deductible for tax purposes.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of the Acquisition:
Cash and cash equivalents, trade accounts receivable, accounts payable, accrued expenses and other current liabilities were recorded at historical carrying values, given the short-term nature of these assets and liabilities. Customer relationships with estimated useful life of 20 years have been valued using an income approach, which utilized a discounted cash flow method. The unpatented technology with an estimated useful life of 10 years was valued utilizing a relief from royalty method. The non-competition agreement with an estimated useful life of 5 years was valued utilizing a form of the discounted cash flow method to determine the value of lost income.
Note 6. Variable Interest Entity
Effective October 31, 2008, Affinia Acquisition LLC completed the purchase of 85% of the equity interests (the “Acquired Shares”) in HBM Investment Limited (“HBM”). HBM was the sole owner of Longkou Haimeng Machinery Company Limited (“Haimeng”), a drum and rotor manufacturing company located in Longkou City, China. The purchase price was $50 million and included $25 million in current and long term debt on Haimeng’s books. Affinia Group Holdings Inc. received $51 million in return for preferred stock from Cypress, co-investors and management. Affinia Group Holdings Inc. contributed $50 million to Affinia Acquisition LLC to purchase 85% of the equity interests in HBM.
HBM subsequently changed its name to Affinia Hong Kong Limited. Affinia Group Holdings Inc. owned 95% of Affinia Acquisition LLC and Affinia Group Inc. owned the remaining 5% interest. Effective June 1, 2009, Affinia Group Inc. acquired an additional 35% ownership interest in Affinia Acquisition LLC for a purchase price of $25 million, which increased its ownership to 40%. ASC Topic 810 requires the “primary beneficiary” of a variable interest entities (“VIE”) to include the VIE’s assets, liabilities and operating results in its consolidated financial statements. Based on the criteria for consolidation of VIEs, we determined that Affinia Group Inc. was deemed the primary beneficiary of Affinia Acquisition LLC. Therefore, our consolidated financial statements include Affinia Acquisition LLC and its subsidiaries.
On September 1, 2010, our parent company, Affinia Group Holdings Inc., contributed the remaining 60% interest in Affinia Acquisition LLC to Affinia Group Intermediate Holdings Inc. and Affinia Group Intermediate Holdings Inc. contributed such interest to Affinia Group Inc. Consequently, the noncontrolling interest balance was decreased by $32 million and the additional paid-in capital was increased by $32 million. The net income attributable to the noncontrolling interest owned in Affinia Acquisition LLC and Affinia India Private Limited was less than $7 million in 2009, $6 million for 2010 and $1 million for 2011.
The aforementioned acquisition has been accounted for under the purchase method of accounting, in accordance ASC Topic 805, “Business Combinations” (formerly Statement of Financial Accounting Standards No. 141, “Business Combinations”). The Company engaged independent appraisers to assist in determining the fair values of property, plant and equipment and intangible assets acquired; including trade names, trademarks, developed technology and customer relationships. Purchase price allocations are subject to adjustment until all pertinent information regarding the acquisition is obtained and fully evaluated. Based on our preliminary valuations and purchase accounting adjustments, we recorded $30 million as goodwill at the end of 2008. In 2009 goodwill was reduced by $7 million related to certain purchase accounting adjustments.
Until January 1, 2011, Affinia Hong Kong Limited reported its financial results on a one-month reporting lag. The previously existing one-month reporting lag was eliminated as it was no longer required to achieve a timely consolidation due to the Company’s investments in systems and personnel to enhance our financial statement close process. Noncontrolling interest decreased to $46 million as of December 31, 2009 from $60 million as of December 31, 2008. The noncontrolling interest decreased $21 million following Affinia Group Inc.’s acquisition of an additional 35% ownership interest in Affinia Acquisition LLC offset by a $7 million increase related to the net income attributable to noncontrolling interest in Affinia Acquisition LLC and our joint venture in India.
Note 7. Inventories, net
Inventories are valued at the lower of cost or market. Cost is determined on the FIFO basis for all domestic inventories or average cost basis for non-U.S. inventories. Inventories are reduced by an allowance for slow-moving and obsolete inventories based on management’s review of on-hand inventories compared to historical and estimated future sales and usage. A summary of inventories, net is provided in the table below:
(1) The inventory as of December 31, 2011 excludes $221 million of inventory in our Brake North America and Asia group, which is classified in current assets of discontinued operations.
Note 8. Goodwill
Goodwill as of December 31, 2011 was $28 million and consisted of the following: $22 million for the acquisition of NAPD, $4 million for the initial acquisition in 2004 and $2 million for a minor acquisition in 2008.
In conjunction with the acquisition of the NAPD business in 2010, we determined the fair value of intangibles, property, plant and equipment, other assets and liabilities. Based on our valuations and purchase accounting adjustments, we recorded $22 million as goodwill in 2010.
The goodwill also relates to the initial acquisition in 2004 and a minor acquisition in the second quarter of 2008. For the 2004 acquisition, in accordance with ASC Topic 805-740 the tax benefit for the excess of tax-deductible goodwill over the reported amount of goodwill is applied to first reduce the goodwill related to the Acquisition. The tax benefit for the excess of tax deductible goodwill reduced reported goodwill by approximately $8 million during 2009, 2010 and 2011. The amount of goodwill remaining at the end of December 31, 2011 relating to the initial 2004 acquisition is $4 million. Once the reported amount of goodwill for the 2004 acquisition is reduced to zero, the remaining tax benefit reduces the basis of intangible assets purchased in the 2004 acquisition. Any remaining tax benefit reduces the income tax provision.
The following table summarizes our goodwill activity, which is related to the Brake North America and Asia and On and Off-highway segments, during 2010 and 2011:
(1) The goodwill as of December 31, 2011 excludes $25 million of goodwill in our Brake North America and Asia group, which is classified in discontinued operations.
Note 9. Other Intangible Assets
As of December 31, 2010 and 2011, the Company’s other intangible assets primarily consisted of trade names, customer relationships, and developed technology. The Company recorded approximately $9 million, $8 million and $9 million of intangible asset amortization in 2009, 2010 and 2011, respectively, which includes $4 million for 2009, 2010 and 2011 related to our discontinued operations. We anticipate on a continuing and discontinued basis $9 million in amortization in each of the next three years and $8 million in 2015 and 2016. In 2010, we acquired the NAPD business and as a result we increased our customer relationships by $8 million, unpatented technology by $5 million and non-competition agreement by $1 million. Amortization expense is calculated on a straight line basis over 5 to 20 years. We determine on a periodic basis whether the lives and the method for amortization are accurate.
Trade names are tested for impairment annually as of December 31 of each year by comparing their fair value to their carrying values. The fair value for each trade name was established based upon a royalty savings approach. We determined that there were impairments of other intangible assets of $4 million, nil and less than $1 million in 2009, 2010 and 2011, respectively. A rollforward of the other intangibles and trade names for 2010 and 2011 is shown below:
(1) The intangible assets as of December 31, 2011 exclude $53 million of intangible assets in our Brake North America and Asia group, which is classified in current assets of discontinued operations.
Accumulated amortization for the intangibles was $51 million and $60 million as of December 31, 2010 and 2011, respectively. Accumulated amortization related to the continuing operations for the intangibles was $28 million and $33 million as of December 31, 2010 and 2011, respectively. The weighted average amortization period by class of intangible was the following: 20 years for customer relationships and 13 years for developed technology and other intangibles.
Note 10. Debt
On August 13, 2009, we refinanced our former term loan facility, revolving credit facility and accounts receivable facility. The refinancing consisted of the ABL Revolver and the Secured Notes, the proceeds of which were used to repay outstanding borrowings under our former term loan facility, revolving credit facility and accounts receivable facility, as well as to settle interest rate derivatives and to pay fees and expenses related to the refinancing. The ABL Revolver and the Secured Notes replaced our revolving credit facility, which would have otherwise matured on November 30, 2010, our former term loan facility, which would have otherwise matured on November 30, 2011, and our accounts receivables facility, which would have otherwise matured on November 30, 2009.
On December 1, 2010, we issued an irrevocable notice of redemption to redeem $22.5 million aggregate principal amount of our Secured Notes on December 31, 2010, pursuant to their terms at a redemption price equal to 103% of the principal amount of such notes being redeemed, plus accrued and unpaid interest to the redemption date.
On December 9, 2010, we completed an offering of an additional $100 million of Additional Notes. The Additional Notes have been issued at a price equal to 100% of their face value. The Additional Notes were issued pursuant to the Indenture, dated November 30, 2004, pursuant to which Affinia Group Inc. issued its existing outstanding $267 million aggregate principal amount of the Initial Notes. Other than with respect to the date of issuance and issue price, the Additional Notes have the same terms as, and are treated as a single class with, the Initial Notes. Affinia Group Inc.’s obligations under the Additional Notes are guaranteed on an unsecured senior subordinated basis by Affinia Intermediate Holdings Inc. and certain of Affinia Groups Inc.’s current and future wholly-owned domestic subsidiaries. The Company used the proceeds from the offering of the Additional Notes to finance its $24 million acquisition of the remaining 50% interest of Affinia India Private Limited and to finance our $52 million acquisition of the NAPD business on December 16, 2010. Debt consists of the following:
(1) The debt as of December 31, 2011 excludes $20 million of notes payable in our Brake North America and Asia group, which is classified in current liabilities of discontinued operations and has rates ranging from 5.2% to 5.4%. The other debt of $20 million as of December 31, 2011 relates to our Poland operations. Our Poland operations in 2011 initiated a revolving credit facility with borrowings up to $20 million.
Scheduled maturities of debt for each of the next five years and thereafter are as follows:
(1) The debt as of December 31, 2011 excludes $20 million of notes payable in our Brake North America and Asia group, which is classified in current liabilities of discontinued operations.
The fair value of debt is as follows:
Fair Value of Debt at December 31, 2010
Fair Value of Debt at December 31, 2011
(1) The debt as of December 31, 2011 excludes $20 million of notes payable in our Brake North America and Asia group, which is classified in current liabilities of discontinued operations.
The carrying value of fixed rate short-term debt approximates fair value because of the short term nature of these instruments, and the carrying value of the Company’s current floating rate debt instruments approximates fair value because of the variable interest rates pertaining to those instruments. The fair value of the long-term debt was estimated based on quoted market prices.
Asset based credit facilities. On August 13, 2009, Affinia Group Inc. and certain of its subsidiaries entered into a four-year $315 million ABL Revolver that includes (i) a revolving credit facility (the “U.S. Facility”) of up to $295 million for borrowings solely to the U.S. domestic borrowers, including (a) a $40 million sub-limit for letters of credit and (b) a $30 million swingline facility, and (ii) a revolving credit facility (the “Canadian Facility”) of up to $20 million for Canadian Dollar denominated revolving loans solely to a Canadian borrower. Availability under the ABL Revolver is based upon monthly (or more frequent under certain circumstances) borrowing base valuations of Affinia Group Inc.’s eligible continuing and discontinued operations inventory and accounts receivable and is reduced by certain reserves in effect from time to time. The ABL Collateral consists of all accounts receivable, inventory, cash (other than certain cash proceeds of Notes Collateral (as defined in the indenture governing the Secured Notes)) and proceeds of the foregoing and certain assets related thereto, in each case held by Affinia Group Intermediate Holdings Inc., Affinia Group Inc. and certain of their subsidiaries.
On November 30, 2010, we entered into an amendment to the credit agreement governing the ABL Revolver. The ABL Revolver has been amended to, among other things, (a) increase the amount of additional unsecured indebtedness that we may incur from $100 million to $300 million and provide certain conditions to any issuance of such indebtedness in excess of $100 million, (b) amend the covenants with respect to: making certain dividends, distributions, restricted payments and investments; extending, renewing and refinancing certain existing indebtedness; amending certain material documents; and issuing and disposing of certain equity interests, (c) reduce the pricing spread applicable to each type of loan by 150 basis points at each level of average aggregate availability and remove the floor formerly applicable to the LIBOR rate and the BA rate, (d) extend the maturity date from August 13, 2013 to November 30, 2015 (subject to early termination under certain limited circumstances), (e) allow for prepayments of certain outstanding indebtedness with the proceeds of an initial public offering (if Affinia Group Holdings Inc. undertakes an initial public offering) and permit the merger of Affinia Group Intermediate Holdings Inc. with and into Affinia Group Holdings Inc. upon satisfaction of certain preconditions to such merger and (f) modify certain other provisions thereof.
At December 31, 2011, we had $110 million outstanding under the ABL Revolver. During the year, we borrowed funds at a weighted average interest rate of approximately 3.3% under this facility. We had an additional $166 million of availability after giving effect to $13 million in outstanding letters of credit and $3 million for borrowing base reserves as of December 31, 2011.
Mandatory Prepayments. If at any time the outstanding borrowings under the ABL Revolver (including outstanding letters of credit and swingline loans) exceed the lesser of (i) the borrowing base as in effect at such time and (ii) the aggregate revolving commitments as in effect at such time, we will be required to prepay an amount equal to such excess and/or cash collateralize outstanding letters of credit.
The maturity date of the ABL Revolver is November 30, 2015, subject to early termination if our senior subordinated notes which mature less than six months after such date are not refinanced, renewed or extended, or fully redeemed, fully cash defeased, paid in full or fully cash collateralized, prior to the date which is 91 days before the earlier of November 30, 2015 and the maturity date of the senior subordinated notes.
Voluntary Prepayments. Subject to certain conditions, the ABL Revolver allows us to voluntarily reduce the amount of the revolving commitments and to prepay the loans without premium or penalty other than customary breakage costs for LIBOR rate contracts.
Covenants. The ABL Revolver contains affirmative and negative covenants that, among other things, limit or restrict our ability to create liens and encumbrances; incur debt; merge, dissolve, liquidate or consolidate; make acquisitions and investments; dispose of or transfer assets; pay dividends or make other payments in respect of our capital stock; amend certain material documents; change the nature of our business; make certain payments of debt; engage in certain transactions with affiliates; change our fiscal periods; and enter into certain restrictive agreements, in each case, subject to certain qualifications and exceptions.
In addition, if availability under the ABL Revolver is less than the greater of 12.5% of the total revolving loan commitments and $39.5 million, we will be required to maintain a fixed charge coverage ratio, which is defined in the ABL Revolver, of at least 1.10x measured for the last twelve-month period.
Interest Rates and Fees. Outstanding borrowings under the U.S. Facility accrue interest at an annual rate of interest equal to (i) a base rate plus the applicable spread or (ii) a LIBOR rate plus the applicable spread. Outstanding borrowings under the Canadian Facility accrue interest at an annual rate of interest equal to (i) the Canadian prime rate plus the applicable spread or (ii) the BA rate (the average discount rate of bankers’ acceptances as quoted on the Reuters Screen CDOR page) plus the applicable spread. We pay a commission on letters of credit issued under the U.S. Facility at a rate equal to the applicable spread for loans based upon the LIBOR rate. The ABL Revolver, as amended on November 30, 2010, revises the applicable spread, as set forth below, for purposes of calculating the annual rate of interest applicable to outstanding borrowings under the U.S. Facility and the Canadian Facility. In addition, the 1.50% floor formerly applicable to the LIBOR rate and the BA rate was eliminated.
We pay certain fees with respect to the ABL Revolver, including (i) an unused commitment fee of 0.50% per annum on the undrawn portion of the credit facility (subject to a step-down to 0.375% in the event more than 50% of the commitments (excluding swingline loans) under the credit facility are utilized) and (ii) customary annual administration fees and fronting fees in respect of letters of credit equal to 0.125% per annum on the stated amount of each letter of credit outstanding during each month. During an event of default, the fee payable under clause (i) shall be increased by 2% per annum.
Secured Notes. On August 13, 2009, Affinia Group Inc. issued $225 million of Secured Notes as part of the refinancing. The Secured Notes were offered at a price of 98.799% of their face value, resulting in approximately $222 million of net proceeds. The approximately $3 million discount will be amortized based on the effective interest rate method and included in interest expense until the Secured Notes mature. Subject to Affinia Group Inc.’s compliance with the covenants described in the indenture securing the Secured Notes, Affinia Group Inc. is permitted to issue more Secured Notes from time to time under the Indenture. The Secured Notes and the additional notes, if any, will be treated as a single class for all purposes of the indenture governing the Secured Notes, including waivers, amendments, redemptions and offers to purchase. The Secured Notes mature in 2016 and accrue interest at rate of 10.75% per annum payable semiannually. The Secured Notes are senior obligations of Affinia Group Inc.
On December 1, 2010, we issued an irrevocable notice of redemption to redeem $22.5 million aggregate principal amount of our Secured Notes on December 31, 2010, pursuant to their terms at a redemption price equal to 103% of the principal amount of such notes being redeemed, plus accrued and unpaid interest to the redemption date. The Secured Notes outstanding balance net of the discount was $201 million as of December 31, 2011.
Subordinated Notes. On November 30, 2004, Affinia Group Inc. issued $300 million of Subordinated Notes. The Subordinated Notes and the additional notes, if any, will be treated as a single class for all purposes of the indenture governing the Subordinated Notes, including waivers, amendments, redemptions and offers to purchase. The Subordinated Notes mature in 2014 and accrue interest at rate of 9% per annum payable semiannually. The Subordinated Notes are senior obligations of Affinia Group Inc.
