UNITED STATES
FORM 10-Q
(Mark One)
x
For the quarterly period ended September 30, 2004, or
o
For the transition period from to
Commission file number 1-15827
VISTEON CORPORATION
Registrant’s telephone number, including area code: (800)-VISTEON
17000 Rotunda Drive, Dearborn, Michigan 48120
Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ü No
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).
As of October 29, 2004, the Registrant had outstanding 129,535,697 shares of common stock, par value $1.00 per share.
Exhibit index located on page number 44.
TABLE OF CONTENTS
VISTEON CORPORATION AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The accompanying notes are part of the financial statements.
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CONSOLIDATED BALANCE SHEET
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CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
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NOTES TO FINANCIAL STATEMENTS
NOTE 1. Financial Statements
The financial data presented herein are unaudited, but in the opinion of management reflect those adjustments, including normal recurring adjustments, necessary for a fair statement of such information. Results for interim periods should not be considered indicative of results for a full year. Reference should be made to the consolidated financial statements and accompanying notes included in Visteon’s Annual Report on Form 10-K for the year ended December 31, 2003, as filed with the Securities and Exchange Commission on February 13, 2004. Certain amounts for prior periods were reclassified to conform with present period presentation.
Visteon Corporation (“Visteon”) is a leading, global supplier of automotive systems, modules and components. Visteon sells products primarily to global vehicle manufacturers, and also sells to the worldwide aftermarket for replacement and vehicle appearance enhancement parts. Visteon became an independent company when Ford Motor Company (“Ford”) established Visteon as a wholly-owned subsidiary in January 2000 and subsequently transferred to Visteon the assets and liabilities comprising Ford’s automotive components and systems business. Ford completed its spin-off of Visteon on June 28, 2000 (the “spin-off”). Prior to incorporation, Visteon operated as Ford’s automotive components and systems business.
NOTE 2. Selected Costs, Income and Other Information
Depreciation and Amortization
Depreciation and amortization expenses, which do not include asset impairment charges, are summarized as follows:
Investments in Affiliates
The following table presents summarized financial data for those affiliates accounted for under the equity method. The amounts represent 100% of the results of operations of these affiliates. Our share of their net income is reported in the line “Equity in net income of affiliated companies” on the Consolidated Statement of Operations.
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NOTES TO FINANCIAL STATEMENTS — (Continued)
Accounts Receivable
The allowance for doubtful accounts was $40 million at September 30, 2004 and $35 million at December 31, 2003. Allowance for doubtful accounts is determined considering factors such as length of time accounts are past due, historical experience of write-offs, and our customers’ financial condition. Accounts receivable are written-off when they become uncollectible.
Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets include $134 million and $96 million of European value added and other tax receivables at September 30, 2004 and December 31, 2003, respectively.
Other
Costs of sales were reduced by $20 million, and selling, administrative and other expenses were reduced by $15 million in the third quarter of 2004, related to adjustments made to estimated provisions for annual incentive compensation programs recorded during the first half of 2004. Costs of sales in the third quarter of 2004 were reduced by $49 million related to an adjustment made to product recall accruals as a result of settling a product recall claim.
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Stock-Based Awards
Starting January 1, 2003, Visteon began expensing the fair value of stock-based awards granted to employees pursuant to Statement of Financial Accounting Standards No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation.” This standard was adopted on a prospective method basis for stock-based awards granted, modified or settled after December 31, 2002. For stock options and restricted stock awards granted prior to January 1, 2003, Visteon measures compensation cost using the intrinsic value method. If compensation cost for all stock-based awards had been determined based on the estimated fair value of stock options and the fair value set at the date of grant for restricted stock awards, in accordance with the provisions of SFAS 123, Visteon’s reported net (loss) and (loss) per share would have changed to the pro forma amounts indicated below:
Shareholder approval was obtained in May 2004 for the Visteon Corporation 2004 Incentive Plan, as amended and restated (the “Incentive Plan”). The Incentive Plan was originally adopted effective as of June 28, 2000 as the 2000 Incentive Plan, and approved by shareholders on May 9, 2001. The amended and restated Incentive Plan includes changes to increase the maximum number of shares of common stock that may be issued by 1.8 million shares to 14.8 million shares and to change the maximum term of an option or stock appreciation right awarded under the plan after the effective date of the amendment to five years from ten years.
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NOTE 3. Income Taxes
Deferred income taxes are provided for temporary differences between amounts of assets and liabilities for financial reporting purposes and the basis of such assets and liabilities as measured by tax laws and regulations, as well as net operating loss, tax credit and other carryforwards. Statement of Financial Accounting Standards No. 109 (“SFAS 109”), “Accounting for Income Taxes”, requires that deferred tax assets be reduced by a valuation allowance if, based on all available evidence, it is considered more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. This assessment requires significant judgment, and in making this evaluation, Visteon considers all available positive and negative evidence, including past results, the existence of cumulative losses in recent periods, and our forecast of taxable income for the current year and future years.
In performing this analysis during the third quarter of 2004, Visteon considered the anticipated impact on our 2004 operating results from Ford’s lower than expected North American production estimates for the fourth quarter and full year 2004, as well as increased steel and fuel costs, which we have not been able to recover fully, and delays in the benefits that were expected to be achieved from labor strategies, such as flowbacks and plant-level operating agreements. In light of these recent developments, we no longer believe that Visteon’s forecast of 2004 taxable earnings in the U.S. will be achieved. Visteon believes that there is now sufficient negative evidence and uncertainty as to the timing of when we will be able to generate the necessary level of U.S. taxable earnings to recover our net deferred tax assets in the U.S., as such, a full valuation allowance against these deferred tax assets is required. Visteon also has concluded that full valuation allowances are required for deferred tax assets related to certain other foreign countries where recoverability is uncertain. Visteon ceased recording income tax benefits for losses in the U.S. and other affected countries as of July 1, 2004, and will maintain full valuation allowances against our deferred tax assets in the U.S. and applicable foreign countries, which include Germany and the United Kingdom, until sufficient positive evidence exists to reduce or eliminate them.
Visteon’s provision for income taxes of $904 million for the third quarter of 2004 includes $872 million to write-down our net deferred tax assets, as of the beginning of the third quarter, in the U.S. and certain foreign countries. This charge is comprised of $901 million of deferred tax assets as of the beginning of the year and $48 million for income tax benefits recorded during the first half of 2004, partially offset by the reduction of related tax reserves, previously included in other liabilities, of $77 million. Visteon’s provision for income taxes also includes expense of $32 million and $109 million for the third quarter and first nine months of 2004, respectively, related to foreign countries where a valuation allowance is not considered necessary and whose operating results continue to be tax-effected.
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NOTE 4. Special Charges and Dispositions
First Nine Months 2004 Actions
Visteon recorded $336 million and $352 million of pre-tax special charges in costs of sales and $1,208 million and $1,172 million of after-tax special charges in the third quarter and first nine months of 2004, respectively, as summarized below:
Early retirement incentive and other related charges during the third quarter of 2004 are related to incentive programs offered to eligible Visteon-assigned Ford-UAW employees to voluntarily retire or to relocate in order to return to a Ford facility. About 500 employees elected to retire early at a cost of $18 million and about 210 employees have agreed to return to a Ford facility at a cost of $7 million.
Plant closure charges are related to the involuntary separation of up to about 200 employees as a result of the closure of our La Verpilliere, France, manufacturing facility. As of September 30, 2004 about 170 employees have been separated, with the remainder expected to be separated by the end of 2004. European Plan for Growth charges are comprised of $6 million related to the separation of about 50 hourly employees located at Visteon’s plants in Europe through a continuation of a special voluntary retirement and separation program started in 2002.
In the third quarter of 2004, accrued liabilities of $3 million relating to prior year’s actions were credited to costs of sales, including $2 million related to costs to complete the transfer of seat production located in Chesterfield, Michigan, to another supplier, as discussed further in this note.
