| TENNECO INC ITEM 1A RISK FACTORS CHANGES IN CONSUMER DEMAND AND PRICES COULD MATERIALLY AND ADVERSELY IMPACT OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS Demand for and pricing of our products are subject to economic conditions and other factors present in the various domestic and international markets where the products are sold |
| Demand for our OE products is subject to the level of consumer demand for new vehicles that are equipped with our parts |
| The level of new car purchases is cyclical, affected by such factors as interest rates, consumer confidence, patterns of consumer spending, fuel cost and the automobile replacement cycle |
| For example, we believe a key strength for our company is our supply of parts for many North American light trucks and SUVs, which are currently top sellers, but which consumers may not continue to prefer |
| Demand for our aftermarket, or replacement, products varies based upon such factors as the level of new vehicle purchases, which initially displaces demand for aftermarket products, the severity of winter weather, which increases the demand for certain aftermarket products, and other factors, including the average useful life of parts and number of miles driven |
| Further decreases in demand for automobiles and automotive products generally, or in the demand for our products in particular, could materially and adversely impact our financial condition and results of operations |
| WE MAY BE UNABLE TO REALIZE SALES REPRESENTED BY OUR AWARDED BUSINESS, WHICH COULD MATERIALLY AND ADVERSELY IMPACT OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS The realization of future sales from awarded business is inherently subject to a number of important risks and uncertainties, including the number of vehicles that our OE customers will actually produce, the timing of that production and the mix of options that our OE customers and consumers may choose |
| 21 Substantially all of our North American vehicle manufacturer customers have slowed or maintained at flat levels new vehicle production during the past several years |
| For example, production rates for 2003 were down three percent from 2002 and production rates for 2004 were down one percent from 2003 |
| Production rates for 2005 were the same as for 2004 |
| We remain cautious regarding production volumes for 2006 due to rising interest rates, oil and steel prices, current OE manufacturers &apos inventory levels and uncertainty regarding the willingness of OE manufacturers to continue to support vehicle sales through incentives |
| Given current economic conditions, we expect the North American light vehicle build to be approximately 15dtta8 million units in 2006, which is equal to 2005 levels |
| We also expect the European light vehicle production to remain relatively flat in 2006 |
| In addition, our customers generally have the right to replace us with another supplier at any time for a variety of reasons and have increasingly demanded price decreases over the life of awarded business |
| Accordingly, we cannot assure you that we will in fact realize any or all of the future sales represented by our awarded business |
| Any failure to realize these sales could have a material adverse effect on our financial condition and results of operations |
| In many cases, we must commit substantial resources in preparation for production under awarded OE business well in advance of the customerapstas production start date |
| In certain instances, the terms of our OE customer arrangements permit us to recover these pre-production costs if the customer cancels the business through no fault of our company |
| Although we have been successful in recovering these costs under appropriate circumstances in the past, we can give no assurance that our results of operations will not be materially impacted in the future if we are unable to recover these types of pre-production costs related to OE cancellation of awarded business |
| WE ARE DEPENDENT ON LARGE CUSTOMERS FOR FUTURE REVENUE THE LOSS OF ANY OF THESE CUSTOMERS OR THE LOSS OF MARKET SHARE BY THESE CUSTOMERS COULD HAVE A MATERIAL ADVERSE IMPACT ON US We depend on major vehicle manufacturers for a substantial portion of our net sales |
| For example, during 2005, General Motors, Ford, Volkswagen, and DaimlerChrysler accounted for 17 percent, 12 percent, 9 percent, and 9 percent of our net sales, respectively |
| The loss of all or a substantial portion of our sales to any of our large-volume customers could have a material adverse effect on our financial condition and results of operations by reducing cash flows and our ability to spread costs over a larger revenue base |
| We may make fewer sales to these customers for a variety of reasons, including: (1) loss of awarded business; (2) reduced or delayed customer requirements; or (3) strikes or other work stoppages affecting production by the customers |
| Ford recently announced a plan to significantly reduce the number of its global suppliers |
| While we currently believe that our relationship with Ford will not be impacted by this plan, any significant reduction in sales to Ford could have a material adverse effect on us |