In June of 2009, Affinia Group Holdings Inc. purchased in the open market approximately $33 million in principal amount of the Subordinated Notes and thereafter contributed such notes to Affinia Group Intermediate Holdings Inc., which contributed such notes to Affinia Group Inc. Affinia Group Inc. promptly surrendered such purchased notes for cancellation, which resulted in a pre-tax gain on the extinguishment of debt of $8 million in 2009.
On December 9, 2010, Affinia Group Inc. completed an offering of $100 million of Additional Notes. The Additional Notes were issued at a price equal to 100% of their face value. The Additional Notes were issued pursuant to the Indenture, dated November 30, 2004, pursuant to which the Company previously issued its $267 million aggregate principal amount of Initial Notes. Other than with respect to the date of issuance and issue price, the Additional Notes have the same terms as, and are treated as a single class with, the Initial Notes. Affinia Group Inc.’s obligations under the Additional Notes are guaranteed on an unsecured senior subordinated basis by Affinia Group Intermediate Holdings Inc. and certain of our current and future wholly-owned domestic subsidiaries. The outstanding balance of the Subordinated Notes at December 31, 2011 was $367 million. Subject to Affinia Group Inc.’s compliance with the covenants described in the indenture securing the Subordinated Notes, Affinia Group Inc. is permitted to issue more Subordinated Notes from time to time under the indenture.
Indenture Provisions. The indentures governing the Secured Notes and the Subordinated Notes limit Affinia Group Inc.’s (and its restricted subsidiaries’) ability to incur and guarantee additional indebtedness, issue disqualified stock or issue certain preferred stock; pay dividends on, make other distributions on, redeem or repurchase our capital stock or make certain other restricted payments; create certain liens or encumbrances; issue capital stock; make certain investments or acquisitions; make capital expenditures; pay dividends, make distributions or make other payments from its subsidiaries; changes their lines of business; enter into certain types of transactions with affiliates; use assets as security in other transactions; sell certain assets or merge with or into other companies and designate subsidiaries as unrestricted subsidiaries. Subject to certain exceptions, Affinia Group Inc. and its restricted subsidiaries are permitted to incur additional indebtedness, including secured indebtedness, under the terms of the indentures governing the Secured Notes and the Subordinated Notes.
During 2010, we recorded a write-off of $1 million to interest expense for unamortized deferred financing costs associated with the redemption of $22.5 million of the Secured Notes. Additionally, we recorded $5 million in total deferred financing costs related to the amendment to ABL Revolver and the issuance of additional $100 million in Senior Subordinated Notes. The unamortized deferred financing will be charged to interest expense over the next four years for the ABL Revolver, five years for the Secured Notes and three years for the Subordinated Notes.
The following table summarizes the deferred financing activity from December 31, 2009 to December 31, 2011:
Note 11. Accounts Receivable Factoring
We have agreements with third party financial institutions to factor certain receivables on a non-recourse basis. The terms of the factoring arrangements provide for the factoring of certain U.S. Dollar-denominated or Canadian Dollar-denominated receivables, which are purchased at the face value amount of the receivable discounted at the annual rate of LIBOR plus a spread on the purchase date. The amount factored is not contractually defined by the factoring arrangements and our use will vary each month based on the amount of underlying receivables and the cash flow needs of the Company.
We began factoring our accounts receivable during the third quarter of 2010. During 2010, the total accounts receivable factored was $156 million and the cost incurred on factoring was $2 million. During 2011, the total accounts receivable factored was $408 million and the cost incurred on factoring was $4 million. Accounts receivable factored by us are accounted for as a sale and removed from the balance sheet at the time of factoring and the cost of the factoring is accounted for in either other income or discontinued operations if it relates to our Brake North America and Asia group.
Note 12. Stock Incentive Plan
On July 20, 2005, Affinia Group Holdings Inc. adopted the Affinia Group Holdings Inc. 2005 Stock Incentive Plan, which we refer to as our 2005 Stock Plan. The 2005 Stock Plan permits the grant of non-qualified stock options, incentive stock options, stock appreciation rights, restricted stock and other stock-based awards to employees, directors or consultants of Affinia Group Holdings Inc. and its affiliates. A maximum of 350,000 shares of Affinia Group Holdings Inc. common stock may be subject to awards under the 2005 Stock Plan. The number of shares issued or reserved pursuant to the 2005 Stock Plan (or pursuant to outstanding awards) is subject to adjustment on account of mergers, consolidations, reorganizations, stock splits, stock dividends and other dilutive changes in the common stock. Shares of common stock covered by awards that terminate or lapse and shares delivered by a participant or withheld to pay the minimum statutory withholding rate, in each case, will again be available for grant under the 2005 Stock Plan.
Administration. The 2005 Stock Plan is administered by the compensation committee of Affinia Group Holdings Inc.’s Board of Directors. The committee has full power and authority to make, and establish the terms and conditions of any award, and to waive any such terms and conditions at any time (including, without limitation, accelerating or waiving any vesting conditions or payment dates). The committee is authorized to interpret the plan, to establish, amend and rescind any rules and regulations relating to the plan and to make any other determinations that it, in good faith, deems necessary or desirable for the administration of the plan and may delegate such authority as it deems appropriate. The committee may correct any defect or supply an omission or reconcile any inconsistency in the plan in the manner and to the extent the committee deems necessary or desirable and any decision of the committee in the interpretation and administration of the plan shall lie within its sole and absolute good faith discretion and shall be final, conclusive and binding on all parties concerned.
Options. The committee determines the option price for each option; however, the stock options must have an exercise price that is at least equal to the fair market value of the common stock on the date the option is granted. An option holder may exercise an option by written notice and payment of the option price (i) in cash or its equivalent, (ii) by the surrender of a number of shares of common stock already owned by the option holder for at least six months (or such other period established by the committee) with a fair market value equal to the exercise price, (iii) if there is a public market for the shares, subject to rules established by the committee, through the delivery of irrevocable instructions to a broker to sell shares obtained upon the exercise of the option and to deliver to Affinia Group Holdings Inc. an amount out of the proceeds of the sale equal to the aggregate option price for the shares being purchased or (iv) by another method approved by the committee.
Stock Appreciation Rights. The committee may grant stock appreciation rights independent of or in connection with an option. The exercise price per share of a stock appreciation right shall be an amount determined by the committee. Generally, each stock appreciation right shall entitle a participant upon exercise to an amount equal to (i) the excess of (1) the fair market value on the exercise date of one share of common stock over (2) the exercise price, multiplied by (ii) the number of shares of common stock covered by the stock appreciation right. Payment shall be made in common stock or in cash, or partly in common stock and partly in cash, all as shall be determined by the committee.
Other Stock-Based Awards. The committee may grant awards of restricted stock units, rights to purchase stock, restricted stock and other awards that are valued in whole or in part by reference to, or are otherwise based on the fair market value of, shares of common stock. The other stock-based awards will be subject to the terms and conditions established by the committee.
Transferability. Unless otherwise determined by the committee, awards granted under the 2005 Stock Plan are not transferable other than by will or by the laws of descent and distribution.
Change of Control. In the event of a change of control (as defined in the 2005 Stock Plan), the committee may provide for (i) the termination of an award upon the consummation of the change of control, but only if the award has vested and been paid out or the participant has been permitted to exercise an option in full for a period of not less than 30 days prior to the change of control, (ii) the acceleration of all or any portion of an award, (iii) payment in exchange for the cancellation of an award and/or (iv) the issuance of substitute awards that would substantially preserve the terms of any awards.
Amendment and Termination. Affinia Group Holdings Inc.’s Board of Directors may amend, alter or discontinue the 2005 Stock Plan in any respect at any time, but no amendment may diminish any of the rights of a participant under any awards previously granted, without his or her consent.
Management Stockholders Agreement. All shares issued under the plan will be subject to a management stockholders agreement or a director stockholders agreement, as applicable.
Restrictive Covenant Agreement. Unless otherwise determined by Affinia Group Holdings Inc.’s Board of Directors, all award recipients will be obligated to sign the standard Confidentiality, Non-Competition and Proprietary Information Agreement which includes restrictive covenants regarding confidentiality, proprietary information and a one year period restricting competition and solicitation of our clients, customers or employees. In the event a participant breaches these restrictive covenants, any exercise of, or payment or delivery pursuant to, an award may be rescinded by the committee in its discretion in which event the participant may be required to pay to us the amount of any gain realized in connection with, or as a result of, the rescinded exercise, payment or delivery.
Amendment. On November 14, 2006, the Compensation Committee of Affinia Group Holdings Inc. revised the vesting terms applicable to options previously awarded by the Committee to its named executive officers, as well as all other employees, under the Plan. One-half of these options vest in equal portions at the end of each year beginning with the year of the grant and ending December 31, 2009 (the “Vesting Period”), 40% are eligible for vesting in equal portions upon the Company’s achievement of certain specified annual EBITDA performance targets over the Vesting Period and 10% are eligible for vesting in equal portions upon the Company’s achievement of certain net working capital performance targets over the Vesting Period. The Committee has not modified the time-vesting options or the working capital performance options. The Committee elected to modify the vesting terms for the EBITDA performance options so that these options were eligible for vesting in equal portions at the end of each of the years 2007, 2008, and 2009. The Committee also modified the performance targets for those years. The fair value of the modified award was slightly higher than the grant date fair value.
Stock Plan
On July 20, 2005, Affinia Group Holdings Inc. adopted the 2005 Stock Plan with a maximum of 227,000 shares of common stock subject to awards. On August 25, 2010, Affinia Group Holdings Inc. increased the number of shares of common stock subject to awards from 227,000 to 300,000, and Affinia Group Holdings Inc. commenced an offer to certain eligible holders of stock options to exchange their existing options to purchase shares of Affinia Group Holdings Inc.’s common stock for RSUs with new vesting terms (the “Option Exchange”). The RSUs granted in connection with the Option Exchange are governed by the 2005 Stock Plan and the new Restricted Stock Unit Award Agreement. On December 2, 2010, Affinia Group Holdings Inc. increased the number of shares of common stock subject to awards from 300,000 to 350,000.
A table of the 2005 Stock Plan balances for the restricted stock units, stock options, deferred compensation shares and stock awards is summarized below.
Stock Options
As of December 31, 2011, 28,680 stock options had been awarded, which included vested options of 27,680 and 1,000 unvested options. Pursuant to the terms of the 2005 Stock Plan, each option expires August 1, 2015. The exercise price is $100 per option.
We account for our employee stock options under the fair value method of accounting using a Black-Scholes model to measure stock-based compensation expense at the date of grant. Dividend yields were not a factor because there were no cash dividends declared during 2009, 2010, and 2011. Our weighted-average Black-Scholes fair value assumptions include:
The fair value of the stock option grants is amortized to expense over the vesting period. The Company reduces the overall compensation expense by a turnover rate consistent with historical trends. Stock-based compensation expense, which was recorded in selling, general and administrative expenses, and tax related income tax benefits were $1 million for 2009, less than $1 million for 2010 and nil for 2011.
Option Exchange
Affinia Group Holdings Inc. completed an offer to certain eligible holders of stock options to exchange their existing stock options to purchase shares of Affinia Group Holdings Inc.’s common stock for restricted stock units (“RSUs”) with new vesting terms (the “Option Exchange”). The Option Exchange election period commenced on August 25, 2010 and expired on September 24, 2010. The completion of the Option Exchange for the RSUs occurred on October 18, 2010 and 100% of the eligible option holders elected to participate. A total of 24 eligible employees and directors participated in the Option Exchange. In addition, three eligible employees and directors who did not have vested options received RSUs. Affinia Group Holdings Inc. accepted for exchange options to purchase a total of 61,868 shares of Affinia Group Holdings Inc.’s common stock. All surrendered options were cancelled in exchange for RSUs. The options had been fully expensed by the exchange date. The total RSUs issued on October 18, 2010 covered 235,000 shares of Affinia Group Holdings Inc.’s common stock.
On December 23, 2011, Affinia Group Holdings Inc. completed another Option Exchange. The Option Exchange election period commenced on December 1, 2011 and expired on December 23, 2011. The completion of the Option Exchange for the RSUs occurred on December 23, 2011 with 100% of the two eligible option holders elected to participate. Affinia Group Holdings Inc. accepted for exchange options to purchase a total of 825 shares of Affinia Group Holdings Inc.’s common stock. All surrendered options were cancelled in exchange for RSUs. The options had been fully expensed by the exchange date. The total RSUs issued on December 23, 2011 covered 4,000 shares of Affinia Group Holdings Inc.’s common stock.
Restricted Stock Units
The RSUs granted in connection with the Option Exchanges are governed by the 2005 Stock Plan and a new Restricted Stock Unit Award Agreement.
The RSUs are subject to performance-based and market-based vesting restrictions, which differ from the performance and time-based vesting restrictions applicable to the exchanged stock options. The RSUs will vest if (i) the RSU holder remains employed with Affinia Group Holdings Inc. on the date that either of the following vesting conditions occurs and (ii) either of the following vesting conditions occurs on or prior to the date on which Cypress ceases to hold any remaining Affinia Group Holdings Inc. common stock:
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Cypress Scenario-Cypress has received aggregate transaction proceeds in cash or marketable securities (not subject to escrow, lock-up, trading restrictions or claw-back) with respect to the disposition of more than 50% of its common equity interests in Affinia Group Holdings Inc. in an amount that represents a per-share equivalent value that is greater than or equal to two times the average per share price paid by Cypress for its aggregate common equity investment in Affinia Group Holdings Inc.; or
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IPO Scenario-Affinia Group Holdings Inc.’s common stock trades on a public stock exchange at an average closing price of $225 (as adjusted for stock splits) over a 60 consecutive trading day period.
As of December 31, 2011, 242,000 RSUs had been awarded and remained outstanding, none of which have vested. We estimate the fair value of market-based RSUs using a Monte Carlo simulation model on the date of grant. Our weighted-average Monte Carlo fair value assumptions include:
In the event that either of the performance-based conditions (Cypress Scenario or IPO Scenario) are met, the fair value of the RSUs will be recognized in stock-based compensation expense either 1) pro rata over the requisite service term including a cumulative catch-up related to service provided through the date the performance condition is met or 2) in full once the respective market-based condition is met or 3) in full if the requisite service period has already passed when the performance condition is met. Stock-based compensation expense, which would be recorded in selling, general and administrative expenses, and tax related income tax benefits was not recorded for 2011 as neither of the performance conditions have been met. If the RSUs do not vest prior to ten years from the date of grant then the RSUs will expire. If the performance condition is met on the 242,000 RSUs the amount of expense we would have to record is $30 million under the IPO scenario or $26 million under the Cypress scenario.
Deferred Compensation Plan
We started a deferred compensation plan in 2008 that permits executives to defer receipt of all or a portion of the amounts payable under our non-equity incentive compensation plan. All amounts deferred are treated solely for purposes of the plan to have been notionally invested in the common stock of Affinia Group Holdings Inc. As such, the accounts under the plan will reflect investment gains and losses associated with an investment in the Affinia Group Holdings Inc.’s common stock. We match 25% of the deferral with an additional notional investment in common stock of Affinia Group Holdings Inc., which is subject to vesting as provided in the plan. Deferred compensation expense, which was recorded in selling, general and administrative expenses, and tax related income tax benefits were nil for 2009, $1 million for 2010 and $2 million for 2011.
Note 13. Pension and Other Postretirement Benefits
The Company provides defined contribution and defined benefit, qualified and nonqualified, pension plans for certain employees.
Under the terms of the defined contribution retirement plans, employee and employer contributions may be directed into a number of diverse investments. Expenses related to these defined contribution plans were $1 million for the year ended December 31, 2009, $5 million for the year ended December 31, 2010 and $5 million for the year ended December 31, 2011.
The Company has Canadian defined benefit pension plans (the assets of which are referred to as the “Fund”). These plans are managed in accordance with applicable legal requirements relating to the investment of registered pension plans. The responsibility for the investment of the Fund lies with the Investment Committee of ITT Industries of Canada Ltd. (the “Committee”), which changed its name to Xylem Canada Company in November 2011. The Committee is composed of representatives of Xylem and of the participating companies, which includes our Company. The investments objectives of the plans are to maximize long-term total investment returns while assuming a prudent level of risk deemed appropriate by the Committee. The Fund may not engage in certain investments that are not permitted for a pension plan pursuant to applicable provincial pension benefits legislation and the Income Tax Act of Canada. Additionally, the Fund may not invest more than 10% of the assets in any single public issue of securities except where the security is issued by or guaranteed by the government of Canada or a Canadian province. This investment policy permits plan assets to be invested in a number of diverse investment categories such as demand or term deposits, short term notes, treasury bills, bankers acceptances, commercial paper, investment certificates issued by banks, insurance companies or trust companies, bonds and non-convertible debentures, mortgages and other asset-backed securities, convertible debentures, real estate, preferred and common stocks that are traded publicly, including both Canadian and foreign stocks, resource properties, venture capital, insured contracts, pooled funds, segregated funds, trusts, closed-end investment companies, limited partnerships and other structured vehicles invested directly or indirectly in, or in interests.