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During the third quarter of 2004, the Automotive Operations recorded a pre-tax, non-cash impairment write-down of $314 million in costs of sales to reduce the net book value of certain long-lived assets. This write-down was based on an assessment by product line asset group, completed in the third quarter of 2004, of the recoverability of our long-lived assets in light of the challenging environment in which we operate, and included consideration of lower than anticipated Ford North American production volume and the related impact on our future operating projections. Assets are considered impaired if the book value is greater than the undiscounted cash flows expected from the use of the asset. As a result of this analysis the assets of the steering systems product group were impaired. The write-down was approximately $249 million in North America and $65 million in Europe and was determined on a “held for use” basis. Fair values were determined primarily based on prices for similar groups of assets determined by a third-party valuation firm.
We continue to assess the recoverability of our long-lived assets in light of the challenging environment in which we operate and as part of our business planning process. If conditions, including the results of any discussions with Ford, indicate that any of these assets are impaired, impairment charges will be required, although we cannot predict the timing or range of amounts, if any, which may result. Visteon considers projected future undiscounted cash flows, trends and other circumstances in making such estimates and evaluations. While we believe that our estimates of future cash flows are reasonable, different assumptions regarding such factors as future automotive production volumes (primarily for Ford), selling price changes, labor cost changes, material cost changes, productivity and other cost savings and capital expenditures could significantly affect our evaluations.
First Nine Months 2003 Actions
Visteon recorded in operating results $2 million and $299 million of pre-tax special charges in the third quarter and first nine months of 2003, respectively, as summarized below:
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European Plan for Growth charges of $56 million are comprised of $49 million related to the involuntary separation of 675 hourly employees located in Germany and $7 million related to the separation of about 141 hourly employees located at Visteon’s plants in Europe through a continuation of a special voluntary retirement and separation program started in 2002. North American salaried charges of $18 million are related to the involuntary separation of about 135 U.S. salaried employees. Other actions of $17 million include the elimination of about 120 manufacturing positions in Mexico and $4 million of non-cash charges related to the write-down of a group of coiled spring and stamping equipment at our Monroe, Michigan, plant for which production activities were discontinued and the future undiscounted cash flows were less than the carrying value of these fixed assets held for use. Of the $82 million of pre-tax restructuring and other charges described above, $6 million was recorded in selling, administrative and other expenses and the remainder in costs of sales.
Accrued restructuring liabilities relating to prior year’s restructuring actions of $9 million were credited to costs of sales in the third quarter of 2003, primarily as a result of reduced costs to complete the closure of the Markham, Ontario facility and the related employee separations.
During the second quarter of 2003, Visteon finalized an agreement with Ford Motor Company to transfer seat production located in Chesterfield, Michigan, to another supplier. As part of this agreement, about 1,470 Visteon-assigned Ford-UAW employees working at the Chesterfield, Michigan, facility transferred to Ford, and Visteon agreed to be responsible to reimburse Ford for the actual net costs of transferring seating production through June 2004, including costs related to Ford hourly employee voluntary retirement and separation programs that Ford was expected to implement, offset by certain cost savings expected to be realized by Ford.
Included in costs of sales and our operating results for the second quarter of 2003 is $217 million related to the seating operations consisting of:
A determination of the net costs that Visteon is responsible to reimburse Ford under this agreement was completed in the third quarter of 2004, subject to the final actuarial valuation results expected in the fourth quarter of 2004, resulting in a $2 million reduction in previously established accruals and a credit to costs of sales. Visteon paid Ford about $52 million in the first nine months of 2004 and about $30 million in 2003 under this agreement.
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Reserve Activity
Reserve balances of $33 million and $45 million at September 30, 2004 and December 31, 2003, respectively, are included in current accrued liabilities on the accompanying balance sheets. The September 30, 2004 reserve balance includes $14 million related primarily to 2003 restructuring activities. Visteon currently anticipates that the restructuring activities to which all of the above charges relate will be substantially complete by the end of 2004.
Utilization in the first nine months of 2004 of $52 million is related to incentives paid related to the Ford-UAW early retirement program and severance pay related to other programs.
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NOTE 5. Employee Retirement Benefits
Visteon’s retirement plans’ expense for the third quarter and first nine months of 2004 and 2003, respectively, are summarized as follows:
The expense amount for Visteon-assigned Ford-UAW employees included in the table above for the first nine months of 2003 includes pension expense of $85 million and retiree health care and life insurance expense of $17 million related to the transfer of the Chesterfield, Michigan, seat production as discussed further in Note 4.
As of September 30, 2004, contributions to U.S. retirement plans and postretirement health care and life insurance plans were $138 million and $40 million, respectively, including payments to Ford of $80 million and $18 million, respectively. Visteon presently anticipates additional contributions to U.S. retirement plans and postretirement health care and life insurance plans of $29 million and $17 million, respectively in 2004 for a total of $167 million and $57 million, respectively, including additional payments to Ford of $28 million and $3 million, respectively, for totals of $108 million and $21 million, respectively.
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The Medicare Drug Improvement and Modernization Act of 2003 was signed into law on December 8, 2003. This legislation provides for a federal subsidy beginning in 2006 to sponsors of retiree health care benefit plans that provide a benefit at least actuarially equivalent to the benefit established by the law. Visteon’s plans generally provide retiree drug benefits that exceed the value of the benefit that will be provided by Medicare Part D, and we have concluded that our plans are actuarially equivalent, pending further definition of the criteria used to determine equivalence. This subsidy was estimated to reduce the benefit obligation for Visteon plans by $95 million as of March 31, 2004, and will be recognized through reduced retiree health care expense over the related employee future service lives, of which $7 million has been recognized in the first nine months of 2004.
NOTE 6. Asset Securitization
United States
In the first quarter of 2004, Visteon established a revolving accounts receivable securitization facility in the United States (“facility agreement”) of up to $100 million. Under this facility agreement, Visteon can sell a portion of its U.S. trade receivables to Visteon Receivables LLC (“VRL”), a wholly-owned consolidated special purpose entity. VRL may then sell, on a non-recourse basis (subject to certain limited exceptions), an undivided interest in the receivables to an asset-backed, multi-seller commercial paper conduit, which is unrelated to Visteon or VRL. The conduit typically finances the purchases through the issuance of commercial paper, with back-up purchase commitments from the conduit’s financial institution. The sale of the undivided interest in the receivables from VRL to the conduit is accounted for as a sale under the provisions of Statement of Financial Accounting Standards No. 140, “Accounting for the Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” When VRL sells an undivided interest to the conduit, VRL retains the remaining undivided interest. The carrying value of the remaining undivided interests approximates the fair market value of these receivables. The value of the undivided interest sold to the conduit is excluded from our consolidated balance sheet and will reduce our accounts receivable balance. Visteon continues to perform the collection and administrative functions related to the accounts receivable. The facility expires in March 2005 and can be extended annually through March 2008 based upon the mutual agreement of the parties. Additionally, the agreement contains financial covenants similar to our unsecured revolving credit facilities.
At the time VRL sells the undivided interest to the conduit, the sale is recorded at fair market value with the difference between the carrying amount and fair value of the assets sold included in operating income as a loss on sale. This difference between carrying value and fair value is principally the estimated discount inherent in the facility agreement, which reflects the borrowing costs as well as fees and expenses of the conduit, and the length of time the receivables are expected to be outstanding. For the first nine months of 2004, gross proceeds from new securitizations were $85 million; collections and repayments to the conduit were $45 million, resulting in net proceeds of $40 million. The retained interest at September 30, 2004 of $277 million is included in Accounts receivable — other customers on the Consolidated Balance Sheet. The loss on the sale of receivables and customer delinquencies were each less than $1 million for the first nine months of 2004.
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Europe
As of September 30, 2004 and December 31, 2003, Visteon has sold euro 38 million ($47 million) and euro 12 million ($15 million), respectively, of trade receivables under a European sale of receivables agreement with a bank. This agreement currently provides for the sale of up to euro 60 million in trade receivables.