| During the past several years, General Motors, Ford and Daimler Chrysler have lost market share in the United States, primarily to Asian competitors |
| While revenue from Japanese automakers represented approximately 20 percent of our North American original equipment sales in 2005 and we are actively targeting Korean automakers, any further market share loss by these North American- and European-based automakers could, if we are unable to achieve increased sales to the Asian OE manufacturers, have a material adverse effect on our business |
| FINANCIAL DIFFICULTIES FACING OTHER AUTOMOTIVE COMPANIES MAY HAVE AN ADVERSE IMPACT ON US A number of companies in the automotive industry are, and over the last several years have been, facing severe financial difficulties |
| As a result, there have been numerous recent bankruptcies of companies in the automotive industry, including the fall of 2005 bankruptcy of Delphi Corporation, one of the worldapstas largest automotive parts suppliers |
| In addition, Dana Corporation filed bankruptcy in March 2006 |
| Severe financial difficulties at any major automotive company could have a significantly disruptive effect on the automotive industry in general, including by leading to labor unrest, supply chain disruptions and weakness in demand |
| In particular, severe financial difficulties at any of our major suppliers could have a material adverse effect on us if we are unable to obtain on a timely basis the quantity and quality of components we require to produce our products |
| In addition, such financial difficulties at any of our major customers 22 could have a material adverse impact on us if such customer was unable to pay for the products we provide or we experienced a loss of, or material reduction in, business from such customer |
| THE HOURLY WORKFORCE IN THE AUTOMOTIVE INDUSTRY IS HIGHLY UNIONIZED AND OUR BUSINESS COULD BE ADVERSELY AFFECTED BY LABOR DISRUPTIONS Although we consider our current relations with our employees to be good, if major work disruptions were to occur, our business could be adversely affected by, for instance, a loss of revenues, increased costs or reduced profitability |
| We have not experienced a material labor disruption in our workforce in the last ten years, but there can be no assurance that we will not experience a material labor disruption at one of our facilities in the future in the course of renegotiation of our labor arrangements or otherwise |
| In addition, substantially all of the hourly employees of North American vehicle manufacturers and many of their other suppliers are represented by the United Automobile, Aerospace and Agricultural Implement Workers of America under collective bargaining agreements and vehicle manufacturers and such suppliers and their employees in other countries are also subject to labor agreements |
| A work stoppage or strike at the production facilities of a significant customer, at our facilities or at a significant supplier of ours or any of our customers could have an adverse impact on us by disrupting demand for our products and/or our ability to manufacture our products |
| WE HAVE EXPERIENCED SIGNIFICANT INCREASES IN RAW MATERIALS PRICING, AND FURTHER CHANGES IN THE PRICES OF RAW MATERIALS COULD HAVE A MATERIAL ADVERSE IMPACT ON US Significant increases in the cost of certain raw materials used in our products, to the extent they are not timely reflected in the price we charge our customers or otherwise mitigated, could materially and adversely impact our results |
| For example, since 2004, we have experienced significant increases in processed metal and steel prices |
| High steel prices are expected to continue into the foreseeable future |
| We worked hard in 2005 and continue to work hard to address this issue by evaluating alternative materials and processes, reviewing material substitution opportunities, increasing component and assembly outsourcing to low cost countries and aggressively negotiating with our customers to allow us to recover these higher costs from them |
| In addition to these actions, we continue to pursue productivity initiatives and review opportunities to reduce costs through restructuring activities |
| The situation remains fluid as we continue to pursue these actions and, at this point, we cannot assure you that these actions and recent increases in new business awards will be effective in containing margin pressures from these significant raw materials price increases |
| THE CYCLICALITY OF AUTOMOTIVE PRODUCTION AND SALES COULD CAUSE A DECLINE IN OUR FINANCIAL CONDITION AND RESULTS A decline in automotive sales and production would likely cause a decline in our sales to vehicle manufacturers, and could result in a decline in our results of operations and financial condition |
| The automotive industry has been characterized historically by periodic fluctuations in overall demand for vehicles due to, among other things, changes in general economic conditions and consumer preferences |
| These fluctuations generally result in corresponding fluctuations in demand for our products |