We did not terminate any plans in 2010 or 2011; however, we settled $20 million and $1 million of the assets in the pension plans in 2010 and 2011, respectively. During the year we purchased annuities for many of the participants of the pension plans. We are in the process of winding down the plans. How quickly we settle all of the pension plan assets is subject to approval from a Canadian regulatory agency. The following tables provide a reconciliation of the changes in the Company’s defined benefit pension plans’ and the fair value of assets for the years ended December 31, 2010 and December 31, 2011, as well as the statements of the funded status and schedules of the net amounts recognized in the balance sheet at December 31, 2010 and 2011. The measurement date for the amounts in these tables was December 31 of each year presented:
The weighted average asset allocations of the pension plans at December 31, 2010 and December 31, 2011 were as follows:
The target asset allocations of the pension plans for equity securities, controlled-risk debt securities, absolute return strategies investments and cash and other assets at December 31, 2010 and December 31, 2011 were 70%, 30%, 0% and 0%.
The following table presents the funded status of the Company’s pension plans and the amounts recognized in the balance sheet as of December 31, 2010 and 2011:
The Company’s projected benefit payments by the pension plans subsequent to December 31, 2011 are expected to be $1 million in 2012 and $1 million over the next nine years.
Projected contributions to be made to the Company’s defined benefit pension plans are expected to be in aggregate less than $1 million over the next ten years.
Components of net periodic benefit costs for the Company’s defined benefit plans for the years ended December 31, 2009, December 31, 2010 and December 31, 2011 are as follows:
The discount rate and expected return on plan assets for the Company’s plans presented in the tables above are used to determine pension expense for the succeeding year.
Fair Value Measurements. The following tables present our plan assets using the fair value framework as of December 31, 2011 and 2010. The fair value framework requires the categorization of our plan assets into three levels based upon the assumptions (inputs) used to price the plan assets. Level 1 provides the most reliable measure of fair value, whereas Level 3 generally requires significant management judgment. The three levels are defined as follows:
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Level 1: Unadjusted quoted prices in active markets for identical assets and liabilities.
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Level 2: Observable inputs other than those included in Level 1. For example, quoted prices for similar assets or liabilities in active markets or quoted prices for identical assets or liabilities in inactive markets.
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Level 3: Unobservable inputs reflecting management’s own assumptions about the inputs used in pricing the asset or liability.
The following table presents our plan assets using the fair value framework as of December 31, 2011.
The following table presents our plan assets using the fair value framework as of December 31, 2010.
Note 14. Income Tax
The components of the income tax provision (benefit) from continuing operations are as follows:
The income tax provision was calculated based upon the following components of income (loss) from continuing operations before income tax provision, equity in income and noncontrolling interest:
Deferred tax assets (liabilities) consisted of the following:
Valuation allowances are provided for deferred tax assets whenever the realization of the assets is not deemed to meet a more likely than not standard. Accordingly, valuation allowances have been provided for net operating losses in certain non-U.S. countries and U.S. states. U.S. income and foreign withholding taxes have not been recognized on the excess of the amount for financial reporting over the tax basis of investments in foreign subsidiaries that are essentially permanent in duration. This amount becomes taxable upon a repatriation of assets from the subsidiary or a sale or liquidation of the subsidiary. The amount of such temporary differences totaled $104 million at December 31, 2011. Determination of the amount of any unrecognized deferred income tax liability on this temporary difference is not practicable. Net deferred tax assets from discontinued operations were $9 million at December 31, 2011.
The effective income tax rate differs from the U.S. federal income tax rate for the following reasons:
* The U.S. permanent differences affecting the tax rate are a result of a deemed distribution and nondeductible expenses.
At the end of 2011, federal domestic net operating loss carryforwards were $319 million. Of these, $12 million expire in 2024, $13 million expire in 2025, $37 million expire in 2026, $35 million expire in 2027, $76 million expire in 2028, $61 million expire in 2029, $57 million expire in 2030 and $28 million expire in 2031. At the end of 2011, state domestic net operating loss carryforwards were estimated to be $203 million, the majority of which expire between 2021 and 2031. At the end of 2011, foreign net operating loss carryforwards were $23 million and expire as follows: $5 million in 2013, $3 million in 2014, $2 million in 2015, $4 million in 2016, $2 million in 2017, $2 million in 2021, $2 million in 2026, $1 million in 2029 and $2 million in 2030. Realization of the tax benefits associated with loss carryforwards is dependent on generating sufficient taxable income prior to their expiration.
The following table summarizes the activity related to our unrecognized tax benefits:
Included in the balance of unrecognized tax benefits at December 31, 2011, are $2 million of tax benefits that, if recognized, would affect the effective tax rate. The Company recognizes interest related to unrecognized tax benefits in interest expense and penalties as part of the income tax provision. As of December 31, 2011 the Company’s accrual for interest and penalties was less than $1 million.
The Company is subject to taxation in the U.S. and various state and foreign jurisdictions. For jurisdictions in which the Company transacts significant business, tax years ending December 31, 2004 and later remain subject to examination by tax authorities. We do not anticipate any material change in the total amount of unrecognized tax benefits to occur within the next twelve months.
Note 15. Property, Plant and Equipment
The following table breaks out the property, plant and equipment in further detail:
The property, plant and equipment as of December 31, 2011 excludes our Brake North America and Asia group property, plant and equipment, of $122 million. Depreciation is recognized on a straight-line basis over an asset’s estimated useful life. The depreciation expense from continuing operations was $17 million, $18 million, and $16 million for 2009, 2010, and 2011, respectively.
Note 16. Other Accrued Expenses
The following table breaks out the other accrued expenses in further detail:
(1) The other accrued expenses as of December 31, 2011 excludes $82 million in our Brake North America and Asia group, which is classified in current liabilities of discontinued operations.
The other accrued expenses primarily consist of accrued selling and marketing expenses, accrued utilities, accrued legal and professional fees and other miscellaneous accruals.
A reconciliation of the changes in our return reserves is as follows beginning with January 1, 2009:
(1) Includes our Brake North America and Asia group, which is classified as discontinued operations had amounts charged to revenue of $25 million, $22 million and $22 million in 2009, 2010 and 2011, respectively, and returns processed of $26 million, $22 million and $24 million in 2009, 2010 and 2011, respectively.
(2) The return reserve as of December 31, 2011 excludes $6 million in our Brake North America and Asia group, which is classified in current liabilities of discontinued operations.
Note 17. Commitments and Contingencies
At December 31, 2011, the Company had purchase commitments for property, plant and equipment of approximately $2 million which excludes our Brake North America and Asia group purchase commitments for property, plant and equipment of approximately $6 million.
The Company had future minimum rental commitments under non-cancelable operating leases in continuing operations of $45 million at December 31, 2011, with future rental payments of:
The future minimum rental commitments under non-cancelable operating leases at December 31, 2011 excludes $35 million in our Brake North America and Asia group.
The leases do not contain restrictions on future borrowings. There are no significant lease escalation clauses or purchase options. Rent expense from continuing operations was $9 million, $10 million and $11 million in 2009, 2010 and 2011, respectively. The rent expense related to the Brake North America and Asia group was $10 million, $8 million and $10 million in 2009, 2010 and 2011, respectively.
Various claims, lawsuits and administrative proceedings are pending or threatened against us and our subsidiaries, arising from the ordinary course of business with respect to commercial, intellectual property, product liability and environmental matters. We believe that the ultimate resolution of the foregoing matters will not have a material effect on our financial condition or results of operations or liquidity.
On March 31, 2008, a class action lawsuit was filed by S&E Quick Lube Distributors, Inc. of Utah against several auto parts manufacturers for allegedly conspiring to fix prices for replacement oil, air, fuel and transmission filters. Several auto parts companies are named as defendants, including Champion Laboratories, Inc., Purolator Filters NA LLC, Honeywell International Inc., Cummins Filtration Inc., Donaldson Company, Baldwin Filters Inc., Bosch USA., Mann + Hummel USA Inc., ArvinMeritor Inc., United Components Inc. and Wix Filtration Corp LLC (“Wix Filtration”), one of our subsidiaries. The lawsuit is currently pending as a consolidated Multi-District Litigation (“MDL”) Proceeding in Chicago, IL because of multiple “tag-along” filings in several jurisdictions. Two suits have also been filed in the Canadian provinces of Ontario and Quebec. Wix Filtration, along with other named defendants, has filed various motions to dismiss plaintiffs’ complaints, which were denied by the court in December 2009. Several defendants, including Wix Filtration, refiled motions to dismiss based upon plaintiffs’ most recent amended complaint. The court denied those motions in September 2010. Discovery in the action continues. In June 2011, the U.S. Department of Justice indicted the plaintiffs’ main witness, William Burch, for making false statements in connection with the litigation. Burch pleaded guilty, was sentenced to two years in prison and the parties are now considering the implications. Three defendants to the action, Baldwin Filters Inc., Cummins Filtration Inc. and Donaldson Company settled the claims against them for minimal payments in the fall of 2011. In January 2012, all parties to the lawsuit participated in a settlement conference with the Court without success. Shortly afterwards, defendants Wix Filtration, Honeywell and Champion, were able to combine their contributions toward settlement to reach an agreement with plaintiffs to avoid the cost of further litigation. The parties have signed a memorandum of understanding regarding the settlement.
On September 30, 2011, we entered into a settlement agreement with Satisfied for $10 million to settle our claims against Satisfied for their theft of our trade secrets. Upon execution of the settlement agreement, $2.5 million was due immediately and up to an additional $7.5 million is to be provided after liquidation of Satisfied’s business. On September 30, 2011, we have recorded a gain of $2.5 million in continuing operations in the consolidated financial statements. We will record the rest of the income from settlement once the realization is assured beyond a reasonable doubt, which we anticipate will occur if and when we receive the cash.
The Company has various accruals for civil liability, including product liability, and other costs. If there is a range of equally probable outcomes, we accrue at the lower end of the range. The Company had $2 million and $4 million accrued as of December 31, 2010 and 2011, respectively. The increase is due to additional claims, continued evaluation of existing claims and settlements, such as the Wix Filtration class action settlement. In addition, we have various other claims that are reasonably possible of occurrence that range from less than $1 million to $10 million. There are no recoveries expected from third parties.
During the first quarter of 2007 we signed a letter of credit in connection with a real estate lease. ASC 460, “Guarantees”, requires that this letter of credit be accounted for as a guarantee. The fair value of this guarantee as of December 31, 2011 was $1 million and is included in other noncurrent liabilities and other long-term assets.
Note 18. Restructuring of Operations
In 2005, we announced two restructuring plans: (i) a restructuring plan that we announced at the beginning of 2005 as part of the acquisition in 2004, also referred to as the acquisition restructuring and (ii) a restructuring plan that we announced at the end of 2005, also referred to herein as the comprehensive restructuring. We have completed the acquisition restructuring and we have almost completed the comprehensive restructuring.
Comprehensive Restructuring
The comprehensive restructuring was announced in December 2005 and has resulted in the closure of 36 facilities. Additionally, we previously announced the closure of our Litchfield, Illinois plant but the plant has been utilized as a warehouse. We consider the plant closed and the comprehensive restructuring completed. We anticipate less than $1 million of additional comprehensive restructuring costs in 2012 related to other costs related to closed facilities which we still own or lease. The major components of the comprehensive restructuring through 2011 were employee severance costs, asset impairment charges, and other costs (i.e. moving costs, environmental remediation, site clearance and repair costs) each of which we expect to represent approximately 42%, 19% and 39% respectively, of the total cost of the restructuring.
The comprehensive restructuring will result in approximately $169 million in restructuring costs, which exceeds preliminary expectations of $152 million.
In connection with the comprehensive restructuring, we recorded $2 million in restructuring costs in 2011. The comprehensive and other restructuring costs are disclosed by period in the chart below and were recorded in selling, general and administrative expense, cost of sales and as part of discontinued operations.
Other Restructuring
At the end of 2009, we approved the closure of our distribution operations located in Mississauga, Ontario, Canada. The operations closed at the end of the first quarter of 2010. The closure of this operation is part of the Company’s continuing effort to improve its distribution system and serve the replacement parts market effectively and efficiently. We incurred approximately $1 million of restructuring costs in 2011, $4 million in 2010 and $1 million in 2009 related to the closure of this facility. We anticipate another $1 million in restructuring costs in 2012 related to the closure of the facility
On May 3, 2010, we announced the closure of our brake manufacturing operations located in Maracay, Edo Aragua, Venezuela. The operations closed during the second quarter of 2010. We incurred pre-tax charges of approximately $7 million, of which approximately $4 million were cash expenditures. The charges were comprised of employee severance costs of $3 million, asset impairments of $3 million, and other trailing liabilities of $1 million. We will still continue to distribute brake products in Venezuela, which we import from other low cost manufacturing sources. Our Venezuelan filter operation was unaffected by the closure of the brake manufacturing operation.
On May 13, 2011, we announced the closure of our brake manufacturing operations located in Guelph, Ontario, Canada. The operations closed in the third quarter of 2011. We incurred pre-tax charges of $7 million in 2011. The charges were comprised of employee severance costs of $6 million and other trailing liabilities of $1 million. The Guelph operation is included in our Brake North America and Asia group, which is included in discontinued operations.
The restructuring charges for the comprehensive restructuring and further restructuring consist of employee termination costs, other exit costs and impairment costs. Severance costs are being accounted for in accordance with ASC Topic 420, “Exit or Disposal Cost Obligations” and ASC Topic 712, “Compensation-Nonretirement Postemployment Benefits.” The following summarizes the restructuring charges and activity for all the Company’s restructuring programs:
Accrued Restructuring
At December 31, 2011, $3 million of restructuring charges remained in accrued liabilities, relating to wage and healthcare continuation for severed employees and other termination costs. These remaining benefits are expected to be paid during 2012. The following table shows the restructuring expenses by segment:
Note 19. Related Party Transactions
Mr. John M. Riess, an Affinia Group Inc. Board member, is the parent of, J. Michael Riess, who is currently employed with Genuine Parts Company (NAPA) as president of a distribution facility. NAPA is the Company’s largest customer as a percentage of total net sales from continuing operations. NAPA accounted for 29%, 27% and 26% of our total net sales for the years ended December 31, 2009, 2010 and 2011, respectively.
In 2010, Mr. Zhang Haibo, 15% owner of Affinia Hong Kong Limited (“AHK”), loaned $1.4 million to AHK to facilitate the establishment of a new subsidiary, Affinia Qingdao Braking Systems Co. Ltd., a new friction company in China with the intention of manufacturing friction products and distributing these products in Asia and North America. AHK owns 100% of the subsidiary. The contribution agreement had not been finalized as of December 31, 2010, but the cash has been received by AHK, as such we have recorded the $1.4 million as related party debt. In 2011, the contribution agreement has been finalized and the related party debt has been transferred to accumulated paid-in capital.
In 2010, Mr. Zhang Haibo contributed $2.5 million to AHK to facilitate the purchase of land use rights for a new filtration company in China with the intention of manufacturing and distributing filtration products principally in Asia. The contribution did not change the ownership percentage and as a consequence the noncontrolling interest did not change but property, plant and equipment did increase.
In 2011, Mr. Zhang Haibo contributed $0.9 million to AHK for additional funding to Longkou Wix Filtration Co. Ltd., a new filtration company in China with the intention of manufacturing filtration products and distributing these products in Asia and North America. AHK owns 100% of the subsidiary.
The Company is controlled by affiliates of Cypress. Cypress charged Affinia Group Inc. $3 million in 2009, which consisted of a management fee for services related to the refinancing and other advisory services. This amount was included in selling, general, and administrative expenses.
Effective January 1, 2011, we, along with Affinia Group Holdings Inc. and Affinia Group Inc., entered into an Advisory Agreement with Torque Capital Group LLC for services related to corporate strategy, finance, investments and such other services as we may request from time to time. Mr. Joseph E. Parzick, one of our directors, is a managing partner of Torque Capital Group LLC. In connection with the Advisory Agreement, we, along with Affinia Group Holdings Inc. and Affinia Group Inc., have agreed to pay a quarterly fee of $400,000 for six calendar quarters expiring June 30, 2012, and have further agreed to pay a success fee of up to $3.0 million in the event Affinia Group Holdings Inc.’s shareholders realize a specified return on their investment. The advisory service expenses are included in selling, general and administrative expenses.
Effective January 1, 2011, we, along with Affinia Group Holdings Inc. and Affinia Group Inc., entered into an Advisory Agreement with Cypress Advisors, Inc. for services related to corporate strategy, finance, investments and such other services as we may request from time to time. Mr. James A. Stern, one of our directors, is a managing director of Cypress Advisors, Inc. In connection with the Advisory Agreement, we, along with Affinia Group Holdings Inc. and Affinia Group Inc., have agreed to pay a quarterly fee of $100,000 for six calendar quarters expiring June 30, 2012, and have further agreed to pay a success fee of up to $2.0 million in the event Affinia Group Holdings Inc.’s shareholders realize a specified return on their investment. The advisory service expenses are included in selling, general and administrative expenses.