NOTE 7. Debt
Debt at September 30, 2004 and December 31, 2003, including the fair market value of related interest rate swaps, was as follows:
On March 10, 2004, Visteon completed a public offering of unsecured fixed-rate term debt securities totaling $450 million with a maturity of ten years. The securities bear interest at a stated rate of 7.00%, with interest payable semi-annually on March 10 and September 10, beginning on September 10, 2004. The securities rank equally with Visteon’s existing and future unsecured fixed-rate term debt securities and senior to any future subordinated debt. The unsecured term debt securities agreement contains certain restrictions, including, among others, a limitation relating to liens and sale-leaseback transactions, as defined in the agreement. In the opinion of management, Visteon was in compliance with all of these restrictions. In addition, an interest rate swap has been entered into for a portion of this debt ($225 million). This swap effectively converts the securities from fixed interest rate to variable interest rate instruments.
On April 6, 2004, Visteon repurchased $250 million of our existing 7.95% five-year notes maturing on August 1, 2005. In the second quarter of 2004, Visteon recorded a pre-tax debt extinguishment charge of $11 million, consisting of redemption premiums and transaction costs ($19 million), offset partially by the accelerated recognition of gains from interest rate swaps associated with the repurchased debt ($8 million).
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Visteon has financing arrangements with a syndicate of third-party lenders that provide contractually committed, unsecured revolving credit facilities (the “Credit Facilities”). During the second quarter of 2004, the 364-day revolving credit facility in the amount of $565 million was renewed, which now expires in June 2005. In addition to the 364-day revolving facility, Visteon continues to have a five-year revolving credit facility in the amount of $775 million that expires in June 2007. The Credit Facilities also provide for a delayed-draw term loan in the amount of $250 million, expiring in 2007, which is used primarily to finance new construction for facilities consolidation in Southeast Michigan. Borrowings under the Credit Facilities bear interest based on a variable rate interest option selected at the time of borrowing. The Credit Facilities contain certain affirmative and negative covenants including a covenant not to exceed a certain leverage ratio of consolidated total debt to consolidated EBITDA (as defined in the agreement) of 3.5 to 1. Visteon has been in compliance with all covenants since the inception of the Credit Facilities. As of September 30, 2004, there were no outstanding borrowings under either the 364-day or the five-year facility; however, there were $98 million of obligations under standby letters of credit under the five-year facility.
NOTE 8. (Loss) Per Share of Common Stock
Basic (loss) per share of common stock is calculated by dividing reported net (loss) by the average number of shares of common stock outstanding during the applicable period, adjusted for restricted stock. The calculation of diluted income (loss) per share takes into account the effect of dilutive potential common stock, such as stock options, and contingently returnable shares, such as restricted stock.
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For the third quarter of 2004 and 2003 and first nine months of 2004 and 2003 potential common stock of about 3,410,000 shares, 1,030,000 shares, 3,238,000 shares and 751,000 shares respectively, are excluded, as the effect would have been antidilutive due to the losses incurred during those periods. Options to purchase 8,732,000 shares of common stock at exercise prices ranging from $10 per share to $22 per share were outstanding during the third quarter of 2004 but were not included in the computation of diluted income (loss) per share because the options’ exercise price was greater than the average market price of the common shares. The options expire at various dates between 2009 and 2012.
NOTE 9. Variable Interest Entities
In December 2003, the FASB issued revised Interpretation No. 46 (“FIN 46”) “Consolidation of Variable Interest Entities.” Until this interpretation, a company generally included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns. Application of FIN 46 was required during the fourth quarter of 2003 for interests in structures that are commonly referred to as special-purpose entities and for all other types of variable interest entities in the first quarter of 2004.
As a result of the application of FIN 46, the consolidated financial statements include the accounts of Lextron-Visteon Automotive Systems, LLC and MIG-Visteon Automotive Systems, LLC, both joint ventures 49% owned by Visteon or its subsidiaries, that supply integrated cockpit modules and other modules and systems to Nissan. Consolidation of these entities was based on an assessment of the amount of equity investment at risk, the subordinated financial support provided by Visteon, and that Visteon supplies the joint ventures’ inventory. The effect of consolidation on Visteon’s results of operations or financial position as of September 30, 2004 was not significant as substantially all of the joint ventures’ liabilities and costs are related to activity with Visteon.
From June 30, 2002, a variable interest entity owned by an affiliate of a bank is included in Visteon’s consolidated financial statements. This entity was established in early 2002 to build a leased facility for Visteon to centralize customer support functions, research and development and administrative operations. Construction of the facility is planned to be substantially completed in 2004, with initial occupancy started in mid-2004. As of September 30, 2004, this entity has incurred about $210 million of an expected total of $240 million in capital spending related to this facility.
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NOTE 10. Product Warranty
A reconciliation of changes in the product warranty liability is summarized as follows:
NOTE 11. Inventories
Inventories are summarized as follows:
The components of inventory at December 31, 2003 have been conformed to present period presentation to reclassify finished products inventory at several plant locations.
NOTE 12. Comprehensive (Loss)
Comprehensive (loss) is summarized as follows:
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Accumulated other comprehensive (loss) is comprised of the following:
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NOTE 13. Segment Information
Visteon’s reportable operating segments are Automotive Operations and Glass Operations. Financial information for the reportable operating segments is summarized as follows:
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NOTE 14. Litigation and Claims
Various legal actions, governmental investigations and proceedings and claims are pending or may be instituted or asserted in the future against Visteon, including those arising out of alleged defects in Visteon’s products; governmental regulations relating to safety; employment-related matters; customer, supplier and other contractual relationships; intellectual property rights; product warranties; product recalls; and environmental matters. Some of the foregoing matters involve or may involve compensatory, punitive or antitrust or other treble damage claims in very large amounts, or demands for recall campaigns, environmental remediation programs, sanctions, or other relief which, if granted, would require very large expenditures.
Litigation is subject to many uncertainties, and the outcome of individual litigated matters is not predictable with assurance. Reserves have been established by Visteon for matters discussed in the foregoing paragraph where losses are deemed probable; these reserves are adjusted periodically to reflect estimates of ultimate probable outcomes. It is reasonably possible, however, that some of the matters discussed in the foregoing paragraph for which reserves have not been established could be decided unfavorably to Visteon and could require Visteon to pay damages or make other expenditures in amounts, or a range of amounts, that cannot be estimated at September 30, 2004. Visteon does not reasonably expect, based on its analysis, that any adverse outcome from such matters would have a material effect on our financial condition, results of operations or cash flows, although such an outcome is possible.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
We have reviewed the accompanying consolidated balance sheet of Visteon Corporation and its subsidiaries as of September 30, 2004, and the related consolidated statement of operations for each of the three-month and nine-month periods ended September 30, 2004 and September 30, 2003 and the condensed consolidated statement of cash flows for the nine-month periods ended September 30, 2004 and September 30, 2003. These interim financial statements are the responsibility of the Company’s management.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the accompanying consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
We previously audited in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of December 31, 2003, and the related consolidated statements of operations, stockholders’ equity, and of cash flows for the year then ended (not presented herein), and in our report dated January 22, 2004 we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet information as of December 31, 2003, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
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The financial data presented herein are unaudited, but in the opinion of management reflect those adjustments, including normal recurring adjustments, necessary for a fair statement of such information. Reference should be made to the consolidated financial statements and accompanying notes included in the company’s Annual Report on Form 10-K for the year ended December 31, 2003, as filed with the Securities and Exchange Commission on February 13, 2004.
Overview
Visteon’s worldwide sales for the third quarter of 2004 were up $270 million over the same period in 2003. We continued to make progress in the diversification of our customer base, recording $1.38 billion in non-Ford sales for the quarter, including nearly $200 million in net new business. This non-Ford sales mark is the highest for any quarter in Visteon’s history and was an increase of 37% compared to the same quarter last year. This quarter also marked our lowest Ford sales quarter in our history, which was $2.77 billion, a decrease of 4% compared to the same period last year.
Visteon’s worldwide sales in the first nine months of 2004 were $14.0 billion, compared with $13.2 billion in the first nine months of 2003. Sales to non-Ford customers reached $4.1 billion for the first nine months of 2004, an increase of $1.1 billion over the comparable period in 2003, and accounted for 29% of total sales for the first nine months.