| Ford is forecast to produce 1dtta74 million vehicles in North America during the first six months of 2006, approximately 4dtta5 percent fewer than it produced in North America during the first six months of 2005 |
| The highly cyclical nature of the automotive industry presents a risk that is outside our control and that cannot be accurately predicted |
| WE MAY BE UNABLE TO REALIZE OUR BUSINESS STRATEGY OF IMPROVING OPERATING PERFORMANCE AND GENERATING SAVINGS AND IMPROVEMENTS TO HELP OFFSET PRICING PRESSURES FROM OUR SUPPLIERS AND CUSTOMERS We have either implemented or plan to implement strategic initiatives designed to improve our operating performance |
| The failure to achieve the goals of these strategic initiatives could have a material adverse effect on our business, particularly since we rely on these initiatives to offset pricing pressures from 23 our suppliers and our customers, as described above |
| We cannot assure you that we will be able to successfully implement or realize the expected benefits of any of these initiatives or that we will be able to sustain improvements made to date |
| WE MAY INCUR MATERIAL COSTS RELATED TO PRODUCT WARRANTIES, ENVIRONMENTAL AND REGULATORY MATTERS AND OTHER CLAIMS, WHICH COULD HAVE A MATERIAL ADVERSE IMPACT ON OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS From time to time, we receive product warranty claims from our customers, pursuant to which we may be required to bear costs of repair or replacement of certain of our products |
| Vehicle manufacturers are increasingly requiring their outside suppliers to guarantee or warrant their products and to be responsible for the operation of these component products in new vehicles sold to consumers |
| Warranty claims may range from individual customer claims to full recalls of all products in the field |
| We cannot assure you that costs associated with providing product warranties will not be material, or that those costs will not exceed any amounts reserved for them in our financial statements |
| For a description of our accounting policies regarding warranty reserves, see "e Managementapstas Discussion and Analysis of Financial Condition and Results of Operations -- Critical Accounting Policies "e included in Item 7 |
| Additionally, we are subject to a variety of environmental and pollution control laws and regulations in all jurisdictions in which we operate |
| Soil and groundwater remediation activities are being conducted at certain of our current and former real properties |
| We record liabilities for these activities when environmental assessments indicate that the remedial efforts are probable and the costs can be reasonably estimated |
| On this basis, we have established reserves that we believe are adequate for the remediation activities at our current and former real properties for which we could be held responsible |
| Although we believe our estimates of remediation costs are reasonable and are based on the latest available information, the cleanup costs are estimates and are subject to revision as more information becomes available about the extent of remediation required |
| In future periods, we could be subject to cash or non-cash charges to earnings if we are required to undertake material additional remediation efforts based on the results of our ongoing analyses of the environmental status of our properties, as more information becomes available to us |
| We also from time to time are involved in legal proceedings, claims or investigations that are incidental to the conduct of our business |
| Some of these proceedings allege damages against us relating to environmental liabilities, intellectual property matters, personal injury claims, taxes, employment matters or commercial or contractual disputes |
| For example, we are subject to a number of lawsuits initiated by a significant number of claimants alleging health problems as a result of exposure to asbestos |
| Many of these cases involve significant numbers of individual claimants |
| Many of these cases also involve numerous defendants, with the number of defendants in some cases exceeding 200 defendants from a variety of industries |
| As major asbestos manufacturers or other companies that used asbestos in their manufacturing processes continue to go out of business, we may experience an increased number of these claims |
| We vigorously defend ourselves in connection with all of the matters described above |
| We cannot, however, assure you that the costs, charges and liabilities associated with these matters will not be material, or that those costs, charges and liabilities will not exceed any amounts reserved for them in our financial statements |
| In future periods, we could be subject to cash costs or non-cash charges to earnings if any of these matters is resolved unfavorably to us |
| WE MAY BE UNABLE TO COMPETE FAVORABLY IN THE HIGHLY COMPETITIVE AUTOMOTIVE PARTS INDUSTRY The automotive parts industry is highly competitive |
| Although the overall number of competitors has decreased due to ongoing industry consolidation, we face significant competition within each of our major product areas |
| The principal competitive factors include price, quality, service, product performance, design and engineering capabilities, new product innovation, global presence and timely delivery |