Note 20. Segment Information
The products, customer base, distribution channel, manufacturing process, procurement are similar throughout all of the Company’s operations. However, due to different economic characteristics in the Company’s operations and in conformity with ASC Topic 280, “Segment Reporting,” the Company presented three separate reporting segments: (1) the On and Off-highway segment, aggregates the Filtration, Chassis and Commercial Distribution South America operating segments, (2) South America other segment (which was formerly referred to as Brake South America segment) and (3) Discontinued operation which includes the Commercial Distribution Europe segment and Brake North America and Asia group. All three segments are in the On and Off-highway industry but for segment reporting purposes we refer to the first segment as the On and Off-highway segment. Because of the sale of our Commercial Distribution Europe segment, the Commercial Distribution Europe segment was classified as discontinued operations and, as such, is not presented in the net sales and operating profit segment tables below. See “Note 4. Discontinued Operation - Quinton Hazell.” Also our Brake North America and Asia group was classified as discontinued operations and, as such, is not presented in the net sales and operating profit segment tables below. See “Note 3. Discontinued Operation-Brake.” Segment net sales, operating profit, total assets, depreciation and amortization and capital expenditures were as follows:
(1) The amounts related to the Brake North America and Asia group are classified in the On and Off-highway segment in 2010 and in assets of discontinued operations in 2011.
Net sales by geographic region were as follows:
Long-lived assets by geographic region were as follows:
(1) Long-lived assets as of December 31, 2011 excludes $200 million in our Brake North America and Asia group, which is classified in current assets of discontinued operations.
Net sales by geographic area were determined based on origin of sale. Geographic data on long-lived assets are comprised of property, plant and equipment, goodwill, other intangible assets and deferred financing costs.
We offer primarily two types of products: filtration products, which include oil, fuel, air and other filters and chassis products, which include steering, suspension and driveline components. Additionally, we have Commercial Distribution South America products, which offer chassis, filtration and other products. The Company’s sales by group of similar products are as follows:
Note 21. Asset Retirement Obligations
We account for the fair value of an ARO in the period in which it is incurred if it can be reasonably estimated, with the offsetting associated asset retirement costs capitalized as part of the carrying amount of the long-lived assets. The asset retirement cost is subsequently allocated to expense using a systematic and rational method over its useful life. Changes in the ARO resulting from the passage of time are recognized as an increase in the carrying amount of the liability and as accretion expense, which is included in depreciation and amortization expense in the consolidated statements of operations. Changes resulting from revisions to the timing or amount of the original estimate of cash flows are recognized as an increase or a decrease in the asset retirement cost and ARO. The ARO recorded at December 31, 2010 and December 31, 2011 was $2 million, which includes $1 million for our Brake North America and Asia group.
Note 22. Derivatives
The Company’s financial derivative assets and liabilities consist of standard currency forward contracts. The fair value framework requires the categorization of assets and liabilities into three levels based upon the assumptions (inputs) used to price the assets or liabilities. Level 1 provides the most reliable measure of fair value, whereas Level 3 generally requires significant management judgment. The three levels are defined as follows:
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Level 1: Unadjusted quoted prices in active markets for identical assets and liabilities.
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Level 2: Observable inputs other than those included in Level 1. For example, quoted prices for similar assets or liabilities in active markets or quoted prices for identical assets or liabilities in inactive markets.
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Level 3: Unobservable inputs reflecting management’s own assumptions about the inputs used in pricing the asset or liability.
All derivative instruments are recognized on our balance sheet at fair value. The fair value measurements of our currency derivatives are based upon Level 2 inputs consisting of observable market data pertaining to relevant currency exchange rates, as reported by a recognized independent third-party financial information provider. Based upon the Company’s periodic assessment of our own creditworthiness, and of the creditworthiness of the counterparties to our derivative instruments’ fair value measurements are not adjusted for nonperformance risk.
Currency Rate Derivatives
Our currency derivative contracts are valued using then-current spot and forward market data as provided by external financial institutions. We enter into short-term hedging transactions with banking institutions of only the highest tiered credit ratings and thus the counterparty credit risk associated with these contracts is not considered significant.
Our currency derivatives are undesignated hedges of specific monetary asset balances subject to currency revaluation. Changes in the fair value of these hedging transactions are recognized in income each accounting period. At December 31, 2011, the aggregate notional amount of our currency derivatives was $62 million having a fair market value of $1 million in assets and less than $1 million in liabilities.
The Company’s outstanding currency forward contracts are recorded in the Consolidated Balance Sheets as “Other current assets” or “Other accrued expenses,” accordingly. Currency derivative gains and losses are recognized in “Other income, net” in the Consolidated Statements of Operations in the reporting period of occurrence. The Company has not recorded currency derivative gains (losses) to other comprehensive income (loss) nor has it reclassified prior period currency derivative results from other comprehensive income (loss) to earning during the last twelve months. The Company does not anticipate that it will record any currency derivative gains or losses to other comprehensive income (loss) or that it will reclassify prior period currency derivative results from other comprehensive income (loss) to earnings in the next twelve months.
The notional amount and fair value of our outstanding currency forward contracts were as follows:
Currency derivative gains and losses are recognized in “Other income, net” in the Consolidated Statements of Operations in the reporting period of occurrence. The short-term currency exchange rate forward contracts are intended to offset the currency exchange gain (loss) related to the re-measurement process. The currency gains and losses are as follows:
Note 23. Joint Venture Acquisition
In December 2010, we acquired the remaining 50% ownership interest in Affinia India Private Limited, the Company’s India joint venture, for $24 million in cash, increasing our ownership interest from 50% to 100%. The acquisition is not subject to any post closing purchase price adjustments or earn-outs. We had a controlling financial interest in Affinia India Private Limited prior to the purchase of the remaining 50% interest. Since we had control prior to the purchase, the transaction has been accounted for as an equity transaction consistent with ASC Topic 810, “Consolidation.” As a result of the transaction the noncontrolling interest balance was decreased by $8 million and the additional paid-in capital was decreased by $16 million. We financed this acquisition with the available borrowings under our ABL Revolver, which borrowings were repaid with the use of proceeds from our completed offering on December 9, 2010 of the Additional Notes. The net income attributable to the noncontrolling interest owned in Affinia Acquisition LLC and Affinia India Private Limited was $7 million for 2009, $6 million for 2010 and $1 million for 2011, which is included in discontinued operations for the years presented.
Note 24. Venezuelan Operations
As required by U.S. GAAP, effective January 1, 2010, we accounted for Venezuela as a highly inflationary economy because the three-year cumulative inflation rate for Venezuela using the blended Consumer Price Index (which is associated with the city of Caracas) and the National Consumer Price Index (developed commencing in 2008 and covering the entire country of Venezuela) exceeded 100%.
Effective January 1, 2010, our Venezuelan subsidiary uses the U.S. Dollar as its functional currency. The financial statements of our subsidiary must be re-measured into the Company’s reporting currency (U.S. Dollar) and future exchange gains and losses from the re-measurement of monetary assets and liabilities are reflected in current earnings, rather than exclusively in the equity section of the balance sheet, until such time as the economy is no longer considered highly inflationary. The local currency in Venezuela is the Bolivar Fuerte (“VEF”).
On January 11, 2010, the Venezuelan government devalued the country’s currency and changed to a two-tier exchange structure. The official exchange rate moved from 2.15 VEF per U.S. Dollar to 2.60 for essential goods and 4.30 for non-essential goods and services, with our products falling into the non-essential category. A Venezuelan currency control board is responsible for foreign exchange procedures, including approval of requests for exchanges of VEF for U.S. Dollars at the official (government established) exchange rate. Our business in Venezuela has been unsuccessful in obtaining U.S. Dollars at the official exchange rate. An unregulated parallel market existed for exchanging VEF for U.S. Dollars through securities transactions; and our Venezuelan subsidiary had been able to enter into such exchange transactions until May 2010, as discussed further below. The Company used the unregulated parallel market rate to translate the financial statements of its Venezuelan subsidiary through May 2010 because we expected to obtain U.S. Dollars at the unregulated parallel market rate for future dividend remittances. During the second quarter of 2010, the unregulated parallel market was suspended and the Central Bank of Venezuela began regulating the parallel market. The Central Bank of Venezuela has also imposed volume restrictions on use of the regulated parallel market. We will use the regulated parallel market rate to translate the financial statements of our Venezuelan subsidiary to comply with the regulations of Venezuela and are analyzing the impact of the volume restrictions on our business. The currency exchange limitations to date have not had a material effect on our 2010 earnings and cash flow.
Effective January 1, 2010, we changed the rate used to re-measure our Venezuelan subsidiary’s transactions and balances from the official exchange rate of 2.15 VEF to the U.S. Dollar to the parallel market rate, which ranged between 5.30 and 7.70 VEF to the U.S. Dollar during 2010. The one-time devaluation had a $2 million negative impact on our pre-tax net income. As described above, during the second quarter of 2010, we changed the rate used to re-measure our Venezuelan subsidiary’s transactions to the SITME rate of 5.30 VEF to the U.S. Dollar and the rate has remained at that level in 2011. For 2010, our Venezuelan subsidiary represented approximately 1% of our consolidated net sales and it had a net loss attributable to the Company of $8 million, of which $7 million related to restructuring. The Venezuelan subsidiary also had $8 million of total assets and $7 million of total liabilities as of December 31, 2010. For 2011, our Venezuelan subsidiary represented approximately 2% of our consolidated net sales and it had a net income attributable to the Company of $3 million. The Venezuelan subsidiary also had $15 million of total assets and $10 million of total liabilities as of December 31, 2011.
On December 30, 2010, the Venezuelan government devalued the VEF by unifying the essential goods exchange rate of 2.60 VEF per U.S. Dollar with the non-essential goods and services exchange rate of 4.30 VEF per U.S. Dollar. The Company does not transact at the essential goods exchange rate as it has been unsuccessful in obtaining U.S. Dollars at the official exchange rate; as such, the devaluation does not impact the Company’s financial statements. The Company continues to use the regulated parallel market rate of 5.30 VEF per U.S. Dollar.
Note 25. Financial Information for Guarantors and Non-Guarantors
Affinia Group Intermediate Holdings Inc. (presented as “Parent” in the following schedules), through its 100%-owned subsidiary, Affinia Group Inc. (presented as “Issuer” in the following schedules), issued $225 million aggregate principal amount of its 10.75% Senior Secured Notes due 2016 (the “Secured Notes”) on August 13, 2009 and Affinia Group Inc. issued $300 million aggregate principal amount of its 9% Senior Subordinated Notes due 2014 (the “Subordinated Notes”) on November 30, 2004, with an additional $100 million in principal amount issued December 9, 2010. As of December 31, 2011 there were $367 million and $201 million of Subordinated Notes and Secured Notes outstanding, respectively. The notes were offered only to qualified institutional buyers and certain persons in offshore transactions
The Secured Notes are fully, unconditionally and jointly and severally guaranteed on a senior secured basis and the Subordinated Notes are fully, unconditionally and jointly and severally guaranteed on an unsecured senior subordinated basis. The Subordinated Notes are general obligations of the Issuer and guaranteed by the Parent and all of the Issuer’s wholly owned current and future domestic subsidiaries (the “Guarantors”). The Issuer’s obligations under the Secured Notes are guaranteed by the Guarantors and are secured by first-priority liens, subject to permitted liens and exceptions for excluded assets, on substantially all of the Issuers and the Guarantors’ tangible and intangible assets (excluding the ABL Collateral as defined below), including real property, fixtures and equipment owned or acquired in the future by the Issuer and the Guarantors (the “Non-ABL Collateral”) and are secured by second-priority liens on all accounts receivable, inventory, cash, deposit accounts, securities accounts and proceeds of the foregoing and certain assets related thereto held by the Issuer and the Guarantors, which constitute collateral under the asset-based revolving credit facility (the “ABL Revolver”) on a first-priority basis (the “ABL Collateral”).
The following information presents Condensed Consolidating Statements of Operations for the years ended December 31, 2009, December 31, 2010 and December 31, 2011, Condensed Consolidating Balance Sheets as of December 31, 2010 and December 31, 2011 and Condensed Consolidating Statements of Cash Flows for the years ended December 31, 2009, December 31, 2010 and December 31, 2011 of (1) the Parent, (2) the Issuer, (3) the Guarantors, (4) the Non-Guarantors, and (5) eliminations to arrive at the information for the Company on a consolidated basis. Other separate financial statements and other disclosures concerning the Parent and the Guarantors are not presented because management does not believe that such information is material to investors.
Affinia Group Intermediate Holdings Inc.
Guarantor Condensed
Consolidating Statement of Operations
For the Year Ended December 31, 2009
Affinia Group Intermediate Holdings Inc.
Guarantor Condensed
Consolidating Statement of Operations
For the Year Ended December 31, 2010
Affinia Group Intermediate Holdings Inc.
Guarantor Condensed
Consolidating Statement of Operations
For the Year Ended December 31, 2011
Affinia Group Intermediate Holdings Inc.
Guarantor Condensed
Consolidating Balance Sheet
December 31, 2010
Affinia Group Intermediate Holdings Inc.
Guarantor Condensed
Consolidating Balance Sheet
December 31, 2011
Affinia Group Intermediate Holdings Inc.
Guarantor Condensed
Consolidating Statement of Cash Flows
For the Year Ended December 31, 2009
Affinia Group Intermediate Holdings Inc.
Guarantor Condensed
Consolidating Statement of Cash Flows
For the Year Ended December 31, 2010
Affinia Group Intermediate Holdings Inc.
Guarantor Condensed
Consolidating Statement of Cash Flows
For the Year Ended December 31, 2011
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
Not applicable.
Item 9A.
Item 9A. Controls and Procedures
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosures. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Exchange Act. Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of December 31, 2011, the end of the period covered by this annual report.
Management’s Report on Internal Control over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f), and for the assessment of the effectiveness of internal control over financial reporting. As defined by the Securities and Exchange Commission, internal control over financial reporting is a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s Board of Directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements in accordance with U.S. generally accepted accounting principles.
The Company’s internal control over financial reporting is supported by written policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the Company’s transactions and dispositions of the Company’s assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of the consolidated financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of the Company’s management and directors; 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 consolidated 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 connection with the preparation of the Company’s annual consolidated financial statements, management has undertaken an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO Framework”). Management’s assessment included an evaluation of the design of the Company’s internal control over financial reporting and testing of the operational effectiveness of those controls.
Based on this assessment, management has concluded that as of December 31, 2011, the Company’s internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.
Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting during our fourth quarter of 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Set forth below is certain information concerning the individuals serving as our executive officers and members of our Board, including their ages as of March 16, 2012.
Name
Age
Position
Terry R. McCormack
President, Chief Executive Officer and Director
Thomas H. Madden
Senior Vice President and Chief Financial Officer
H. David Overbeeke
President, Global Brake & Chassis Group
Keith A. Wilson
President, Global Filtration Group
Jorge C. Schertel
President, Affinia Group S.A.
Steven E. Keller
Senior Vice President, General Counsel and Secretary
Timothy J. Zorn
Vice President, Human Resources
Patrick M. Manning
Vice President, Business Development
Samuel T. Quick
Vice President, Information Technology
William M. Lasky
Director
James S. McElya
Director
Donald J. Morrison
Director
Joseph A. Onorato
Director
Joseph E. Parzick
Director
John M. Riess
Director
James A. Stern
Director
Terry R. McCormack has served as our President, Chief Executive Officer and a Director on our Board since December 1, 2004. He held a variety of positions at Dana from 1974 through July 2000, when he was named President of Dana’s Aftermarket Group, a position he held until November 30, 2004. Mr. McCormack holds a B.S. degree in Psychology from Ball State University. He has completed the Harvard Advanced Management Program. Mr. McCormack serves as Chairman of the board of directors of MEMA. He is also a member of the Automotive Presidents’ Group. Mr. McCormack formerly served on the boards of the University of North Carolina at Charlotte’s Belk College School of Business and Blue Persuasion, a non-profit organization.
Thomas H. Madden has served as our Senior Vice President and Chief Financial Officer since January 1, 2007. Mr. Madden previously served as our Vice President and Chief Financial Officer from December 1, 2004 until December 31, 2006. Mr. Madden formerly served as Vice President and Group Controller for the Aftermarket Group of Dana since 1998. He earned a B.B.A. in Accounting from the University of Toledo. He also attended the University of Michigan Executive Business School. Mr. Madden serves on the board of directors of Ariston Systems, LLC.
H. David Overbeeke has served as our President, Global Brake & Chassis Group since July 14, 2008, having previously served as a Director of Affinia Group Inc. from April 1, 2008 until July 13, 2008. From April 2006 until February 2010 Mr. Overbeeke served as Operating Advisor for Oak Hill Capital Partners, a private equity firm and prior to that he spent over 20 years with General Electric (“GE”) in various roles including Executive Vice President and CIO Digital Media of NBC Universal, and General Manager of Fleet Operations at GE Aviation until departing GE in December, 2005. Mr. Overbeeke earned a BSe degree in Mechanical Engineering with a minor in Business from the University of Waterloo. Mr. Overbeeke serves on the board of directors of Wilton Re, a life reinsurance company. Mr. Overbeeke formerly served on the boards of Republic National Cabinet Corporation, Torque Medical Holdings, Inc. and Torque Medical, LLC.