Significant special charges in the quarter, totaling $1.2 billion or $9.64 per share, contributed to a net loss of $1.36 billion, or $10.86 per share. Special charges included the non-cash increase in deferred tax asset valuation allowances of $872 million and a non-cash asset impairment write-down of $314 million to reduce the net book value of fixed assets related to the steering systems product group. Additionally, we recognized $25 million of charges related to early retirement and relocation programs to reduce our Master Agreement UAW workforce that we lease from Ford. Operating losses were primarily due to increasing material and fuel costs, which we have been unable to defray through pricing or other means, and the inflexible cost structure of our legacy businesses relative to production volumes. Our results were aided by product recall and annual incentive compensation accrual adjustments.
Net loss for the first nine months of 2004 was $1,299 million, or $10.37 per share, a change of $949 million over a net loss of $350 million, or $2.78 per share, for the first nine months of 2003.
Cash from operations was $227 million during the first nine months of 2004, an improvement of $195 million versus the same period last year, and we ended the first nine months of 2004 with $734 million in cash and marketable securities.
Compared to the third quarter of 2004, we expect our revenues to increase in the fourth quarter of 2004, primarily due to the typical increase in Ford’s North American production volumes during the fourth quarter. However, our current cost structure combined with escalating material surcharges will challenge our operating performance for the rest of the year. As we announced previously, we are exploring strategic and structural changes to our business in the U.S. to achieve a sustainable and competitive business. We are currently in discussions with Ford regarding these and other matters. We cannot predict the impact such discussions or any related actions may have on our results of operations or financial condition at this time. Although we expect to reach an agreement, there can be no assurance that we will reach a favorable agreement with Ford in the near term or at all.
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Restructuring, Dispositions and Special Charges
The table below presents special charges related to deferred tax valuation allowances, fixed asset impairment write-downs, restructuring initiatives and other actions during the third quarter and first nine months of 2004 and 2003, which are discussed further in Notes 3 and 4 to the consolidated financial statements:
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In the third quarter of 2004, accrued liabilities of $3 million relating to prior year’s actions were credited to costs of sales, including $2 million related to costs to complete the transfer of seat production located in Chesterfield, Michigan, to another supplier.
During the third quarter of 2004, Visteon recorded a non-cash charge of $872 million to increase valuation allowances against our deferred tax assets, as of the beginning of the third quarter, in the U.S. and certain foreign countries. This charge is comprised of $901 million of deferred tax assets as of the beginning of the year and $48 million for income tax benefits recorded during the first half of 2004, partially offset by the reduction of related tax reserves, previously included in other liabilities, of $77 million. Statement of Financial Accounting Standards No. 109 (“SFAS 109”), “Accounting for Income Taxes”, requires that deferred tax assets be reduced by a valuation allowance if, based on all available evidence, it is considered more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. This assessment requires significant judgment, and in making this evaluation, Visteon considers all available positive and negative evidence, including past results, the existence of cumulative losses in recent periods, and our forecast of taxable income for the current year and future years.
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In performing this analysis during the third quarter of 2004, Visteon considered the anticipated impact on our 2004 operating results from Ford’s lower than expected North American production estimates for the fourth quarter and full year 2004, as well as increased steel and fuel costs, which we have not been able to recover fully, and delays in the benefits that were expected to be achieved from labor strategies, such as flowbacks and plant-level operating agreements. In light of these recent developments, we no longer believe that Visteon’s forecast of 2004 taxable earnings in the U.S. will be achieved. Visteon believes that there is now sufficient negative evidence and uncertainty as to the timing of when we will be able to generate the necessary level of U.S. taxable earnings to recover our net deferred tax assets in the U.S., as such, a full valuation allowance against these deferred tax assets is required. Visteon also has concluded that full valuation allowances are required for deferred tax assets related to certain other foreign countries where recoverability is uncertain. Visteon ceased recording income tax benefits for losses in the U.S. and other affected countries as of July 1, 2004. Visteon will maintain full valuation allowances against our deferred tax assets in the U.S. and applicable foreign countries, which include Germany and the United Kingdom, until sufficient positive evidence exists to reduce or eliminate them.
Included in costs of sales and our operating results for the first nine months of 2003 is $217 million related to the North American seating operations. During the second quarter of 2003, Visteon finalized an agreement with Ford Motor Company to transfer seat production located in Chesterfield, Michigan, to another supplier. As part of this agreement, about 1,470 Visteon-assigned Ford-UAW employees working at the Chesterfield, Michigan, facility transferred to Ford, and Visteon agreed to be responsible to reimburse Ford for the actual net costs of transferring seating production through June 2004, including costs related to Ford hourly employee voluntary retirement and separation programs that Ford was expected to implement, offset by certain cost savings expected to be realized by Ford. A determination of the net costs that Visteon is responsible to reimburse Ford under this agreement was completed in the third quarter of 2004, subject to the final actuarial valuation results expected in the fourth quarter of 2004, resulting in a $2 million reduction in previously established accruals and a credit to costs of sales.
European Plan for Growth charges of $56 million are comprised of $49 million related to the involuntary separation of 675 hourly employees located in Germany and $7 million related to the separation of about 141 hourly employees located at Visteon’s plants in Europe through a continuation of a special voluntary retirement and separation program started in 2002. North American salaried charges of $18 million are related to the involuntary separation of about 135 U.S. salaried employees. Other actions of $17 million include the elimination of about 120 manufacturing positions in Mexico and $4 million of non-cash charges related to the write-down of a group of coiled spring and stamping equipment at our Monroe, Michigan, plant for which production activities were discontinued.
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Cash payments related to special charges, including those related to the transfer of the North American seating operations and for severance and special pension benefits, were $145 million and $100 million during the first nine months of 2004 and 2003, respectively. Special charges before taxes for the first nine months of 2004 of $352 million consist of $314 million of non-cash charges and $38 million of charges which will be settled in cash.
We continue to evaluate the possibility of partnerships, sales or closings involving other under-performing or non-core businesses. However, there can be no assurance that a transaction or other arrangement favorable to Visteon will occur in the near term or at all. In addition, we continue to assess the recoverability of our long-lived assets in light of the challenging environment in which we operate and as part of our business planning process. If conditions, including the results of any discussions with Ford, indicate that any of these assets are impaired, impairment charges will be required, although we cannot predict the timing or range of amounts, if any, which may result. Visteon considers projected future undiscounted cash flows, trends and other circumstances in making such estimates and evaluations. While we believe that our estimates of future cash flows are reasonable, different assumptions regarding such factors as future automotive production volumes (primarily for Ford), selling price changes, labor cost changes, material cost changes, productivity and other cost savings and capital expenditures could significantly affect our evaluations.
Results of Operations
Third Quarter 2004 Compared with Third Quarter 2003
Sales for each of our segments for the third quarter of 2004 and 2003 are summarized in the following table:
Sales for Automotive Operations were $4.0 billion in 2004, compared with $3.8 billion in 2003, an increase of $276 million or 7%. Third quarter Ford revenue declined by $104 million, or 4%, from the third quarter of 2003. Lower Ford production in North America decreased our revenue by more than $100 million. Price reductions and lower Jaguar production also reduced Ford revenue, but these factors were offset by additional content, Ford European volume, and favorable currency changes of $33 million. Non-Ford revenue increased $381 million, or 41%, including new vehicle launches and $37 million in favorable currency changes.
Sales for Glass Operations were $125 million in 2004, compared with $131 million in 2003, a decrease of $6 million or 5%, reflecting lower volume and price reductions.
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Costs of sales for the third quarter of 2004 were $4.4 billion, up $487 million compared with the third quarter of 2003. Costs of sales include primarily material, labor, manufacturing overhead and other costs, such as product development costs. The increase reflects a non-cash asset impairment charge of $314 million related to our steering systems product group, net higher variable costs of $270 million associated with higher global production volumes including new business, currency changes of $55 million, $37 million in material surcharges, and $25 million for UAW early retirement and incentive flow-back programs. These increases were offset partially by the non-recurrence of $64 million for the 2003 UAW contract ratification, lower other postretirement benefit expense of $36 million, $49 million in adjustments to product recall accruals, $20 million in adjustments to annual incentive compensation accruals made during the first half of 2004, and manufacturing and material cost efficiencies.