| As a result, 24 many suppliers have established or are establishing themselves in emerging, low-cost markets to reduce their costs of production and be more conveniently located for customers |
| Although we are also pursuing a low-cost country production strategy and otherwise continue to seek process improvements to reduce costs, we cannot assure you that we will be able to continue to compete favorably in this competitive market or that increased competition will not have a material adverse effect on our business by reducing our ability to increase or maintain sales or profit margins |
| CONSOLIDATION AMONG AUTOMOTIVE PARTS CUSTOMERS AND SUPPLIERS COULD MAKE IT MORE DIFFICULT FOR US TO COMPETE FAVORABLY Our financial condition and results of operations could be adversely affected because the customer base for automotive parts is consolidating in both the original equipment market and aftermarket |
| Due to the cost focus of these major customers, we have been, and expect to continue to be, requested to reduce prices as part of our initial business quotations and over the life of vehicle platforms we have been awarded |
| We cannot be certain that we will be able to generate cost savings and operational improvements in the future that are sufficient to offset price reductions requested by existing customers and necessary to win additional business |
| Furthermore, the trend toward consolidation among automotive parts suppliers is resulting in fewer, larger suppliers who benefit from purchasing and distribution economies of scale |
| If we cannot achieve cost savings and operational improvements sufficient to allow us to compete favorably in the future with these larger companies, our financial condition and results of operations could be adversely affected due to a reduction of, or inability to increase, sales |
| WE MAY NOT BE ABLE TO SUCCESSFULLY RESPOND TO THE CHANGING DISTRIBUTION CHANNELS FOR AFTERMARKET PRODUCTS Major automotive aftermarket retailers, such as AutoZone and Advance Auto Parts, are attempting to increase their commercial sales by selling directly to automotive parts installers in addition to individual consumers |
| These installers have historically purchased from their local warehouse distributors and jobbers, who are our more traditional customers |
| We cannot assure you that we will be able to maintain or increase aftermarket sales through increasing our sales to retailers |
| Furthermore, because of the cost focus of major retailers, we have occasionally been requested to offer price concessions to them |
| Our failure to maintain or increase aftermarket sales, or to offset the impact of any reduced sales or pricing through cost improvements, could have an adverse impact on our business and operating results |
| LONGER PRODUCT LIVES OF AUTOMOTIVE PARTS ARE ADVERSELY AFFECTING AFTERMARKET DEMAND FOR SOME OF OUR PRODUCTS The average useful life of automotive parts has steadily increased in recent years due to innovations in products and technologies |
| The longer product lives allow vehicle owners to replace parts of their vehicles less often |
| As a result, a portion of sales in the aftermarket has been displaced |
| This has adversely impacted, and will likely continue to adversely impact, our aftermarket sales |
| Also, any additional increases in the average useful lives of automotive parts would further adversely affect the demand for our aftermarket products |
| Aftermarket sales represented approximately 23 percent of our net sales for 2005, as compared to 24 percent of our net sales for 2004 |
| ANY ACQUISITIONS WE MAKE COULD DISRUPT OUR BUSINESS AND SERIOUSLY HARM OUR FINANCIAL CONDITION We may, from time to time, consider acquisitions of complementary companies, products or technologies |
| Acquisitions involve numerous risks, including difficulties in the assimilation of the acquired businesses, the diversion of our managementapstas attention from other business concerns and potential adverse effects on existing business relationships with current customers and suppliers |
| In addition, any acquisitions could involve the incurrence of substantial additional indebtedness |
| We cannot assure you that we will be able to successfully integrate any acquisitions that we pursue or that such acquisitions will perform as 25 planned or prove to be beneficial to our operations and cash flow |
| Any such failure could seriously harm our business, financial condition and results of operations |
| WE ARE SUBJECT TO RISKS RELATED TO OUR INTERNATIONAL OPERATIONS We have manufacturing and distribution facilities in many regions and countries, including Australia, China, India, North America, Europe and South America, and sell our products worldwide |
| For 2005, approximately 54 percent of our net sales were derived from operations outside North America |