Keith A. Wilson has served as our President, Global Filtration Group since January 1, 2008, having previously served as President, Under Hood Group from January 1, 2007 until December 31, 2007. Mr. Wilson served as Vice President and General Manager of our Under Hood Group from December 1, 2004 until December 31, 2006. Prior to that, Mr. Wilson had served as Vice President and division manager of Wix Filtration Products Division of Dana. Mr. Wilson earned a B.A. in Marketing and Management from Ball State University and he is a graduate of Dana’s M.B.A. Program. He also served as Chairman of Dana’s Global Environmental Health & Safety Advisory Council.
Jorge C. Schertel has served as our President, Affinia Group S.A. since January 1, 2011, having previously served as our Vice President, Commercial Distribution, South America from January 1, 2008 until December 31, 2010. Mr. Schertel served as our Vice President and General Manager South America from June 1, 2006 to December 31, 2007 and from December 1, 2004 to May 31, 2006 as our Vice President and General Manager Brazil. Mr. Schertel earned a B.A. in Business Administration from PUC-RGS, Brazil. He also attended the Executive Management Program at Penn State University and the Executive Development Program at the University of Michigan Business School. Mr. Schertel serves on the Council Director of SINDIPECAS (Brazilian Association for Autoparts Manufacturers).
Steven E. Keller has served as our Senior Vice President, General Counsel and Secretary since January 1, 2007. Mr. Keller served as our General Counsel and Secretary from December 1, 2004 until December 31, 2006. Prior to that, Mr. Keller served as Managing Attorney and a member of the Dana Law Department’s Operating Committee. Mr. Keller earned a B.A. in Financial Administration from Michigan State University and a J.D. from the Marshall-Wythe School of Law at the College of William and Mary. He also attended the University of Michigan Executive Business School. He is a member of the Virginia Bar.
Timothy J. Zorn has served as our Vice President, Human Resources since December 1, 2004. Mr. Zorn held the same position with the Aftermarket Group of Dana from May 16, 2003 until November 30, 2004 and was previously the Human Resources Manager of Dana’s Wix division from May 1999 until May 2003. Mr. Zorn earned his B.A. in Economics from Ohio Wesleyan University. He is a certified Senior Professional Human Resources and has served terms on the boards of directors of several charitable and educational organizations.
Patrick M. Manning has served as our Vice President, Business Development since January 1, 2009. Mr. Manning previously served as our Director, Business Development from December 1, 2004 until December 31, 2008. Mr. Manning was a Manager of Corporate Development in 2003 and Director of Business Development in 2004 at Dana. Mr. Manning earned a B.S. in Industrial Engineering from the University of Pittsburgh and an M.B.A. from Southern Connecticut State University.
Samuel T. Quick has served as our Vice President, Information Technology, since December 1, 2011, having previously served as Vice President, Applications Development & Support, from October 29, 2007. Prior to joining Affinia, Mr. Quick served in strategic IT roles at Smurfit Stone, Merck, Alcon Laboratories (Nestle), Tyco Healthcare and Moog Automotive. Mr. Quick earned a B.S. degree in Business Administration from Fontbonne University.
William M. Lasky has served as a director on our Board since January 1, 2011. Mr. Lasky is currently Chairman of the Board of Accuride Corporation. He has served as a member of Accuride Corporation’s Board of Directors since 2007 and as Chairman since 2009. In addition to his board service, Mr. Lasky served as President and Chief Executive Officer of Accuride Corporation from September 2008 until February 2011. Mr. Lasky is also Chairman of the Board for Stoneridge, Inc. Previously, he served as Chairman, President & Chief Executive Officer of JLG Industries and spent much of his career with Dana Corporation. Mr. Lasky is a graduate of both Norwich University and Harvard Business School’s Advanced Management Program. He has served in the United States Army as a Pilot Captain and is a member of the Board of Trustees for Norwich University.
James S. McElya has served as a director on our Board since January 1, 2011. Mr. McElya is currently Chairman and Chief Executive Officer of Cooper Standard Holdings Inc. and its principal operating company, Cooper Standard Automotive. Cooper Standard filed for protection under Chapter 11 of the United States Bankruptcy Code in August 2009 and emerged from the Chapter 11 proceedings in May 2010. Previously, he had served as Corporate Vice President of Cooper Tire & Rubber Company, the parent company of Cooper Standard, until 2004. Mr. McElya has also served as President of Siebe Automotive Worldwide and over a 22-year period held various senior management positions with Handy & Harman. Mr. McElya is a past chairman of the Motor Equipment Manufacturers Association (MEMA) and Original Equipment Supplier Association (OESA).
Donald J. Morrison has served as a Director on our Board since December 1, 2004. Mr. Morrison is a Senior Managing Director with OMERS Private Equity, which makes private equity investments on behalf of OMERS, one of Canada’s largest pension funds. Before joining OMERS, Mr. Morrison spent over ten years with PricewaterhouseCoopers LLP in Corporate Finance focusing on restructurings and turnarounds and eight years as Senior Vice President and member of the Senior Management Investment Committee with one of Canada’s largest venture capital funds originating and structuring expansion and buyout investments. Mr. Morrison has served on the boards of directors of over 20 public and private companies. Mr. Morrison earned a B. Commerce degree from the University of Toronto, is a Chartered Accountant, Chartered Insolvency and Restructuring Practitioner, and a Chartered Director.
Joseph A. Onorato has served as a Director on our Board since December 1, 2004. Mr. Onorato also serves as Chairman of the Audit Committee of our Board. Mr. Onorato was Chief Financial Officer of Echlin, Inc., where he spent 19 years. He served as Treasurer from 1990 to 1994, as Vice President and Treasurer from 1994 to 1997 and as Vice President and Chief Financial Officer from 1997 until the company was acquired by Dana in July 1998. Mr. Onorato served as Senior Vice President and Chief Financial Officer for the Aftermarket Group of Dana from July 1998 until his retirement in September 2000. Mr. Onorato previously worked for PricewaterhouseCoopers LLP. Mr. Onorato also serves on the board of directors of Mohawk Industries Inc. where he is Chairman of the Audit Committee and a member of the Compensation Committee
Joseph E. Parzick has served as a Director on our Board since August 12, 2008. Mr. Parzick also serves as Chairman of the Nominating Committee of our Board. Mr. Parzick is the Managing Partner of the Torque Capital Group LLC which he co-founded in 2011. From June 2003 until December 2010 he was a Managing Director of Cypress Advisors, Inc. Prior to joining Cypress, he spent the previous four years as a Managing Director in Morgan Stanley’s financial sponsor group. Immediately prior to this, he was a professional employee of EXOR America Inc., a merchant banking affiliate of the Agnelli Group and Lehman Brothers, where he was a Managing Director and co-head of the financial sponsors group. He earned a B.S. degree from the University of Virginia and an M.B.A. from the University of Pennsylvania’s Wharton School. Mr. Parzick also serves on the boards of directors of Q.bel Foods, LLC, and is Chairman of the board of directors of Torque Medical Holdings, Inc., Torque Medical, LLC. and Torque Turbine Engine Holdings, LLC. Mr. Parzick formerly served on the boards of Danka Business Systems PLC, Financial Guaranty Insurance Company, Republic National Cabinet Group and Stone Canyon Entertainment Corporation.
John M. Riess has served as a Director on our Board since December 1, 2004. Mr. Riess was elected Lead Director on December 2, 2010. He formerly served as Chairman and Chief Executive Officer of Breed Technologies, Inc. from 2000 to 2003 when he retired. Prior to this, Mr. Riess held various management and executive positions within the Gates Rubber Company, serving as Chairman of the Board of Directors and Chief Executive Officer from 1997 to 1999. Mr. Riess also serves on the board of directors of Formed Fiber Technologies, Inc. where he is Chairman of the audit committee and a member of the compensation committee.
James A. Stern has served as a Director on our Board since December 1, 2004. On December 2, 2010, Mr. Stern was elected Chairman of our Board. Mr. Stern also serves as Chairman of the Compensation Committee of our Board. Mr. Stern is Chairman and Chief Executive Officer of Cypress, a position he has held since 1994. Mr. Stern headed Lehman Brothers’ Merchant Banking Group before leaving that firm to help found Cypress. During his 20-year tenure with Lehman, he held senior management positions where he was responsible for the high yield and primary capital markets groups. He also served as co-head of investment banking and was a member of Lehman’s operating committee. Before graduating from Harvard Business School, Mr. Stern earned a B.S. from Tufts University, where he is Chairman of the Board of Trustees. Mr. Stern formerly served on the boards of Lear Corporation, AMTROL, Inc., Med Pointe, Inc., and Cooper-Standard Automotive Inc.
Section 16(a) Beneficial Ownership Reporting Compliance
Not Applicable.
Board Composition and Director Qualifications
Our Board currently consists of one class of eight directors who serve until resignation or removal. The Board seeks to ensure that it is composed of members whose particular experience, qualifications, attributes and skills, when taken together, will allow the Board to satisfy its oversight responsibilities effectively. In that regard, the Nominating Committee is responsible for recommending candidates for all directorships to be filled by the Board. In identifying candidates for membership on the Board, the Nominating Committee takes into account (1) minimum individual qualifications, such as high ethical standards, integrity, maturity, careful judgment, industry knowledge or experience and an ability to work collegially with the other members of the Board and (2) all other factors that it considers appropriate, including alignment with our stockholders, especially Cypress, OMERS and others.
When considering whether the Board’s directors and nominees have the experience, qualifications, attributes and skills, taken as a whole, to enable the Board to satisfy its oversight responsibilities effectively in light of Company’s business and structure, the Board focused primarily on the information discussed in each of the Board members’ or nominees’ biographical information set forth above.
Each of the Company’s directors possesses high ethical standards, acts with integrity and exercises careful, mature judgment. Each is committed to employing his skills and abilities to aid the long-term interests of the stakeholders of the Company. In addition, our directors are knowledgeable and experienced in one or more business endeavors which further qualifies them for service as members of the Board.
Pursuant to the Stockholders Agreement dated as of November 30, 2004, among Affinia Group Holdings Inc., various Cypress funds, OMERS, The Northwestern Mutual Life Insurance Company, California State Teachers’ Retirement System and Stockwell Fund, L.P., the number of directors serving on the Board of Directors will be no less than seven and no more than eleven. The Stockholders Agreement entitles Cypress to designate three directors. Cypress currently has appointed, Mr. Stern, Mr. Parzick and Mr. McElya. As long as OMERS members own at least 50 percent in the aggregate number of shares owned by them on November 30, 2004, OMERS is entitled to designate one director, who currently is Mr. Morrison. Cypress is entitled to designate three directors not affiliated with any of the parties to the Stockholders Agreement, who currently are Mr. Onorato, Mr. Riess and Mr. Lasky. Additionally, the Stockholders Agreement entitles the individual serving as CEO, currently Mr. McCormack, and another individual serving as one of our senior officers, currently vacant, to seats on the Board of Directors. The Stockholders Agreement also provides that the Nominating Committee of the Board of Directors may from time to time select two additional individuals who must be independent to serve as Directors.
Each of Messrs. Stern, Parzick and Morrison possesses experience as a private equity investor in owning and managing enterprises like the Company and is familiar with corporate finance, strategic business planning activities and issues involving stakeholders more generally. In particular, Mr. Stern has significant experience in high yield and primary capital markets activities, having served as Chairman and Chief Executive Officer of Cypress since 1994 and as the head of Lehman Brothers’ Merchant Banking Group prior to 1994. Mr. Parzick has significant experience in management, having been involved in numerous investments as a managing director of Cypress from 2003 to 2011. Mr. Morrison has significant experience in accounting and management, having spent over ten years with PricewaterhouseCoopers LLP in corporate finance focusing on restructurings and turnarounds and having served on the boards of directors of over 20 public and private companies.
Each of Messrs. Lasky, McElya, Onorato, Reiss and McCormack possesses substantial expertise in advising and managing companies related to the aftermarket replacement parts industry. Mr. Onorato has significant experience in finance and accounting within the aftermarket industry, having served as Senior Vice President and Chief Financial Officer for the Aftermarket Group at Dana Corporation from 1998 to 2000 and prior to that as an officer at Echlin Inc., in financial positions of increasing responsibility over 19 years, including as Chief Financial Officer. Mr. Riess has extensive business experience in the aftermarket replacement parts industry and has experience in management, having served as Chairman and Chief Executive Officer of Breed Technologies, Inc. and Gates Rubber Company. Mr. McCormack has extensive knowledge of our business and the aftermarket replacement parts industry generally, having served as President and Chief Executive Officer of the Company since 2004 with responsibility for the day-to-day oversight of the Company’s business operations. Mr. Lasky has extensive business experience in the manufacturing industry and in the aftermarket replacement parts industry, having served in management roles in our filtration business when it was owned by Dana, as well as substantial experience in management having served as Chairman and Chief Executive Officer of both Accuride Corporation and JLG Industries. Mr. McElya has substantial manufacturing experience and experience in management, having served as Chairman and Chief Executive Officer of Cooper Standard Holdings Inc. and in management positions of increasing responsibility over his prior career.
Board Committees
Audit Committee
We have an Audit Committee, consisting of Mr. Onorato, Mr. Lasky, Mr. Morrison and Mr. Riess. Mr. Onorato, the chairman of our Audit Committee, is our “audit committee financial expert” as such term is defined in Item 407(d)(5) of Regulation S-K.
The purpose of the Audit Committee is to assist our Board in overseeing and monitoring: (1) the quality and integrity of our financial statements; (2) our compliance with legal and regulatory requirements; (3) our independent registered public accounting firm’s qualifications and independence; (4) the performance of our internal audit function and (5) the performance of our independent registered public accounting firm.
The written charter for the Audit Committee is available on our website.
Compensation Committee
We have a Compensation Committee, consisting of Mr. Stern (Chairman), Mr. Riess, Mr. Onorato and Mr. McElya. The purpose of the Compensation Committee is to assist our Board in discharging its responsibility relating to: (1) setting our compensation program and compensation of our executive officers and directors; (2) monitoring our incentive and equity-based compensation plans and (3) preparing the compensation committee report required to be included in our annual report on Form 10-K under the rules and regulations of the SEC.
The written charter for the Compensation Committee is available on our website.
Nominating Committee
We have a Nominating Committee, consisting of Mr. Parzick (Chairman), Mr. Onorato and Mr. Morrison.
The purpose of our Nominating Committee is to assist our Board in discharging its responsibilities relating to: (1) developing and recommending criteria for selecting new directors; (2) screening and recommending to the Board individuals qualified to become executive officers and (3) handling such other matters as are specifically delegated to the Nominating Committee by the Board.
The written charter for the Nominating Committee is available on our website.
Code of Business Conduct and Ethics
We have adopted a code of business conduct and ethics that applies to all of our employees, officers and directors, including those officers responsible for financial reporting. The code of business conduct and ethics is available on our website at www.affiniagroup.com. We will make any legally required disclosures regarding amendments to, or waivers of, our code of business conduct on our website.
Item 11.
Item 11. Executive Compensation
COMPENSATION DISCUSSION AND ANALYSIS
Executive Summary
The primary objectives of our compensation program are to attract and retain talented executives to lead our company and promote our short- and long-term growth. Our compensation program establishes a link between sustained corporate performance and individual rewards, such as ownership opportunities for our executives and key employees. We believe that this link ensures a balance between delivering near-term results and creating long-term value for our investors.
We foster a performance-oriented culture that aligns individual efforts with organizational objectives. Company performance and accomplishments are the primary measures of success upon which we structure our compensation programs. We evaluate and reward our executive officers based upon their contributions to the achievement of our goals.
We reinforce our overall compensation objectives by compensating our executive officers primarily through base salary, non-equity incentive awards, long-term equity incentive awards, competitive benefits packages and perquisites.
Our named executive officers (the “Named Executive Officers”) for the fiscal year ended December 31, 2011 were: Terry R. McCormack (President and Chief Executive Officer), Thomas H. Madden (Senior Vice President and Chief Financial Officer), H. David Overbeeke (President, Global Brake & Chassis Group), Keith A. Wilson (President, Global Filtration Group) and Jorge C. Schertel (President, Affinia Group S.A.).
Compensation Committee Role
The Compensation Committee, composed entirely of non-management directors, administers our executive compensation program. The role of the Compensation Committee is to oversee our compensation and benefit plans and policies, administer our parent company’s 2005 Stock Plan (including reviewing and approving equity grants to executive officers), establish annual goals and objectives for our Chief Executive Officer, and review and approve annually all compensation decisions relating to executive officers, including our Named Executive Officers. The Compensation Committee recognizes the importance of maintaining sound principles for the development and administration of compensation and benefit programs, as well as ensuring that we maintain strong links between executive pay and performance. The Compensation Committee’s charter details the Compensation Committee’s specific responsibilities and functions. The Compensation Committee annually reviews its charter, with the most recent review occurring at the Compensation Committee’s March 7, 2012 meeting. The full text of the Compensation Committee’s charter is available on our website at www.affiniagroup.com. The Compensation Committee’s membership is determined by our Board of Directors and its meeting agendas are established by the Committee Chair. Our Chief Executive Officer, Chief Financial Officer, General Counsel and Vice President of Human Resources generally attend meetings of the Compensation Committee, but do not attend executive sessions and do not participate in determining their specific compensation. There were five formal meetings of the Compensation Committee in 2011, four of which included an executive session. Executive sessions are held with the Compensation Committee members only. The Compensation Committee holds meetings in person, by telephone and also considers and takes action by written consent.