Selling, administrative and other expenses for the third quarter of 2004 were $223 million, $39 million lower compared with the third quarter of 2003. The lower expenses reflect Information Technology (“IT”) and other cost efficiencies, and adjustments to annual incentive compensation program accruals made in the first half of 2004 of $15 million, offset partially by currency fluctuations of $7 million.
Net interest expense and debt extinguishment cost of $23 million in the third quarter of 2004 was $4 million higher than third quarter of 2003 primarily because of increased net debt.
Equity in net income of affiliated companies was $9 million in the third quarter of 2004, compared with $12 million in the third quarter of 2003, with the change primarily related to our affiliates in Asia.
(Loss) before income taxes and minority interests, including and excluding special charges, is the primary profitability measure used by our chief operating decision makers. The following table shows (loss) before income taxes and minority interests for the third quarter of 2004 and 2003, for each of our segments:
Automotive Operations’ third quarter 2004 loss before income taxes and minority interests was $441 million compared with a loss of $260 million for the third quarter of 2003. This includes a non-cash asset impairment charge of $314 million related to our steering systems product group, and $24 million in restructuring charges associated with UAW early retirements and the flow-back of workers to Ford, offset partially by the non-recurrence of 2003’s UAW contract ratification costs of $59 million, an adjustment to product recall accruals of $49 million, and a $34 million adjustment to accruals made during the first half of the year for annual incentive compensation. Favorable cost performance including a reduction in selling, administrative and other expenses and reduced other postretirement benefit expense were offset by reduced prices to our customers, material surcharges of $37 million, fuel cost increases, and wage and benefit economic increases.
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Loss before income taxes and minority interests for Glass Operations in the third quarter of 2004 was $8 million compared with $4 million for the third quarter of 2003, primarily driven by lower volume, offset partially by the non-recurrence of 2003’s UAW contract ratification costs of $5 million, a $1 million adjustment to accruals made during the first half of the year for annual incentive compensation and $1 million in restructuring charges associated with UAW early retirements and the flow-back of workers to Ford.
Provision (benefit) for income taxes was a provision of $904 million for the third quarter compared with a benefit of $99 million in the third quarter of 2003. The third quarter of 2004 includes a charge of $872 million related to additional valuation allowances established against the company’s deferred tax assets in the U.S. and certain foreign countries as of the beginning of the third quarter. This charge is comprised of $901 million related to deferred tax assets as of the beginning of the year and $48 million for income tax benefits recorded during the first half of 2004, offset partially by the reduction of related tax reserves of $77 million. In addition, Visteon has ceased recording income tax benefits for losses in the U.S. and other affected countries beginning July 1, 2004. Visteon’s provision for income taxes in the third quarter of 2004 includes $32 million of income tax expense for those foreign countries where deferred tax asset valuation allowances are not considered necessary and whose results continue to be tax-effected. Going forward, the need to maintain valuation allowances against our deferred tax assets in the U.S. and other affected countries will cause variability in our effective tax rate.
Minority interests in net income of subsidiaries was $7 million in the third quarter of 2004 compared with $3 million in the third quarter of 2003. Minority interest amounts are related primarily to Halla Climate Control Corporation headquartered in Korea, in which we have a 70% ownership interest.
Net (loss) for the third quarter of 2004 and 2003 are shown in the following table for each of our segments:
Visteon reported a net loss for the third quarter of 2004 of $1,360 million compared with a net loss of $168 million for the third quarter of 2003 because of the factors described above in (loss) before income taxes, and an additional valuation allowance of $872 million against our deferred tax assets which includes $48 million of tax expense related to tax benefits recorded during the first half of 2004.
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First Nine Months 2004 Compared with First Nine Months 2003
Sales for each of our segments for the first nine months of 2004 and 2003 are summarized in the following table:
Sales for Automotive Operations in the first nine months were $13.6 billion in 2004, compared with $12.8 billion in 2003, an increase of $832 million or 7%. This increase reflects higher non-Ford sales of $1.1 billion including $202 million of favorable currency changes. In addition, favorable currency changes of $232 million for Ford sales, and higher Ford European production volumes were offset partially by the impact of lower Ford North American production volume of more than $350 million, the loss of revenue from the exit of seating operations of $246 million, and price reductions.
Sales for Glass Operations were $401 million in 2004, compared with $438 million in 2003, a decrease of $37 million or 8%, resulting primarily from price reductions and lower volume.
Costs of Sales for the first nine months of 2004 were $13.6 billion, up $597 million compared with the first nine months of 2003. Costs of sales include primarily material, labor, manufacturing overhead and other costs, such as product development costs. Results were affected by special charges which were $352 million in 2004 and $293 million in 2003. The 2004 special charges included $314 million for the impairment of steering systems assets. The 2003 special charges included $217 million related to the exit of our seating business.
Increased costs also reflected higher net variable costs of $825 million associated with higher global production volumes, including new business, increased costs resulting from currency fluctuations of $382 million and material surcharges of $50 million. These factors were offset partially by the elimination of costs of $270 million resulting from the exit of our seating operations (excluding special charges), and favorable cost performance, including reduced other postretirement benefit expense, of $387 million. Costs of sales was also impacted by the non-recurrence of 2003’s UAW contract ratification costs of $64 million, and adjustments to product recall accruals of $49 million.
Selling, administrative and other expenses for the first nine months of 2004 were $722 million, $21 million lower compared with the first nine months of 2003. The decrease reflects efficiencies and spending controls, and reduced IT incremental infrastructure costs of $16 million offset partially by currency fluctuations of $23 million. Special charges included in this line item were $6 million for 2003.
Net interest expenseof $72 million in the first nine months of 2004 was $14 million higher than the first nine months of 2003, primarily due to $11 million of debt extinguishment costs from the Tender Offer, and higher U.S. debt levels.
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Equity in net income of affiliated companies was $38 million in the first nine months of 2004, compared with $42 million in the first nine months of 2003, with the decrease related primarily to our affiliates in Asia.
Income (loss) before income taxes and minority interests, including and excluding special charges, is the primary profitability measure used by our chief operating decision makers. The following table shows income (loss) before income taxes for the first nine months of 2004 and 2003, for each of our segments:
Automotive Operations’ first nine months 2004 loss before income taxes was $342 million compared with a loss of $546 million for the first nine months of 2003. Results were affected also by special charges which increased $53 million. The 2004 special charges included $314 million for the impairment of steering systems assets. The 2003 special charges included $217 million related to the exit of our seating business.
The first nine months’ results were impacted by the non-recurrence of 2003’s UAW contract ratification costs of $59 million and, an adjustment to product recall accruals of $49 million. Favorable cost performance, net of reduced prices to our customers, material surcharges, fuel cost increases, and wage and benefit economic increases (despite our reduced other postretirement benefit costs), was $64 million. Higher production volumes, including new business and higher Ford European production volume offset partially by lower Ford North American production volume, improved first nine months loss before taxes. Results were also improved by $25 million (excluding special charges) reflecting the exit of our seating operations and currency fluctuations of $33 million.
Income before income taxes for Glass Operations in the first nine months of 2004 was $4 million compared with $7 million before taxes for the first nine months of 2003, reflecting a reduction of aftermarket pricing and volume offset partially by lower other postretirement benefit costs.
Provision (benefit) for income taxes was a provision of $933 million for the first nine months of 2004, compared with a benefit of $209 million for the first nine months of 2003. The first nine months of 2004 includes a charge of $824 million related to additional valuation allowances established against the company’s deferred tax assets in the U.S. and certain foreign countries. This charge is comprised of $901 million related to deferred tax assets as of the beginning of the year, partially offset by the reduction of related tax reserves of $77 million. Visteon’s results for the first nine months of 2004 reflect no income tax benefits for current year losses in the U.S. and other affected countries. In addition, Visteon’s provision for income taxes for the first nine months of 2004 includes $109 million of income tax expense for those foreign countries where deferred tax asset valuation allowances are not considered necessary and whose results continue to be tax-effected. Going forward, the need to maintain valuation allowances against our deferred tax assets in the U.S. and other affected countries will cause variability in our effective tax rate.