| International operations are subject to various risks which could have a material adverse effect on those operations or our business as a whole, including: - exposure to local economic conditions; - exposure to local political conditions, including the risk of seizure of assets by foreign government; - exposure to local social unrest, including any resultant acts of war, terrorism or similar events; - exposure to local public health issues and the resultant impact on economic and political conditions; - currency exchange rate fluctuations; - hyperinflation in certain foreign countries; - controls on the repatriation of cash, including imposition or increase of withholding and other taxes on remittances and other payments by foreign subsidiaries; and - export and import restrictions |
| EXCHANGE RATE FLUCTUATIONS COULD CAUSE A DECLINE IN OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS As a result of our international operations, we generate a significant portion of our net sales and incur a significant portion of our expenses in currencies other than the US dollar |
| To the extent we are unable to match revenues received in foreign currencies with costs paid in the same currency, exchange rate fluctuations in that currency could have a material adverse effect on our business |
| For example, where we have significantly more costs than revenues generated in a foreign currency, we are subject to risk if that foreign currency appreciates against the US dollar because the appreciation effectively increases our cost in that country |
| From time to time, as and when we determine it is appropriate and advisable to do so, we will seek to mitigate the effect of exchange rate fluctuations through the use of derivative financial instruments |
| We cannot assure you, however, that we will continue this practice or be successful in these efforts |
| The financial condition and results of operations of some of our operating entities are reported in foreign currencies and then translated into US dollars at the applicable exchange rate for inclusion in our consolidated financial statements |
| As a result, appreciation of the US dollar against these foreign currencies will have a negative impact on our reported revenues and operating profit while depreciation of the US dollar against these foreign currencies will have a positive effect on reported revenues and operating profit |
| For example, our European operations were positively impacted in 2002, 2003 and 2004 due to the strengthening of the Euro against the US dollar |
| However, in 2005, the dollar strengthened against the Euro which had a negative effect on our results of operations |
| Our South American operations were negatively impacted by the devaluation in 2000 of the Brazilian currency as well as by the devaluation of the Argentine currency in 2002 |
| We do not generally seek to mitigate this translation effect through the use of derivative financial instruments |
| FURTHER SIGNIFICANT CHANGES IN OUR STOCKHOLDER COMPOSITION MAY JEOPARDIZE OUR ABILITY TO USE SOME OR ALL OF OUR NET OPERATING LOSS CARRYFORWARDS As of December 31, 2005, we had a US Federal tax net operating loss ( "e NOL "e ) carryforwards of dlra566 million available to reduce taxable income in future years, and these NOL carryforwards expire in various years through 2025 |
| The federal tax effect of these NOLapstas is dlra198 million and is recorded as a 26 deferred tax asset on our balance sheet as of December 31, 2005 |
| We also have state NOL carryforwards at December 31, 2005 of dlra720 million, which will expire in varying amounts from 2006 to 2025 |
| The tax effect of the state NOL, net of a valuation allowance, is dlra27 million and is recorded as a deferred tax asset on our balance sheet at December 31, 2005 |
| Our ability to utilize our NOL carryforwards could become subject to significant limitations under Section 382 of the Internal Revenue Code ( "e Section 382 "e ) if we undergo a majority ownership change |
| We would undergo a majority ownership change if, among other things, the stockholders who own or have owned, directly or indirectly, five percent or more of our common stock or are otherwise treated as five percent stockholders under Section 382 and the regulations promulgated thereunder, increase their aggregate percentage ownership of our stock by more than 50 percentage points over the lowest percentage of stock owned by these stockholders at any time during the testing period, which is generally the three-year period preceding the potential ownership change |
| In the event of a majority ownership change, Section 382 imposes an annual limitation on the amount of taxable income a corporation may offset with the NOL carryforwards |
| Any unused annual limitation may be carried over to later years until the applicable expiration of the respective NOL carryforwards |
| If we were to undergo a majority ownership change, we would be required to record a reserve for some or all of the asset currently recorded on our balance sheet |
| As of December 31, 2005, we believe that there has not been a significant change in our ownership during the prior three years |
| We cannot, however, assure you that we will not undergo a majority ownership change in the future |
| Further, because an ownership change for federal tax purposes can occur based on trades among our existing stockholders, whether we undergo a majority ownership change may be a matter beyond our control |