General Compensation Philosophy and Elements of Compensation
The Compensation Committee believes that compensation paid to executive officers should be closely aligned with our performance on both a short-term and long-term basis, and that such compensation should enable us to attract, motivate and retain key executives critical to our long-term success. Total compensation should be structured to ensure that a significant portion of compensation opportunity will be directly related to factors that drive future financial and operating performance and align our executive officers’ long-term interests with those of our investors. To that end, the Compensation Committee has determined that the total compensation program for executive officers should consist of the following elements:
(A) Base Salaries
We pay each executive officer a base salary based on the rate of pay that the executive has received in the past, whether the executive’s position or responsibilities associated with his or her position have changed, whether the complexity or scope of his or her responsibilities has increased, and how his or her position relates to other executives and their rate of base salary. While a significant portion of each executive officer’s compensation is “at risk” in the form of non-equity incentive awards (annual cash performance bonuses) and long-term equity incentive awards, the Compensation Committee believes that executive officers should also have the stability and predictability of fixed base salary payments.
(B) Non-Equity Incentive Awards
For fiscal 2011, the Compensation Committee determined that amounts payable under the cash incentive award program would depend on our company consolidated adjusted EBITDA performance, the adjusted EBITDA performance of our business units and the individual performance of each executive officer. While individual performance accounted for 25% of Mr. McCormack’s target bonus opportunity in fiscal 2010, for fiscal 2011, the Compensation Committee determined that individual performance would account for 25% of the target bonus opportunity for all executive officers in order to emphasize each executive officer’s individual contribution to the Company. In addition, in order to emphasize performance at the business unit level, the Compensation Committee eliminated company consolidated adjusted EBITDA performance as component of the fiscal 2011 target bonus opportunity for Messrs. Overbeeke, Wilson and Schertel and determined that adjusted EBITDA performance at the business unit level would determine 75% of their respective target bonus opportunities. For Mr. Madden and the other executive officers at the corporate level, in order to emphasize the Company’s consolidated performance, the Compensation Committee eliminated business unit adjusted EBITDA as a component of the fiscal 2011 target bonus opportunity and determined that company consolidated adjusted EBITDA would determine 75% of Mr. Madden’s target bonus opportunity.
We established the company consolidated and the business unit adjusted EBITDA performance levels for our 2011 non-equity incentive awards such that the threshold performance levels were reasonably likely to be achieved, the target performance levels required significant improvement over actual 2010 performance, and the maximum performance levels were substantially more challenging to achieve.
Our overall EBITDA performance for fiscal 2011, as adjusted by the Compensation Committee, was $191 million. Adjusted EBITDA for this purpose was calculated as follows ($ millions):
(1) EBITDA from discontinued operations excludes the impairment that is explained in Note 3. Discontinued Operation - Brake which is included in Item 8 of this report.
(2) Consists of adjustments for certain expenses relating to the factoring of accounts receivable.
Company consolidated adjusted EBITDA of $191 million was below the threshold performance level of $216 million set by the Compensation Committee. In addition, none of the business unit adjusted EBITDA thresholds set by the Compensation Committee were attained in fiscal 2011. Because none of the threshold adjusted EBITDA performance levels were achieved, the Compensation Committee determined that no cash performance bonuses would be paid, regardless of individual performance. Additional detail describing how non-equity incentive plan awards for fiscal 2011 were calculated appears below under “-Narrative Disclosure to Summary Compensation Table and Grants of Plan-Based Awards in 2011 Table.”
We have also adopted a non-qualified deferred compensation program pursuant to which our executive officers can elect to defer all or a portion of their non-equity incentive awards. Any deferred amount is notionally invested in Holdings’ common stock and a portion is matched in the form of an additional notional investment in Holdings’ common stock. The principal terms of the non-qualified deferred compensation program appear below under “-Non-Qualified Deferred Compensation.” In addition, for fiscal 2011 the Compensation Committee approved an additional contribution of 30% of the amount of an executive officer’s cash-based incentive award, which would vest on the same terms as the 25% matching contribution, if the Company achieved company consolidated adjusted EBITDA performance at or above the target performance level. However, since no cash performance bonuses were paid for fiscal 2011, there were no additional contributions made pursuant to this program.
(C) Long-Term Equity Incentive Awards
We provide long-term equity incentive awards in the form of stock options or restricted stock units to each of our executive officers. The Compensation Committee believes that these awards align the interests of our executive officers with those of our investors and provide an effective incentive for our executive officers to remain with us. The principal terms of the restricted stock unit grants are described below under “-Outstanding Equity Awards at 2011 Fiscal Year-End.”
(D) Certain Other Benefits
We provide our executive officers with those benefits and perquisites that we believe assist us in retaining their services. Some of these benefits are available to our employees generally (e.g., contributions to a defined contribution (401(k)) plan, health care coverage and paid vacation days) and some are available to a more limited number of key employees, including our Named Executive Officers (e.g., car allowances and tax preparation services). The specific benefits provided to each Named Executive Officer are described in the “All Other Compensation” column of the “Summary Compensation Table” and in the “Incremental Cost of Perquisites and Other Compensation Table.”
Our executive compensation decisions are based primarily upon our assessment of each executive’s leadership and operational performance and potential to enhance long-term shareholder value. We rely on our judgment about each individual (and not on rigid formulas or temporary fluctuations in business performance) in determining the optimal magnitude and mix of compensation elements and whether each payment or award provides an appropriate incentive for performance that sustains and enhances long-term shareholder value. Key factors affecting our judgment include the executive officer’s performance compared to the financial, operational and strategic goals established for the executive at the beginning of the year; nature, scope and level of responsibilities; contribution to our financial results, particularly with respect to key metrics such as EBITDA, net working capital and cash flow; effectiveness in leading our restructuring plans and contribution to our commitment to corporate responsibility, including success in creating a culture of integrity and compliance with applicable laws and our ethics policies. The importance of each factor varies by individual. We also consider each executive’s current salary and prior-year bonus, the recommendations of our Chief Executive Officer regarding compensation for the executives he directly supervises, the appropriate balance between incentives for long-term and short-term performance, the compensation paid to the executive’s peers within the Company. From time to time, the Compensation Committee also receives independent advice on competitive practices from Towers Watson. When using peer data to evaluate executive compensation, the Compensation Committee may consider ranges of compensation paid by others for a particular position, both by reference to comparative groups of companies of similar size and stature and, more particularly, a group comprised of our direct competitors, as one point of reference when making compensation decisions regarding total compensation or particular elements of compensation under consideration. The Compensation Committee does not typically use information with respect to our peer companies and other comparable public companies to establish targets for total compensation, or any element of compensation, or otherwise numerically benchmark its compensation decisions. For example, the Compensation Committee has in prior years reviewed pay data for a range of companies in connection with the review of base salaries for our Named Executive Officers. The Compensation Committee did not, however, use third-party data in establishing fiscal 2011 compensation for our Named Executive Officers. None of our Named Executive Officers (including our Chief Executive Officer) participate in determining their specific compensation. In addition, we review the total compensation potentially payable to, and the benefits accruing to, the executive, including (1) current value of outstanding equity incentive awards and (2) potential payments under each executive’s employment agreement upon termination of employment or a change in control.
Employment, Severance and Change in Control Agreements
On July 21, 2005, we entered into employment agreements with Messrs. McCormack, Madden and Wilson, with substantially identical terms, except as noted below. On December 15, 2008, we entered into Amended and Restated Employment Agreements with each of those executives to effectuate certain non-material amendments for compliance with Section 409A of the Internal Revenue Code and, on August 11, 2010, we entered into an amendment to each of the Amended and Restated Employment Agreements to effectuate certain non-material clarifications to the termination provisions thereof.
Each employment agreement has an initial employment term which commenced as of May 1, 2005 and is automatically extended for successive one-year periods on each December 31 unless either party provides the other 90 days prior written notice that the employment term will not be so extended. Under the employment agreements, Messrs. McCormack, Wilson and Madden are each entitled to a specified base salary, subject to increases, if any, as determined by the Compensation Committee. Currently, the base salaries for Messrs. McCormack, Wilson and Madden pursuant to their employment agreements are $725.000, $500,000 and $335,000, respectively, as the same may be increased from time to time. In addition, the employment agreements provide that these Named Executive Officers are eligible to earn target annual cash incentive awards as a percentage of base salary (100% for Messrs. McCormack and Wilson and 80% for Mr. Madden) upon the achievement of performance goals established by the Compensation Committee. Messrs. McCormack, Wilson and Madden are entitled to higher awards for performance in excess of targeted performance goals, lower awards for performance that does not meet targeted performance goals and no award for performance that does not meet threshold performance goals.
On June 28, 2008, we entered into a letter agreement with Mr. Overbeeke, outlining the principal terms of his employment relationship with us. The letter agreement provides that Mr. Overbeeke is entitled to a specified base salary, subject to annual adjustment, if any, as determined by the Compensation Committee. Currently, the base salary for Mr. Overbeeke is $650,000, as the same may be adjusted from time to time. In addition, Mr. Overbeeke is eligible to earn a target annual cash incentive award of 100% of base salary upon the achievement of performance goals established by the Compensation Committee. As with the other executives, Mr. Overbeeke is entitled to a higher award for performance in excess of targeted performance goals, lower awards for performance that does not meet targeted performance goals and no award for performance that does not meet threshold performance goals. Mr. Overbeeke also is entitled to other benefits commensurate with the benefits available to our other executive officers.
Each executive (including Mr. Schertel) has agreed, either in his employment agreement or separately, to certain post-termination restrictions, and each executive is entitled to certain payments and benefits depending on the reason for termination. A description of these provisions, together with a table detailing amounts payable to our Named Executive Officers upon certain termination events, appears below under “-Potential Payments Upon Termination or Change in Control.”
Adjustments to Compensation for Financial Restatements
It is the Board’s policy that the Compensation Committee will, to the extent permitted by governing law, have the sole and absolute authority to make retroactive adjustments to any cash or equity-based incentive compensation paid to executive officers and certain other employees where the payment was predicated upon the achievement of certain financial results that were subsequently the subject of a restatement. Where applicable, we will seek to recover any amount determined to have been inappropriately received by any executive.
Option Exchange Program
On August 25, 2010, Holdings commenced an offer to certain eligible option holders, including our Named Executive Officers, to exchange their existing options to purchase shares of Holdings’ common stock for restricted stock unit awards with new vesting terms (the “Option Exchange”). As part of a review of our executive compensation and employee benefit arrangements on behalf of and under the supervision of our Board, and in light of the economic conditions in which we operate, it was determined that the restricted stock units may be better suited than the existing options to meet our objectives to motivate, retain and reward the eligible option holders.
The Option Exchange was completed on October 18, 2010 and all of the option holders who were eligible for the Option Exchange elected to participate in the exchange. The restricted stock units granted in connection with the Option Exchange are governed by the 2005 Stock Plan and a new Restricted Stock Unit Agreement entered into by each grantee, including each of our Named Executive Officers. The restricted stock units granted in connection with the Option Exchange are subject to performance-based vesting restrictions, which have been modified from the performance and time-based vesting restrictions applicable to the options for which they were issued in the Option Exchange. The RSUs will vest if (i) the RSU holder remains employed with Affinia Group Holdings Inc. on the date that either of the following vesting conditions occurs and (ii) either of the following vesting conditions occurs on or prior to the date on which Cypress ceases to hold any remaining Affinia Group Holdings Inc. common stock:
•
Cypress has received aggregate transaction proceeds in cash or marketable securities (not subject to escrow, lock-up, trading restrictions or claw-back) with respect to the disposition of more than 50% of its common equity interests in Holdings in an amount that represents a per-share equivalent value that is greater than or equal to two times the average per share price paid by Cypress for its common equity investment in Holdings; or
•
Holdings’ common stock trades on a public stock exchange at an average closing price of $225 (as adjusted for stock splits) over a 60 consecutive trading day period.
Following a “qualifying termination” of the holder’s employment due to an involuntary termination by us without cause or due to the holder’s death, disability or retirement, the restricted stock units granted in connection with the Option Exchange will also vest if either of the performance conditions described above is met upon or prior to the first to occur of (1) a final exit by Cypress of its equity investment in Holdings or (2) one year following the termination date.
See Note 12. “Stock Incentive Plan” of our Consolidated Financial Statements contained in Item 8. “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K for more information about the Option Exchange.
The following table sets forth certain information concerning the options surrendered by, and the restricted stock units granted to, each of our Named Executive Officers in connection with the Option Exchange.
Summary Compensation Table
The following table provides summary information concerning compensation paid or accrued by us to or on behalf of our President and Chief Executive Officer, our Senior Vice President and Chief Financial Officer, and each of our three other most highly compensated executive officers serving as of December 31, 2011. We collectively refer to these five individuals herein as the Named Executive Officers. Mr. McCormack also served as a Director but received no separate remuneration in that capacity.
(1) The amounts reported for 2010 reflect the incremental fair value of restricted stock units granted during the fiscal year in connection with the Option Exchange in accordance with FASB ASC Topic 718, “Compensation - Stock Compensation” (“ASC Topic 718”). This is not the value actually received. The actual value the Named Executive Officers may receive will depend on whether the performance criteria are met and, if so, the fair market value of Holdings’ common stock at that time. The incremental fair value under ASC Topic 718 was determined by calculating the fair value of the restricted stock units on October 18, 2010, the closing date of the Option Exchange, minus the fair value of the outstanding options on October 18, 2010. The fair value of each Named Executive Officer’s outstanding options on October 18, 2010, immediately preceding the Option Exchange was as follows: McCormack: $1,013,042; Madden: $473,475; Overbeeke: $268,158; Wilson: $552,568; and Schertel: $179,855. The fair value of the restricted stock units received in connection with the Option Exchange was calculated by multiplying the number of restricted stock units awarded by the fair market value of the restricted stock units on the date of the grant, immediately following the Option Exchange, assuming that the restricted stock units vest on satisfaction of the vesting condition described as the “Cypress Scenario” in Note 12. “Stock Incentive Plan - Restricted Stock Units” of our Consolidated Financial Statements contained in Item 8. “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K. Assuming the restricted stock units vest on satisfaction of the vesting condition described as the “IPO Scenario” in Note 12 to our Consolidated Financial Statements, the fair market value of the restricted stock units would be increased and the incremental fair value amounts reported would change as follows: McCormack: $5,199,458; Madden: $1,390,275; Overbeeke: $5,944,342; Wilson: $3,174,932; and Schertel: $1,062,645.
(2) We report non-equity incentive plan compensation for the year in which such compensation is determined against annual performance metrics, regardless of whether it is paid in that year, or the following year, or is deferred under our non-qualified deferred compensation plan.
(3) The components of this column for 2011 are detailed in the “Incremental Cost of Perquisites and Other Compensation Table” below.
(4) Amounts reported in the salary column reflect Mr. Schertel’s base salary ($313,956 for fiscal 2011) and an additional payment in respect of vacation ($35,654 for fiscal 2011) as required under Brazilian law. Amounts for Mr. Schertel reported in the salary column for 2009 have been converted from Brazilian Reals to U.S. Dollars at an exchange rate of .5716 U.S. Dollars for each Brazilian Real, which was the exchange rate in effect on December 31, 2009, for 2010 at a rate of .6020 U.S. Dollars for each Brazilian Real, which was the exchange rate in effect on December 31, 2010 and for 2011 at a rate of .53568 U.S. Dollars for each Brazilian Real, which was the exchange rate in effect on December 31, 2011.
Incremental Cost of Perquisites and Other Compensation in 2011 Table
(1) We contribute 3% of a U.S. employee’s earnings to the employee’s 401(k) account, subject to Internal Revenue Service limitations.
(2) The amounts in this column constitute the tax gross-up expense incurred in respect of tax preparation costs shown in the table and, for Mr. Wilson, the tax gross-up expense ($687) incurred in respect of our reimbursement of certain spousal travel expenses and, for Mr. Overbeeke, the tax gross-up expense ($6,380) incurred in respect of health insurance costs and the tax gross-up expense ($20,546) incurred in respect of our reimbursement of certain travel and living expenses shown in the “Other” column of the table and, for Mr. McCormack, the tax gross-up expense ($257) incurred in respect of our reimbursement of certain spousal travel expenses and of certain financial planning services ($2,205).
(3) Represents the amount of the matching contribution made by us in accordance with our non-qualified deferred compensation plan. Matching contributions are reported for the year in which the non-equity incentive compensation, against which the applicable deferral election is applied, has been earned (regardless of whether such matching contribution is actually credited to the Named Executive Officer’s non-qualified deferred compensation account in that year or the following year).
(4) The amount in this column for Mr. McCormack reflects certain expenses incurred for financial planning services ($6,301) and certain spousal travel expenses ($834) reimbursed by us. The amount in this column for Mr. Overbeeke reflects expenses incurred to continue the health insurance coverage Mr. Overbeeke maintained prior to becoming our employee ($14,226) and our reimbursement of Mr. Overbeeke’s expenses incurred in commuting from his primary residence in Connecticut to our McHenry, IL offices and his living expenses while in McHenry, IL ($45,943). The amount in this column for Mr. Wilson reflects certain spousal travel expenses ($2,116) reimbursed by us. The amount in this column for Mr. Schertel is composed of a Brazilian government mandated severance fund payment in Mr. Schertel’s name ($29,972), a company contribution to a defined contribution plan on Mr. Schertel’s behalf ($38,699), a meal allowance at our cafeteria ($2,027), dues for a social club ($7,817) and operating costs for Mr. Schertel’s vehicle ($14,580).