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Minority interests in net income of subsidiaries were $28 million in the first nine months of 2004 compared with $20 million in the first nine months of 2003. Minority interest amounts are related primarily to our 70% ownership interest in Halla Climate Control Corporation headquartered in Korea.
Net income (loss)for the first nine months of 2004 and 2003 are shown in the following table for each of our segments:
Visteon reported a net loss for the first nine months of 2004 of $1,299 million compared with a net loss of $350 million for the first nine months of 2003 because of the factors described above in income (loss) before income taxes, and additional valuation allowance of $824 million against our deferred tax assets. Special charges after taxes were $1,172 million for the first nine months of 2004 and $191 million for the first nine months of 2003.
Liquidity and Capital Resources
Visteon finances its worldwide business with cash flows from operations, supplemented by a combination of liquidity sources, including but not limited to our cash balance, receivables-based programs, committed and uncommitted bank facilities, leasing arrangements, and the issuance of securities. These sources are used also to fund working capital needs, which are highly variable during the year because of changing customer production schedules.
Visteon’s balance sheet reflects cash and marketable securities of $734 million and total debt of $2,015 million at September 30, 2004, compared with cash and marketable securities of $956 million and total debt of $1,818 million at December 31, 2003. The decline in cash and marketable securities is due primarily to an increase in trade working capital related to higher sales volumes at the end of the third quarter compared with the year-end shutdown period. As our operating profitability has become more concentrated with our foreign subsidiaries and joint ventures, our cash balance located outside the U.S. has grown. Approximately one-half of Visteon’s cash and marketable securities at September 30, 2004 were held in the United States. Visteon’s ability to move cash among our operating locations is subject to the operating needs of each location as well as restrictions imposed by local laws.
Visteon’s ratio of total debt to total capital, which consists of total debt plus total stockholders’ equity, was 81% at September 30, 2004 and 49% at December 31, 2003, and increased primarily because of the increase in net loss reported during the period.
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Financing Arrangements
On March 10, 2004, Visteon completed a public offering (the “Notes Sale”) of unsecured fixed-rate 7.00% term debt securities totaling $450 million in aggregate principal amount due in March 2014. Proceeds from the Notes Sale were used for a debt retirement and for general corporate purposes. Concurrent with the Notes Sale, Visteon announced an offer (the “Tender Offer”) to purchase for cash up to $250 million aggregate principal amount of our 7.95% notes due in August 2005. The Tender Offer expired on April 2, 2004, and $250 million of these notes were retired on April 6, 2004.
In March 2004, Visteon established a revolving accounts receivable securitization facility (the “facility”) in the U.S. The facility allows for the sale of a portion of U.S. trade receivables to a wholly-owned consolidated special purpose entity, Visteon Receivables LLC (“VRL”), which may then sell an undivided interest in the receivables to an asset-backed multi-seller conduit which is unrelated to Visteon or VRL. At September 30, 2004, VRL had sold a $40 million undivided interest in a pool of $317 million of net receivables. The facility expires in March 2005 and is extendable annually through March 2008 through mutual agreement of both parties. The current maximum amount of undivided interests that VRL could sell to the conduit is approximately $70 million, although the amount would decrease in the event that Visteon’s credit rating were to be lowered.
In Europe, Visteon has an agreement to sell up to euro 60 million in trade receivables to a bank. As of September 30, 2004 and December 31, 2003, Visteon has sold euro 38 million ($47 million) and euro 12 million ($15 million), respectively, of trade receivables under this agreement.
Visteon has financing arrangements with a syndicate of third-party lenders that provide contractually committed, unsecured credit facilities in an aggregate maximum amount of $1,590 million (the “Credit Facilities”). The Credit Facilities include a 364-day revolving credit line in the amount of $565 million, which expires June 2005, a five-year revolving credit line in the amount of $775 million which expires June 2007, and a delayed-draw term loan in the amount of $250 million expiring in 2007, which is used primarily to finance new construction for our facilities consolidation in Southeast Michigan. Borrowings under the Credit Facilities bear interest based on a variable rate interest option selected at the time of borrowing and Visteon’s credit rating. Except for the construction related facility, Visteon and its subsidiaries may use the Credit Facilities for any and all general corporate purposes at the discretion of management. As of September 30, 2004, Visteon has borrowed about $198 million against the delayed-draw term loan facility. As of September 30, 2004, there were no outstanding borrowings under either the 364-day or the five-year facility; however, there were $98 million of obligations under standby letters of credit under the five-year facility, and, during the third quarter of 2004, Visteon borrowed and repaid $200 million under the 364-day revolving credit line to fund seasonal working capital needs.
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The Credit Facilities contain various affirmative and negative covenants, including limited cross default provisions, a negative financial covenant, a limitation on sale and leaseback transactions, as well as other customary provisions. The cross default provisions of the Credit Facilities could be triggered by an uncured default by Visteon in the payment of the principal of or interest on any borrowing of Visteon of at least $5 million. Pursuant to the negative financial covenant, Visteon may not exceed a leverage ratio of consolidated total debt to consolidated EBITDA for the trailing four quarters of 3.5 to 1. Consolidated total debt is defined as the aggregate principal amount of all indebtedness of Visteon and its subsidiaries minus all amounts of cash and cash equivalents. Consolidated EBITDA is defined as Visteon’s consolidated net income plus the sum of income tax expense, interest expense, amortization or write-off of debt discount and debt issuance costs, depreciation and amortization expense, any non-recurring expenses or losses, and adjusting for any gain or loss from a discontinued operation, or other material acquisition or disposition. At September 30, 2004, Visteon was in compliance with this as well as all other covenants. This covenant would have allowed an increase in Visteon’s consolidated total debt of approximately $850 million at September 30, 2004. Visteon expects to continue to be in compliance with this and other covenants contained in the Credit Facilities.
In addition, our indentures related to our unsecured debt securities contain cross default provisions which could be triggered by a default by Visteon or a significant subsidiary in its obligation to pay a principal or interest payment of $25 million or more.
Visteon also has bilateral financing arrangements with three banks providing a total of $75 million of revolving credit which contain similar covenants to those contained in the Credit Facilities and which expire in June 2006. At September 30, 2004, there were no outstanding borrowings under these bilateral arrangements.
At September 30, 2004, Visteon had $50 million of commercial paper outstanding, compared with $81 million outstanding at December 31, 2003. Moody’s short-term credit rating for Visteon is NP (Not Prime) while S&P’s short-term credit rating is WR (Withdrawn). These short-term credit ratings have significantly restricted Visteon’s access to the commercial paper market. Consequently, commercial paper is not relied upon as a source of short-term liquidity.
Visteon maintains a trade payables program through General Electric Capital Corporation (“GECC”), subject to periodic review, that provides financial flexibility to Visteon and its suppliers. When a supplier participates in the program, GECC pays the supplier the amount due from Visteon in advance of the original due date. In exchange for the earlier payment, our suppliers accept a discounted payment. Visteon pays GECC the full amount. Approximately $72 million and $100 million was outstanding to GECC under this program at September 30, 2004 and December 31, 2003, respectively, which is included in our reported debt balance. The $72 million balance is supported by standby letters of credit. At September 30, 2004, the maximum advance payment allowed was $95 million. As part of the same program with GECC, Visteon is allowed to defer payment to GECC for a period of up to 30 days. As of September 30, 2004, Visteon had not exercised the deferral option of the program. This agreement with GECC is scheduled to expire in December 2005. Visteon is evaluating opportunities to replace GECC with another service provider.
At December 31, 2003, Visteon participated in the Ford Supplier Early Pay program in which our receivables were reduced and our cash balances were increased. Visteon stopped participating in this program in the first quarter of 2004 and Ford is no longer offering this program to Visteon. At December 31, 2003, our receivables had been reduced by $75 million due to this program.
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Visteon uses interest rate swaps to manage its interest rate risk. These swaps effectively convert a portion of Visteon’s fixed rate debt into variable rate debt, and as a result, approximately 40% of Visteon’s borrowings are effectively on a fixed rate basis, while the remainder are subject to changes in short-term interest rates.
Credit Ratings
Visteon’s long-term credit rating with Standard & Poor’s (“S&P”) is BB+; with Moody’s it is Ba1, and with Fitch it is BB+. Visteon was placed on Negative watch by all three agencies during the third quarter of 2004. Visteon’s access to liquidity has become less reliable and more costly as a result of recent rating agency actions, and any further downgrade in Visteon’s credit ratings could further reduce its access to capital, further increase the costs of future borrowings, and increase the possibility of more restrictive terms and conditions contained in any new or replacement financing arrangements.
Cash Requirements
Visteon’s expected near-term cash outflows related to debt have changed since December 31, 2003 as a result of completing the March Notes Sale and the April Tender Offer as discussed further in Note 7 to the consolidated financial statements. The remaining balance of the 7.95% notes due August 1, 2005, of $250 million is now payable within one year. The weighted average maturity of Visteon’s long-term notes was 6.1 years at September 30, 2004, compared with 4.2 years in March 2004.
As of September 30, 2004, Visteon had guaranteed about $22 million of borrowings held by unconsolidated joint ventures. In addition, we have guaranteed Tier 2 suppliers’ debt and lease obligations of about $16 million at September 30, 2004 to ensure the continued supply of essential parts.
Visteon’s cash and liquidity needs also are impacted by the level, variability, and timing of our customers’ worldwide vehicle production, which varies based on economic conditions and market shares in major markets. Our intra-year needs are impacted also by seasonal effects in the industry, such as the shutdown of operations for about two weeks in July, the subsequent ramp-up of new model production and the additional one-week shutdown in December by our primary North American customers. These seasonal effects normally require use of liquidity resources during the first and third quarters.
Primarily due to the impact on profitability of recent production cutbacks by Visteon’s largest customer and material surcharges, we currently do not expect cash flows from operations for 2004 to be greater than capital expenditures. In addition, capital expenditures in 2005 related to our facilities consolidation project are expected to be lower than in 2004. If cash flow from operations is not sufficient to fund capital spending in 2005, we expect to have access to sufficient liquidity to supplement such spending, including but not limited to cash balances, short-term borrowings under the Credit Facilities, receivables-based programs, other asset-backed financing such as leasing, and capital markets access. However, because of the uncertainty regarding economic and market conditions, as well as our discussions with Ford, there can be no assurance that sufficient liquidity from internal or external sources will be available at the times or in the amounts required.
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Pension and Postretirement Benefits
Postretirement health care and life insurance expense during the third quarter 2004 was $36 million lower than the same period in 2003, reflecting Ford’s assumption of a portion of the liability for Visteon-assigned employees under the amended and restated agreements entered into with Ford in December 2003 and the Medicare Act, offset partially by lower discount rates. Pension expense for third quarter of 2004 was $4 million higher than the same period in 2003, reflecting primarily lower discount rates and the effect of the 2003 Ford-UAW collective bargaining agreement.
Ford has disclosed recently that they have received a request for information from the Securities and Exchange Commission in connection with an inquiry related to accounting for pension and other post-retirement benefit plans. Ford charges Visteon for a portion of the cost of pension and other postretirement benefits that are provided by Ford to Visteon-assigned Ford-UAW employees and certain salaried employees, as determined by Ford’s actuaries. Given the early stage of this matter, Visteon is unable to predict the impact, if any, that this matter may have on our results of operations or financial position.
Legislation
The Medicare Drug Improvement and Modernization Act of 2003 was signed into law on December 8, 2003. This legislation provides for a federal subsidy beginning in 2006 to sponsors of retiree health care benefit plans that provide a benefit at least actuarially equivalent to the benefit established by the law. Visteon’s plans generally provide retiree drug benefits that exceed the value of the benefit that will be provided by Medicare Part D, and we have concluded that our plans are actuarially equivalent, pending further definition of the criteria used to determine equivalence. This subsidy is estimated to reduce the benefit obligation for Visteon plans by $95 million, and will be recognized through reduced retiree health care expense over the related employee future service lives, of which $7 million has been recognized in the first nine months of 2004. The impact on Ford plans is included in the postretirement health care and life insurance expense decrease noted above.
Cash Flows
Operating Activities
Cash provided by operating activities during the first nine months of 2004 totaled $227 million, compared with cash provided by operating activities of $32 million for the same period in 2003. The improvement is more than explained by reduced pre-tax losses (net of non-cash asset impairment write-downs), improvements in non-Ford receivables and an increase in the utilization of our receivables-based programs. These improvements were offset partially by changes in Ford receivables and inventories. Cash provided from the utilization of our receivables-based programs was $72 million and $8 million during the first nine months of 2004 and 2003, respectively. Cash payments related to special charges, including those for severance and special pension benefits, were $145 million and $100 million during the first nine months of 2004 and 2003, respectively.
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Investing Activities
Cash used in investing activities was $552 million during the first nine months of 2004, compared with $554 million for the same period in 2003. Visteon’s capital expenditures in the first nine months of 2004 totaled $573 million, compared with $641 million for the same period in 2003. Visteon’s capital spending in each of 2003 and 2004 included spending to fund new construction for consolidation of operations in Southeast Michigan and also to fund IT infrastructure transition and improvements. Visteon anticipates that the facilities’ consolidation will allow us to centralize customer support functions, research and development, and selected business operations at lower recurring lease and operating costs. During the first nine months of 2004, Visteon sold $3 million of marketable securities, compared with net sales of securities of $70 million in the same period last year. Other investing cash flows are comprised mainly of proceeds from the sale of fixed assets.
Financing Activities
Cash provided by financing activities totaled $103 million in the first nine months of 2004, compared with $230 million in the same period in 2003. Financing activities in the first nine months of 2004 include a net increase in debt of $200 million due to the March Notes Sale and April Tender Offer, offset partially by reductions in short term debt and other debt.
On October 18, 2004, the Visteon Board of Directors declared a dividend of $0.06 per share on Visteon’s common stock payable on December 1, 2004, to the stockholders of record as of October 29, 2004.
Cautionary Statement regarding Forward-Looking Information
This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as “anticipate,” “expect,” “intend,” “plan,” “believe,” “seek,” “outlook” and “estimate” as well as similar words and phrases signify forward-looking statements. Visteon’s forward-looking statements are not guarantees of future results and conditions and important factors, risks and uncertainties may cause our actual results to differ materially from those expressed in our forward-looking statements, including, but not limited to, the following:
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These risks and uncertainties are not the only ones facing our company. Additional risks and uncertainties not presently known to Visteon or currently believed to be immaterial also may adversely affect Visteon. Any risks and uncertainties that develop into actual events could have material adverse effects on Visteon’s business, financial condition and results of operations. For these reasons, do not place undue reliance on our forward-looking statements. Visteon does not intend or assume any obligation to update any of these forward-looking statements.
New Accounting Standards and Accounting Changes
In December 2003, the FASB issued revised Interpretation No. 46 (“FIN 46”) “Consolidation of Variable Interest Entities.” Until this interpretation, a company generally included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns. Application of FIN 46 was required during the fourth quarter of 2003 for interests in structures that are commonly referred to as special-purpose entities and for all other types of variable interest entities in the first quarter of 2004. The effect of applying the consolidation provisions of FIN 46 on Visteon’s results of operations or financial position as of September 30, 2004 was not significant.
In December 2003, the FASB issued Statement of Financial Accounting Standards No. 132 (revised 2003) (“SFAS 132-R”), “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” This revised statement expands financial statement disclosures for defined benefit plans related to plan assets, investment policies, future benefit payments and plan contributions. Certain disclosure requirements of SFAS 132-R were effective for the year ended December 31, 2003, with additional disclosure requirements during 2004.