Grants of Plan-Based Awards in 2011 Table
Narrative Disclosure to Summary Compensation Table and Grants of Plan-Based Awards in 2011 Table
Non-Equity Incentive Plan Awards
The Compensation Committee provides for non-equity incentive plan awards in the form of an annual cash incentive award plan. In fiscal 2011, 75% of the amounts payable under this plan were based on our full-year adjusted EBITDA performance (either company consolidated or for specified business units) and individual performance determined the remaining 25% of each Named Executive Officer’s target bonus opportunity. The target bonus opportunity is determined as a percentage of the Named Executive Officer’s base salary, which, in the case of our Named Executive Officers, is 100% for Messrs. McCormack, Overbeeke and Wilson, 80% for Mr. Madden, and 50% for Mr. Schertel.
In fiscal 2011, for Messrs. McCormack and Madden, our company consolidated adjusted EBITDA performance determined 75% of their target bonus opportunity, with individual performance determining the remaining 25%. In fiscal 2011, for Messrs. Wilson and Schertel, the adjusted EBITDA performance of each of their respective business units determined 75% of their target bonus opportunity, with individual performance determining the remaining 25%. In fiscal 2011, for Mr. Overbeeke, a combination of the adjusted EBITDA performance of the Brake products business (60%) and the adjusted EBITDA performance of the Chassis products business (15%) determined 75% of his target bonus opportunity, with individual performance determining the remaining 25%.
Under the non-equity incentive plan, there are threshold, target and maximum performance levels that have been established for each of the relevant adjusted EBITDA performance goal components. If the threshold performance level for any adjusted EBITDA performance goal component is not achieved, no bonus is earned with respect to that component. At the threshold adjusted EBITDA performance levels, the Named Executive Officers are entitled to payouts equal to 50% of the weighting assigned to such component. At the target adjusted EBITDA performance levels, the Named Executive Officers are entitled to payouts equal to 100% of the weighting assigned to their respective adjusted EBITDA performance component(s). Performance above the performance goal component target levels entitles the Named Executive Officers to non-equity incentive awards in excess of their target bonus opportunity, up to a maximum of 175% of the weighting assigned to their respective adjusted EBITDA performance component(s). For actual adjusted EBITDA performance results that fall between the specified performance levels, the payout percentages for the respective components are adjusted on a linear basis.
For fiscal 2011, the threshold, target and maximum company consolidated adjusted EBITDA performance levels were $216.0 million, $224.5 million and $254.2 million, respectively. With respect to fiscal 2011, business unit and company consolidated adjusted EBITDA target performance levels were set at challenging levels, which required significant improvement over fiscal 2010 business unit performance. Threshold business unit adjusted EBITDA performance levels ranged from 88% to 97.8% of target and maximum business unit adjusted EBITDA performance levels ranged from 111.1% to 119.8% of target.
With respect to the individual performance component that determines 25% of each Named Executive Officer’s target bonus opportunity, the payout percentage can range from 0% to a maximum of 175% of the individual performance component target bonus opportunity. For actual individual performance ratings that fall between the specified performance levels, the payout percentage for the individual performance component is adjusted on a linear basis. For fiscal 2011, since none of the threshold adjusted EBITDA performance targets were achieved, the Compensation Committee determined that no cash performance bonuses would be paid, regardless of individual performance.
The following table illustrates the operation of the cash incentive award program for fiscal 2011:
Equity Incentive Plan Awards
The Compensation Committee grants equity incentive awards periodically, as and when appropriate in the Compensation Committee’s judgment. On July 20, 2005, we adopted the 2005 Stock Plan, which was subsequently amended on November 14, 2006, January 1, 2007, August 25, 2010 and December 2, 2010. The 2005 Stock Plan, as amended, permits the grant of non-qualified stock options, incentive stock options, stock appreciation rights, restricted stock and other stock-based awards to our employees, directors or consultants. The Compensation Committee has granted stock options, restricted stock units and a stock award pursuant to the 2005 Stock Plan and has not granted any other stock-based awards.
Administration. The 2005 Stock Plan is administered by the Compensation Committee; provided, that our Board may take any action designated to the Compensation Committee. The Compensation Committee has full power and authority to make, and to establish the terms and conditions of, any award and to waive any such terms and conditions at any time (including, without limitation, accelerating or waiving any vesting conditions or payment dates). The Compensation Committee is authorized to interpret the plan, to establish, amend and rescind any rules and regulations relating to the plan and to make any other determinations that it, in good faith, deems necessary or desirable for the administration of the plan and may delegate such authority as it deems appropriate.
Options. The Compensation Committee determines the exercise price for each option; provided, however, that incentive stock options must have an exercise price that is at least equal to the fair market value of our common stock on the date the option is granted. An option holder may exercise an option by written notice and payment of the exercise price (1) in cash or its equivalent, (2) by the surrender of a number of shares of common stock already owned by the option holder for at least six months (or such other period established by the Compensation Committee) with a fair market value equal to the exercise price, (3) if there is a public market for the shares, subject to rules established by the Compensation Committee, through the delivery of irrevocable instructions to a broker to sell shares obtained upon the exercise of the option and to deliver to Holdings an amount out of the proceeds of the sale equal to the aggregate exercise price for the shares being purchased or (4) by another method approved by the Compensation Committee.
Stock Appreciation Rights. The Compensation Committee may grant stock appreciation rights independent of or in connection with an option. The exercise price per share of a stock appreciation right shall be an amount determined by the Compensation Committee provided that the exercise price is at least equal to the fair market value of our common stock on the date the stock appreciation right is granted. Generally, each stock appreciation right shall entitle a participant upon exercise to an amount equal to (1) the excess of (a) the fair market value on the exercise date of one share of common stock over (b) the exercise price, multiplied by (2) the number of shares of common stock covered by the stock appreciation right. Payment shall be made in common stock or in cash, or partly in common stock and partly in cash, all as shall be determined by the Compensation Committee.
Other Stock-Based Awards. The Compensation Committee may grant awards of restricted stock units, rights to purchase stock, restricted stock and other awards that are valued in whole or in part by reference to, or are otherwise based on the fair market value of, shares of common stock. The other stock-based awards will be subject to the terms and conditions established by the Compensation Committee.
Transferability. Unless otherwise determined by the Compensation Committee, awards granted under the 2005 Stock Plan are not transferable other than by will or by the laws of descent and distribution.
Change of Control. In the event of a “change of control” (as defined in the 2005 Stock Plan), the Compensation Committee may provide for (1) the termination of an award upon the consummation of the change of control, but only if the award has vested and been paid out or the participant has been permitted to exercise an option in full for a period of not less than 30 days prior to the change of control, (2) the acceleration of all or any portion of an award, (3) payment in exchange for the cancellation of an award and/or (4) the issuance of substitute awards that would substantially preserve the terms of any awards.
Amendment and Termination. Our Board may amend, alter or discontinue the 2005 Stock Plan in any respect at any time, but no amendment may diminish any of the rights of a participant under any awards previously granted, without his or her consent.
Management or Director Stockholders Agreement. All shares issued under the 2005 Stock Plan will be subject to the management stockholders’ agreement or directors stockholders’ agreement, as applicable. The stockholders’ agreements impose restrictions on transfers of the shares by the individuals and also provide for various put and call rights with respect to the shares which put and call rights expired November 30, 2011. The individuals have also agreed to a 180-day lock up period (during which the sale of shares not covered by a registration statement is prohibited) in the case of an initial public offering of the shares and have been granted limited “piggyback” registration rights with respect to the shares. Certain individuals also entered into confidentiality and non-competition agreements in connection with the shares they purchased. The forms of the various agreements are referenced under “Item 15. Exhibits and Financial Statement Schedules.” The forms of the agreements for directors are substantially similar to the forms for management.
Restrictive Covenant Agreement. Unless otherwise determined by our Board, all award recipients are obligated to sign our standard confidentiality, non-competition and proprietary information agreement, which includes restrictive covenants regarding confidentiality, proprietary information and a one-year period restricting competition and solicitation of our clients, customers or employees. If a participant breaches these restrictive covenants, the Compensation Committee has discretion to rescind any exercise of, or payment or delivery pursuant to, an award under the 2005 Stock Plan, in which case the participant may be required to pay to Holdings the amount of any gain realized in connection with, or as a result of, the rescinded exercise, payment or delivery.
Outstanding Equity Awards at 2011 Fiscal Year-End
(1) As of December 31, 2011, all outstanding equity awards granted to our Named Executive Officers were in the form of performance-based restricted stock units granted pursuant to our 2005 Stock Plan in connection with the Option Exchange. The restricted stock units are subject to the vesting criteria described above under “Compensation Discussion and Analysis-Option Exchange Program.”
(2) Because Holdings’ common stock is not publicly traded, the market value of the outstanding restricted stock units is based on the value of Holdings’ common stock as of December 31, 2011 of $131.33.
Option Exercises and Stock Vested in 2011
None of our Named Executive Officers exercised any stock options in 2011, nor have any of them received any restricted stock, or other awards of shares of stock which have vested.
Pension Benefits for 2011
We do not sponsor a defined benefit plan for our U.S. employees. However, we do offer a defined contribution (401(k)) plan for our U.S. employees pursuant to which we contribute 3% of an employee’s earnings (which contributions were postponed for 2009 until October 1, 2009), all subject to applicable Internal Revenue Service limitations. We also maintain a defined contribution plan for certain of our employees in Brazil, including Mr. Schertel, pursuant to which we contribute 12.5% of Mr. Schertel’s base salary each year.
Although we maintain defined benefit plans for our employees in Canada, none of our Named Executive Officers participate in or are entitled to receive benefits pursuant to any defined benefit plan sponsored by us.
Non-Qualified Deferred Compensation for 2010
On March 6, 2008, we adopted a non-qualified deferred compensation program pursuant to which certain of our senior employees, including our Named Executive Officers, are permitted to elect to defer all or a portion of their annual cash-based incentive awards which are then credited to the participant’s deferral account. The Company makes matching contributions of 25% of the amount of an employee’s deferral which vest on December 31 of the second calendar year following the calendar year in which such matching contributions were credited to an employee’s account. Employee deferrals and Company matching contributions are notionally invested under this plan in Holdings’ common stock, and once vesting of the Company matching contributions has occurred, distributions will be paid in the form of such shares of common stock (or cash, in certain circumstances) on the payment date elected by the participant or the participant’s separation from service (or the date that is six months following the date of such separation from service in the case of a “specified employee” within the meaning of Section 409A of the Internal Revenue Code), if earlier. Upon the retirement, death or disability of a participant or in the event a “change in control” (as defined in the non-qualified deferred compensation plan) or an initial public offering occurs prior to a participant’s separation from service, the participant will be fully vested in his or her entire account, including any unvested Company matching contributions. In addition, in the event of a change in control, a participant’s entire account balance, including any unvested matching contributions that vest as a result of the change in control, will be distributed in a lump sum cash payment no later than thirty days following the date of the change in control.
Non-qualified Deferred Compensation
(1) Because no cash performance bonuses were awarded in fiscal 2011, there are no executive contributions and registrant contributions reported in the non-qualified deferred compensation table for fiscal 2011.
(2) Aggregate earnings reflects the earnings on executive and registrant contributions based on the increase in value of Holdings’ common stock during 2011. The amounts reported are not considered compensation reportable in the Summary Compensation Table.
(3) Aggregate balance includes contributions made by the Named Executive Officer in prior fiscal years and the matching contribution made by the Company in prior fiscal years which were reported in the Summary Compensation Table for previous years as follows: McCormack: $490,487 and $122,622, respectively; Madden: $268,045 and $67,011 respectively; Overbeeke: $104,484 and $26,121, respectively; Wilson: $436,737 and $109,184, respectively; and Schertel: $279,340 and $69,835, respectively.
Potential Payments Upon Termination or Change in Control
Termination Provisions of Employment Agreements
Each of our Named Executive Officers (other than Mr. Overbeeke and Mr. Schertel) has entered into an employment agreement with us. Under the employment agreements and Mr. Overbeeke’s letter agreement, each Named Executive Officer (other than Mr. Schertel) is entitled to the following payments and benefits in the event of a termination by us “without cause” (as defined in the employment agreements) or in the case of Messrs. McCormack, Wilson and Madden, by the executive for “good reason” (as defined in the employment agreements) during the employment term: (1) subject to the executive’s compliance with the restrictive covenants described below, an amount equal to the “severance multiple” (2.0 for each of Messrs. McCormack, Overbeeke and Wilson; 1.5 for Mr. Madden) times the sum of base salary and the “average annual bonus” paid under the agreement for the preceding two years (the “Multiplier”), payable as follows: an amount equal to 1 times the Multiplier to be paid in equal monthly installments for 12 months following termination of employment and the balance to be paid in a lump sum on the first anniversary of the termination of the executive’s employment; (2) a pro-rata annual bonus for the year of termination; and (3) continued medical and dental coverage at our cost, on the same basis made available for active employees for a period of years corresponding with the severance multiple; provided that, if such coverage is not available for any portion of such period under our medical plans, we must arrange for alternate comparable coverage. In addition, if the executive (other than Mr. Overbeeke and Mr. Schertel) is terminated by us without cause or the executive resigns for good reason within two years following a change in control, the executive shall be entitled to a supplemental payment equal to the excess, if any, of (X) the product of the severance multiple times the executive’s target annual bonus, over (Y) the product of the severance multiple times the average annual bonus described above.
In addition, under the terms of the employment agreements, in the event the employment term ends due to election by either party not to extend the employment term, then the executive shall be entitled, subject to the executive’s compliance with the restrictive covenants described below, to (x) if we elect not to extend the employment term or, in the case of Messrs. McCormack and Wilson, if the executive elects not to extend the employment term, an amount equal to the “severance multiple” times the base salary, payable as follows: an amount equal to one times the base salary to be paid in 12 equal monthly installments following termination of employment and the balance to be paid in a lump sum on the first anniversary of the termination of the executive’s employment and (y) if, in the case of Mr. Madden, the executive elects not to extend the employment term, an amount equal to one times the base salary paid in equal monthly installments over 12 months.
Each executive (including Mr. Overbeeke and Mr. Schertel) is restricted (either pursuant to their employment agreement or a separate agreement), for a period following termination of employment (24 months for Messrs. McCormack, Overbeeke and Wilson; 18 months for Mr. Madden (or 12 months for Mr. Madden if his employment agreement expires due to his election not to extend the term); 12 months for Mr. Schertel), from (1) soliciting in competition certain of our customers, (2) competing with us or entering the employment or providing services to entities who compete with us or (3) soliciting or hiring our employees. The specific agreement containing these restrictions also provides that the Company may cease further payments and pursue its other rights and remedies in the event of a breach by the executive. Mr. Schertel’s contract containing the foregoing restrictions includes our agreement to pay him an amount equal to his annual base salary to be paid in 12 equal monthly installments if we terminate his employment without cause.
Total Potential Payout Assuming Termination Event Occurred on December 31, 2011
(1) The ability of an executive to terminate for good reason applies only to Messrs. McCormack, Madden and Wilson.
(2) Amounts payable under our non-equity incentive plan (annual cash incentive plan) are earned on the last day of the applicable calendar year.
(3) Upon retirement, death or disability, the Named Executive Officer (or his estate) is entitled to receive any earned but unpaid cash incentive award plus a pro-rata portion of any annual cash incentive award that the Named Executive Officer would have earned had his employment not terminated. In addition, on death, each of our Named Executive Officer’s designated beneficiaries would be entitled to receive life insurance proceeds equal to 1.5 times the Named Executive Officer’s base salary (with the exception of Mr. Schertel whose life insurance policy has a face amount of $363,365.
(4) In accordance with the terms of our deferred compensation plan, any unvested matching contributions made by us will vest immediately upon the retirement, death or disability of the participant or upon any change-in-control or initial public offering of Holdings common stock that occurs prior to a participant’s separation from service. If any of the foregoing events had occurred on December 31, 2011, then our prior unvested matching contributions in the following amounts would have vested on such date: Mr. McCormack: $143,507; Mr. Madden: $54,566; Mr. Overbeeke: $30,297; Mr. Wilson: $130,681; and Mr. Schertel: $51,416. In addition, in the event of a change in control, a participant’s entire account balance, including any unvested matching contributions that vest as a result of the change in control, will be distributed in a lump sum cash payment no later than thirty days following the date of the change in control (see the amounts in the “Aggregate Balance at Last Fiscal Year End” column in the non-qualified deferred compensation table above).
Director Compensation for 2011
The annual retainer for non-management directors is $75,000. Prior to 2011, non-management directors received an annual retainer of $50,000 plus $1,500 for each board or committee meeting attended. The Chairman of the Board is paid an additional $15,000 annually. Mr. Riess, as Lead Director, is paid an additional $25,000 annually. The chair of our Audit Committee is paid an additional $50,000 annually in recognition of the Audit Committee chair’s expanded responsibilities. The Chair of our Compensation Committee and the Chair of our Nominating Committee each are paid an additional $10,000 annually.