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Other Financial Information
PricewaterhouseCoopers LLP, an independent registered public accounting firm, performed a limited review of the financial data presented on page 1 through 20 inclusive. The review was performed in accordance with standards for such reviews established by the Public Company Accounting Oversight Board (United States). The review did not constitute an audit; accordingly, PricewaterhouseCoopers LLP did not express an opinion on the aforementioned data. Their review report included herein is not a “report” with the meaning of Sections 7 and 11 of the 1933 Act and the independent registered public accounting firm’s liability under Section 11 does not extend to it.
Visteon is exposed to market risks from changes in currency exchange rates, interest rates and certain commodity prices. To manage these risks, we use a combination of fixed price contracts with suppliers, cost sourcing arrangements with customers and financial derivatives. We maintain risk management controls to monitor the risks and the related hedging. Derivative positions are examined using analytical techniques such as market value and sensitivity analysis. Derivative instruments are not used for speculative purposes, as per clearly defined risk management policies.
Foreign Currency Risk
Visteon’s net cash inflows and outflows exposed to the risk of changes in exchange rates arise from the sale of products in countries other than the manufacturing source, foreign currency denominated supplier payments, debt and other payables, subsidiary dividends and investments in subsidiaries. Visteon’s on-going solution is to reduce the exposure through operating actions. We use foreign exchange forward contracts to manage a portion of our exposure.
Visteon’s primary foreign exchange exposure includes the Mexican peso, euro, Canadian dollar and Czech koruna. Because of the mix between our costs and our revenues in various regions, we are exposed generally to weakening of the euro and to strengthening of the Mexican peso, Canadian dollar and Czech koruna. For transactions in these currencies, Visteon utilizes a strategy of partial coverage. As of September 30, 2004, our coverage for projected transactions in these currencies was about 65% for 2004.
As of September 30, 2004 and December 31, 2003, the net fair value of financial instruments with exposure to currency risk was an asset of $9 million and a liability of $10 million, respectively. The hypothetical pre-tax gain or loss in fair value from a 10% favorable or adverse change in quoted currency exchange rates would be approximately $77 million and $81 million as of September 30, 2004 and December 31, 2003, respectively. These estimated changes assume a parallel shift in all currency exchange rates and include the gain or loss on financial instruments used to hedge loans to subsidiaries. Because exchange rates typically do not all move in the same direction, the estimate may overstate the impact of changing exchange rates on the net fair value of our financial derivatives. It is also important to note that gains and losses indicated in the sensitivity analysis would be offset by gains and losses on the underlying exposures being hedged.
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Interest Rate Risk
Visteon has entered into interest rate swaps to manage its interest rate risk. These swaps effectively convert a portion of Visteon’s fixed rate debt into variable rate debt, and as a result, approximately 40% of the company’s borrowings are on a fixed rate basis, while the remainder is subject to changes in short-term interest rates. Visteon’s interest rate swaps have contributed favorably to reduce interest expense in 2004. During the third quarter of 2004, Visteon reduced the portion of its debt that is subject to changes in short-term interest rates by unwinding some of its interest rate swaps. This action allowed us to maintain our desired mix of fixed and variable debt, after considering our cash balances.
As of September 30, 2004 and December 31, 2003, the net fair value of interest rate swaps was an asset of $6 million and $15 million, respectively. The potential loss in fair value of these swaps from a hypothetical 50 basis point adverse change in interest rates would be approximately $15 million and $10 million as of September 30, 2004 and December 31, 2003, respectively. Because of hedge accounting under Statement of Financial Accounting Standards No. 133 (“SFAS 133”), “Accounting for Derivative Instruments and Hedging Activities,” this reduction in value would not immediately affect Visteon’s reported income.
The annual increase in pre-tax interest expense from a hypothetical 50 basis point adverse change in variable interest rates (principally LIBOR) would be approximately $6 million and $5 million as of September 30, 2004 and December 31, 2003, respectively. Approximately half of the increases in expense is related to variable-rate debt and half is related to interest rate swaps.
Commodity Risk
Visteon has entered into long-term agreements with some of our key suppliers of non-ferrous metals to protect Visteon from changes in market prices. In addition, some products Visteon manufactures and sells to Ford containing non-ferrous metals are price-adjusted monthly based on metal content and market price. During the third quarter of 2003, Visteon initiated the use of financial instruments to lock in pricing of its forward year copper purchases. As of September 30, 2004 and December 31, 2003, the net fair value of copper derivatives was an asset of $3 million and $2 million, respectively. The potential loss in fair value from a 10% adverse change in quoted prices would be $2 million at September 30, 2004 and December 31, 2003. Because of hedge accounting under SFAS 133, this reduction in value would not immediately affect Visteon’s reported income.
Natural gas is a commodity Visteon uses in its manufacturing processing, related primarily to glass production, as well as for heating our facilities. Uncertainty in both supply and demand for this commodity has led to price instability over the last three years. As of September 30, 2004, Visteon has locked in pricing on about 80% of its remaining projected usage for 2004, through financial derivatives. As of September 30, 2004 and December 31, 2003, the net fair value of natural gas derivatives was an asset of $13 million and $9 million, respectively. The potential loss in fair value of these derivative contracts from a 10% adverse change in quoted prices would be approximately $5 million at September 30, 2004 and December 31, 2003. Because of hedge accounting under SFAS 133, this reduction in value would not immediately affect Visteon’s reported income.
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Steel products and plastics resins are purchased for various uses but are not hedged due to the lack of acceptable hedging instruments in the market. Visteon’s exposures to steel and resin price changes are currently managed through negotiations with our suppliers and our customers although there can be no assurance that Visteon will not have to absorb any or all price increases and/or surcharges. When and if acceptable hedging instruments for steel and plastics resins are available in the market, management will determine at that time if financial hedging is appropriate, depending upon Visteon’s exposure level at that time, the effectiveness of the financial hedge and other factors.
Precious metals (for catalytic converter production) are purchased through a Ford-directed source; Ford accepts all market price risk. As a result, we presently do not enter into financial derivatives to hedge these potential exposures.
As of the end of the period covered by this report, Visteon carried out an evaluation, under the supervision and with the participation of Visteon’s Disclosure Committee and management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon, and as of the date of, this evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in Visteon’s periodic SEC reports is recorded, processed, summarized and reported as and when required. Except as otherwise discussed herein, there have been no changes in Visteon’s internal control over financial reporting during the most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, Visteon’s internal control over financial reporting.
In January 2003, we entered into a global IT outsourcing arrangement with IBM, which provides for, among other things, the transition of Visteon applications from Ford’s IT systems, upon which we have relied since our spin-off. The first phase of this transition was completed in October 2003, and the second phase was completed in April 2004. The migration of all remaining applications from Ford’s IT systems is expected to be completed early in 2005.
We are currently undergoing a comprehensive effort in preparation for compliance with Section 404 of the Sarbanes-Oxley Act of 2002. In the course of its evaluation, management has identified certain deficiencies in internal controls over financial reporting which the company is addressing with remediation actions. Specifically, we are improving the controls and procedures related to the company’s new business processes and systems utilized to record revenue and manage the related accounts receivable associated with sales to Ford. Management will consider these and other matters when assessing the effectiveness of the company’s internal controls over financial reporting at year end.
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PART II. OTHER INFORMATION
We are involved in various legal proceedings, which are ordinary, routine proceedings, incidental to the conduct of our business. We do not believe that any legal proceedings to which we are a party will have a material adverse effect on our financial condition or results of operations, although such an outcome is possible.
Exhibits
Please refer to the Exhibit Index on Page 44.
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SIGNATURE
Pursuant to the requirements 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.
Date: November 4, 2004
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EXHIBIT INDEX
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In lieu of filing certain instruments with respect to long-term debt of the kind described in Item 601(b)(4) of Regulation S-K, Visteon agrees to furnish a copy of such instruments to the Securities and Exchange Commission upon request.
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