The following table summarizes compensation for our non-employee directors for 2011.
(1) Amounts reported for Mr. Lasky and Mr. McElya for 2011 reflect the grant date fair value of the restricted stock units granted on April 1, 2011 in accordance with FASB ASC Topic 718, “Compensation - Stock Compensation” (“ASC Topic 718”). These are not the values actually received. The actual value Directors may receive will depend on whether the performance criteria are met and, if so, the fair market value of Holdings’ common stock at that time. The fair value of the restricted stock units granted to Mr. Lasky and Mr. McElya was calculated by multiplying the number of restricted stock units awarded by the fair market value of the restricted stock units on the date of the grant, assuming that the restricted stock units vest upon satisfaction of the vesting condition described as the “Cypress Scenario” in Note 12. “Stock Incentive Plan - Restricted Stock Units” of our Consolidated Financial Statements contained in Item 8. “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K. Assuming the restricted stock units vest upon satisfaction of the vesting condition described as the “IPO Scenario” in Note 12 to our Consolidated Financial Statements, the fair market value of the restricted stock units would be increased and the grant date fair value reported would change as follows: Lasky: $194,580; McElya: $194,580. As of December 31, 2011, Messrs Lasky, McElya, Morrison, Onorato, Parzick, Riess, and Stern each held 1,500, 1,500, 3,000, 3,000, 3,000, 3,000, 3,000 unvested restricted stock units, respectively. The restricted stock units are subject to the same vesting critereia as all other Restricted Stock Units granted in connection with the option exchange. See “Compensation Discussion and Analysis - Option Exchange Program.”
(2) Mr. Morrison’s fees were paid directly to his employer in accordance with his employer’s policies regarding employee participation on boards of directors of the employer’s investment portfolio companies.
Compensation Committee Interlocks and Insider Participation
No member of the Compensation Committee was at any time during 2011, or at any other time, one of our officers or employees or had any relationship requiring disclosure by us under any paragraph of Item 404 of Regulation S-K. None of our executive officers served on the compensation committee or Board of Directors of another entity whose executive officer(s) served on our Compensation Committee or Board of Directors.
Compensation Committee Report
The Compensation Committee has reviewed and discussed the foregoing Compensation Discussion and Analysis with management and, based on that review and discussion, the Compensation Committee recommended to the Board of Directors that the Compensation Discussion and Analysis be included in our annual report on Form 10-K.
The Compensation Committee
James A. Stern, Chairman
James S. McElya
Joseph A. Onorato
John M. Riess
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
(a) Equity Compensation Plan Information
The following table sets forth information about our common stock that may be issued under all of our existing equity compensation plans as of December 31, 2011, including the 2005 Stock Plan (a description of which may be found above under the heading “Equity Incentive Plan Awards”).
(1) Consists of 28,680 shares of Holding’s common stock issuable upon the exercise of outstanding options and 242,000 shares of Holdings’ common stock issuable upon the vesting of restricted stock units awarded under the 2005 Stock Plan. Also includes 30,819 shares of Holdings’ common stock that may be issued under the Affinia Group Senior Executive Deferred Compensation and Stock Award Plan and 163 shares that were issued as a stock award.
(2) Weighted-average exercise price does not include restricted stock units or shares that may be issued under the Affinia Group Senior Executive Deferred Compensation and Stock Award Plan, which by their nature do not have an exercise price.
(3) Consists of shares of Holdings’ common stock issuable under the 2005 Stock Plan pursuant to various awards the compensation committee of the Board of Directors may make, including non-qualified stock options, incentive stock options, restricted and unrestricted stock, restricted stock units and other equity-based awards. See “Item 11. Executive Compensation” for a description of the 2005 Stock Plan.
(b) Security Ownership of Certain Beneficial Owners and Management
Affinia Group Holdings Inc. owns 100% of the issued and outstanding common stock of Affinia Group Intermediate Holdings Inc. Affinia Group Intermediate Holdings Inc. owns 100% of the issued and outstanding common stock of Affinia Group Inc.
The following table and accompanying footnotes show information regarding the beneficial ownership of the common stock of Affinia Group Holdings Inc. as of March 16, 2012 by (1) each person known by us, based on information available to us, to beneficially own more than 5% of the issued and outstanding common stock of Affinia Group Holdings Inc., (2) each of our directors and nominees, (3) each named executive officer and (4) all directors and executive officers as a group.
The amounts and percentages of common stock beneficially owned are reported on the basis of regulations of the SEC governing the determination of beneficial ownership of securities. Under the SEC rules, a person is deemed to be a beneficial owner of a security if that person has or shares voting power, which includes the power to vote or to direct the voting of such security, or investment power, which includes the power to dispose of or to direct the disposition of such security. Unless otherwise indicated below, each beneficial owner named in the table below has sole voting and sole investment power with respect to all shares beneficially owned, subject to community property laws where applicable.
Except as otherwise indicated in the footnotes below, each of the beneficial owners has, to our knowledge, sole voting and investment power with respect to the indicated shares of common stock. Unless otherwise noted, the address of each beneficial owner is 1101 Technology Drive, Ann Arbor, Michigan 48108.
* The executive officers or members of the Board of Directors of Affinia Group Inc. currently hold 0.1697% of shares of the outstanding common stock of Affinia Group Holdings Inc. The amount of ownership for each Named Executive Officer or member of the Board is shown above and each of the executive officers or members of the Board own less than 1.0% of outstanding shares.
(1) Applicable percentage of ownership is based on 3,563,056 shares of common stock outstanding as of March 16, 2012 plus, as to any person, shares are deemed to be beneficially owned by such person if the person has the right to acquire the shares (for example, upon exercise of an option) within 60 days of the date as of which the information is provided. In computing the percentage ownership of any person, the amount of shares outstanding is deemed to include the amount of shares beneficially owned by such person (and only such person) by reason of these acquisition rights.
(2) Includes 2,063,038 shares of common stock owned by Cypress Merchant Banking Partners II L.P., 87,703 shares of common stock owned by Cypress Merchant Banking II C.V., 19,909 shares of common stock owned by 55th Street Partners II L.P. (collectively, the “Cypress Funds”) and 4,350 shares of common stock owned by Cypress Side-by-Side LLC. Cypress Associates II L.L.C. is the managing general partner of Cypress Merchant Banking II C.V. and the general partner of Cypress Merchant Banking Partners II L.P. and 55th Street Partners II L.P., and has voting and investment power over the shares held or controlled by each of these funds. Certain executives of The Cypress Group L.L.C., including Messrs. Jeffrey Hughes and James Stern, may be deemed to share beneficial ownership of the shares shown as beneficially owned by the Cypress Funds. Each of such individuals disclaims beneficial ownership of such shares. Cypress Side-By-Side L.L.C. is a sole member-L.L.C. of which Mr. James Stern is the sole member.
The following table and accompanying footnotes show information regarding the beneficial ownership of the preferred stock of Affinia Group Holdings Inc. as of March 16, 2012 by (1) each person known by us to beneficially own more than 5% of the issued and outstanding preferred stock of Affinia Group Holdings Inc., (2) each of our directors and nominees, (3) each named executive officer and (4) all directors and executive officers as a group. The preferred stock was issued at $1,000 per share and, among other things, is convertible to common stock at a conversion price of $100 per share and earns a dividend of 9.5% per annum. A complete description of the rights of preferred stockholders may be found in the certificate of designations on file with the Delaware Secretary of State.
(1) Applicable percentage of ownership is based on 70,121 shares of preferred stock outstanding as of March 16, 2012.
Item 13.
Item 13. Certain Relationships and Related Person Transactions and Director Independence
Director Independence
The members of our Board of Directors are James A. Stern, William M. Lasky, Terry R. McCormack, James S. McElya, Donald J. Morrison, Joseph A. Onorato, Joseph E. Parzick and John M. Riess. Though not formally considered by our Board of Directors, given that our securities are not registered or traded on any national securities exchange, based upon the listing standards of the New York Stock Exchange, we do not believe that Mr. Stern, Mr. McCormack or Mr. Parzick would be considered independent either because they serve as members of our management team or because of their relationships with various Cypress funds or certain affiliates of Affinia Group Holdings Inc. or other entities that hold significant interests in Affinia Group Holdings Inc. We do believe that Mr. Lasky, Mr. McElya, Mr. Morrison, Mr. Onorato and Mr. Riess would qualify as “independent” based on the New York Stock Exchange’s director independence standards for listed companies.
Investor Stockholders Agreement
Pursuant to the Stockholders Agreement dated as of November 30, 2004, among Affinia Group Holdings Inc., various Cypress funds, OMERS, The Northwestern Mutual Life Insurance Company, California State Teachers’ Retirement System and Stockwell Fund, L.P., the number of directors serving on the Board of Directors will be no less than seven and no more than eleven. The Stockholders Agreement entitles Cypress to designate three directors. Cypress has currently appointed Mr. Stern, Mr. Parzick and Mr. McElya. As long as OMERS members own at least 50 percent in the aggregate of the number of shares owned by them on November 30, 2004, OMERS is entitled to designate one director, who currently is Mr. Morrison. Cypress is entitled to designate three directors who are not affiliated with any of the parties to the Stockholders Agreement, who currently are Mr. Lasky, Mr. Onorato and Mr. Riess. Additionally, the Stockholders Agreement entitles the individual serving as CEO, currently Mr. McCormack, and another individual serving as one of our senior officers, currently vacant, to seats on the Board of Directors. The Stockholders Agreement also provides that the nominating committee of the Board of Directors may from time to time select two additional individuals who must be independent to serve as Directors.
Other Related Person Transactions
We describe below the transactions that have occurred since the beginning of fiscal 2011, and any currently proposed transactions, that involve the Company or a subsidiary and exceed $120,000, and in which a related party had or has a direct or indirect material interest.
Mr. John M. Riess, a Board member, is the parent of J. Michael Riess, who is currently employed with Genuine Parts Company (NAPA) as president of a distribution facility. NAPA is the Company’s largest customer as a percentage of total net sales from continuing operations. NAPA accounted for $523 million, $535 million and $531 million of our total net sales, which represented 29%, 27% and 25% of our total net sales for the years ended December 31, 2009, 2010 and 2011, respectively.
Effective January 1, 2011, we, along with Affinia Group Holdings Inc. and Affinia Group Inc., entered into an Advisory Agreement with Torque Capital Group LLC for services related to corporate strategy, finance, investments and such other services as we may request from time to time. Mr. Joseph E. Parzick, one of our directors, is a managing partner of Torque Capital Group LLC. In connection with the Advisory Agreement, we, along with Affinia Group Holdings Inc. and Affinia Group Inc., have agreed to pay a quarterly fee of $400,000 for six calendar quarters expiring June 30, 2012, and have further agreed to pay a success fee of up to $3.0 million in the event Affinia Group Holdings Inc.’s shareholders realize a specified return on their investment.
Effective January 1, 2011, we, along with Affinia Group Holdings Inc. and Affinia Group Inc., entered into an Advisory Agreement with Cypress Advisors, Inc. for services related to corporate strategy, finance, investments and such other services as we may request from time to time. Mr. James A. Stern, one of our directors, is a managing director of Cypress Advisors, Inc. In connection with the Advisory Agreement, we, along with Affinia Group Holdings Inc. and Affinia Group Inc., have agreed to pay a quarterly fee of $100,000 for six calendar quarters expiring June 30, 2012, and have further agreed to pay a success fee of up to $2.0 million in the event Affinia Group Holdings Inc.’s shareholders realize a specified return on their investment.
Related Person Transactions Policy
Our Board has adopted a written statement of policy for the evaluation of and the approval, disapproval and monitoring of transactions involving us and “related persons.” For the purposes of the policy, “related persons” include our executive officers, directors and director nominees or their immediate family members, or stockholders owning five percent or more of our outstanding common stock.
Our related person transactions policy requires:
•
that any transaction in which a related person has a material direct or indirect interest and which exceeds $120,000, such transaction referred to as a “related person transaction,” and any material amendment or modification to a related person transaction, be evaluated and approved or ratified by our Audit Committee or by the disinterested members of the Audit Committee; and
•
that any employment relationship or transaction involving an executive officer and any related compensation solely resulting from that employment relationship or transaction must be approved by the Compensation Committee of the Board or recommended by the Compensation Committee to the Board for its approval.
In connection with the review and approval or ratification of a related person transaction:
•
management must disclose to the Audit Committee or the disinterested members of the Audit Committee, as applicable, the material terms of the related person transaction, including the approximate dollar value of the amount involved in the transaction, and all the material facts as to the related person’s direct or indirect interest in, or relationship to, the related person transaction;
•
management must advise the Audit Committee or the disinterested members of the Audit Committee, as applicable, as to whether the related person transaction complies with the terms of our agreements governing our material outstanding indebtedness;
•
management must advise the Audit Committee or the disinterested members of the Audit Committee, as applicable, as to whether the related person transaction will be required to be disclosed in our SEC filings. To the extent it is required to be disclosed, management must ensure that the related person transaction is disclosed in accordance with SEC rules; and
•
management must advise the Audit Committee or the disinterested members of the Audit Committee, as applicable, as to whether the related person transaction constitutes a “personal loan” for purposes of Section 402 of Sarbanes-Oxley.
In addition, the related person transaction policy provides that the Audit Committee, in connection with any approval or ratification of a related person transaction involving a non-employee director or director nominee, should consider whether such transaction would compromise the director or director nominee’s status as an “independent,” “outside,” or “non-employee” director, as applicable, under the rules and regulations of the SEC, The New York Stock Exchange and the Code. Subsequent to the adoption of the written procedures above, the Company has followed these procedures regarding all reportable related person transactions.
Item 14.
Item 14. Independent Registered Public Accounting Firm Fees
For services rendered in 2010 and 2011 by Deloitte and Touche LLP, our independent public accounting firm, we incurred the following fees:
(1) Represents fees incurred for the annuals audits of the consolidated financial statements, quarterly reviews of interim financial statements, statutory audits of foreign subsidiaries and SEC registration statements.
(2) Represents fees incurred for U.S. and foreign income tax compliance, acquisition related tax services and state tax planning services.
(3) Represents fees primarily incurred for services related to acquisitions and other professional services.
The Audit Committee, as required by its Charter, approves in advance any audit or permitted non-audit engagement or relationship between the Company and the Company’s independent auditors. The Audit Committee has adopted an Audit and Non-Audit Services Pre-Approval Policy which provides that the Company’s independent auditors are only permitted to provide services to the Company that have been specifically approved by the Audit Committee or entered into pursuant to the pre-approval provisions of the Policy. All tax services to be performed by the independent auditors that fall within certain categories and certain designated dollar thresholds have been pre-approved under the Policy. All tax services that exceed the dollar thresholds and any other services must be approved in advance by the Audit Committee. The Audit Committee also has delegated approval authority, subject to certain dollar limitations, to the Chairman of the Audit Committee, who is an independent director. Pursuant to this delegation, the Chairman is required to present at each scheduled meeting, and as of the date of this report has presented, all approval decisions to the full Audit Committee.
PART IV.
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) The following documents are filed as part of this report:
1. Financial Statements:
See Item 8 above.
2. Financial Statement Schedules:
Schedule II-Valuation and Qualifying Accounts
The allowance for doubtful accounts is summarized below for the period ending December 31, 2009, December 31, 2010, and December 31, 2011:
(1) The allowance for doubtful accounts excludes the $1 million reserve that is classified in the current assets of discontinued operations.
All other financial statement schedules are not required under the relevant instructions or are inapplicable and therefore have been omitted.
3. Exhibits
The agreements and other documents filed as exhibits to this report are not intended to provide factual information or other disclosure other than with respect to the terms of the agreements or other documents themselves and you should not rely on them for that purpose. In particular, any representations and warranties made by us in these agreements or other documents were made solely within the specific context of the relevant agreement or document and may not describe the actual state of affairs as of the date they were made or at any other time.
* filed herewith
# 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.
AFFINIA GROUP INTERMEDIATE HOLDINGS INC.
By:
/S/ TERRY R. MCCORMACK
Terry R. McCormack
President, Chief Executive Officer, and Director (Principal
Executive Officer)
Date: March 16, 2012
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 16, 2012.
Signature
Title
By:
/s/ TERRY R. MCCORMACK
Terry R. McCormack
President, Chief Executive Officer, and Director
(Principal Executive Officer)
By:
/s/ THOMAS H. MADDEN
Thomas H. Madden
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)
By:
/s/ SCOT S. BOWIE
Scot S. Bowie
Chief Accounting Officer
(Principal Accounting Officer)
By:
/s/ JAMES A. STERN
James A. Stern
Chairman of the Board of Directors
By:
/s/ WILLIAM M. LASKY
William M. Lasky
Director
By:
/s/ JAMES S. MCELYA
James S. McElya
Director
By:
/s/ DONALD J. MORRISON
Donald J. Morrison
Director
By:
/s/ JOSEPH A. ONORATO
Joseph A. Onorato
Director
By:
/s/ JOSEPH E. PARZICK
Joseph E. Parzick
Director
By:
/s/ JOHN M. RIESS
John M. Riess
Director