| MILACRON INC Item 1A Risk Factors Risks Relating to Our Liquidity and Our Indebtedness If our cash flow available to service our debt does not continue to improve, we may not be able to service our debt with cash from operating activities, which may cause us to default on our debt instruments |
| In 2001, 2002 and 2003, we experienced significantly lower demand for our plastics machinery, primarily due to the global economic slowdown and, more specifically, a dramatic decline in capital goods spending |
| While shipment volumes improved in 2004 and 2005, they remained below historical levels |
| These lower levels of demand for plastics machinery led to significantly more intense price competition than we had historically experienced |
| Our plastics processing customers’ production capacities were under utilized during the period 2001 through 2004 which resulted in a significant reduction in capital spending |
| While capacity utilization in the plastics processing industry improved in 2005, a return to higher levels of capital spending can be expected to trail the increase in utilization |
| During the year ended December 31, 2005, our earnings were inadequate to cover fixed charges by dlra20 million |
| It is possible that our business will not be able to generate sufficient cash flow from operations to service our indebtedness and pay other expenses, that currently anticipated cost savings and operating improvements will not be realized on schedule or at all or that future borrowings will not be available to us under our asset based facility in an amount sufficient to enable us to make interest payments on our indebtedness or to fund other liquidity needs |
| Our continued viability depends on realizing anticipated cost savings and operating improvements on schedule during 2006 and, as we have seen moderate improvements in order levels in 2005, continued improvement in sales volume in 2006 and beyond, the latter of which is largely beyond our control |
| Unless we realize anticipated cost savings and operating improvements on schedule and volume and pricing levels improve, we may need to fund interest payments on our 111/2prca Senior Secured Notes in part with the proceeds of borrowings under our asset based facility, the major provisions of which are discussed in detail in the section of Item 7 of this Form 10-K captioned “Liquidity and Sources of Capital |
| ” However, our ability to borrow under our asset based facility is subject to borrowing base limitations, including an excess availability reserve (as described below), which may be adjusted from time to time by the administrative agent for the lenders at its discretion, and our satisfaction of certain conditions to borrowing under our asset based facility, including, among other things, conditions related to the continued accuracy of our representations and warranties and the absence of any unmatured or matured defaults (including under financial covenants) or any material adverse change in our business or financial condition |
| In particular, our continued ability to borrow under our asset based facility is contingent on our ability to comply with financial covenants, including a minimum cumulative total North America EBITDA requirement and a cumulative capital expenditures limitation that will apply during 2006 if our availability under the asset based facility falls below specified levels for specified periods and a minimum fixed charge coverage ratio requirement beginning in 2007 |
| We have had to seek several waivers of and amendments to the financial covenants in our asset based facility in order to continue to be able to borrow, and we may need to attempt to further renegotiate our covenants with our lenders to assure compliance |
| However, we cannot control our lenders’ actions and future negotiations may be unsuccessful |
| If we have no additional availability or are otherwise unable to borrow against our asset based facility, our liquidity would be impaired and we would need to pursue alternative sources of liquidity to service our debt and pay our expenses |
| It is possible that we would not be able to sell assets, refinance debt or raise equity on commercially acceptable terms or at all, which could cause us to default on our obligations under our indebtedness |
| Our inability to generate sufficient cash flow or draw sufficient amounts under our asset based facility to satisfy our debt obligations and pay our other expenses, or our failure to comply with the covenants governing our indebtedness, could cause us to default on our obligations and would have a material adverse effect on our business, financial condition and results of operations |
| Our liquidity depends on the availability of borrowings under our asset facility, which is subject to the discretion of the administrative agent thereunder |
| Pursuant to the terms of our asset based facility, the cash we receive from collection of receivables is subject to an automatic “sweep” to repay the borrowings under our asset based facility on a daily basis |
| As a result, we rely on borrowings under our asset based facility as our primary source of cash for use in our North American operations |
| 11 _________________________________________________________________ [64]Table of Contents The availability of borrowings under our asset based facility is subject to a borrowing base limitation, including a dlra10 million excess availability reserve and a dlra1 million hedging reserve (as a result of an interest rate swap that was entered into in 2004), and other conditions to borrowing |
| Certain of the components of the borrowing base are subject to the discretion of the administrative agent |
| In addition, the satisfaction of conditions to borrowing under our asset based facility is determined by the administrative agent in its discretion |
| Further, the administrative agent has the customary ability to reduce, unilaterally, the availability of borrowings at any time by, for example, reducing advance rates, imposing or changing collateral value limitations, establishing reserves or declaring certain collateral ineligible |
| If the administrative agent exercises its discretion and limits the availability of borrowings under our asset based facility, our liquidity could be materially adversely affected and our availability could fall below the levels at which additional covenants, including a minimum cumulative total North America EBITDA requirement, would begin to apply |
| Our substantial level of indebtedness may adversely affect our financial condition, limit our ability to grow and compete and prevent us from fulfilling our obligations under our indebtedness |
| As of December 31, 2005, we had approximately dlra240 million in total indebtedness |
| In addition, as of December 31, 2005, we and certain of our non-US subsidiaries had guaranteed dlra6 million of off-balance sheet obligations related to customer financings |
| As of December 31, 2005, we had approximately dlra65 million of undrawn commitments under our asset based facility of which approximately dlra37 million was available to be borrowed |
| Our substantial indebtedness could have important consequences |
| For example, it could: • require us to dedicate a substantial portion or even all of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, research and development efforts and other general corporate purposes; • increase the amount of interest expense that we have to pay because some of our borrowings are at variable rates of interest, which, if increased, will result in higher interest payments; • increase our vulnerability to existing and future adverse economic and industry conditions; • limit our flexibility in planning for, or reacting to, changes in our business and the industries in which we operate; • make it more difficult for us to satisfy our obligations with respect to our indebtedness; • place us at a competitive disadvantage compared to our competitors that have less indebtedness; • limit, along with the financial and other restrictive covenants in our indebtedness, among other things, our ability to borrow additional funds, dispose of assets or pay cash dividends; and • restrict us from making strategic acquisitions, introducing new technologies or exploiting business opportunities |
| The agreements governing our indebtedness impose financial and other restrictions upon us, including compliance with certain financial covenants |
| In addition, our asset based facility is subject to a borrowing base limitation, including the excess availability reserve, which may be adjusted from time to time in the discretion of the administrative agent for the lenders and is subject to meeting financial covenants |
| We have had to seek several waivers of and amendments to the covenants in our asset based facility in order to remain in compliance, and we may not be able to comply with these covenants in the future or satisfy conditions to the availability of borrowings |
| Failure to achieve compliance with covenants contained in any of these agreements could result in a loss of funding availability or a default under the related agreement, and could lead to acceleration of the related debt and the acceleration of debt under the other agreements |
| If we are unable to meet our expenses and debt obligations, we will need to refinance all or a portion of our indebtedness, sell assets or raise equity |
| However, we may not be able to refinance or otherwise repay such indebtedness, sell assets or raise equity on acceptable terms or at all and, if that is the case, we would be unable to service our indebtedness and our continued viability would be threatened |
| 12 _________________________________________________________________ [65]Table of Contents Despite current indebtedness levels, we and our subsidiaries may still be able to incur substantially more debt |
| This could further exacerbate the risks associated with our substantial leverage |
| We and our subsidiaries may be able to incur substantial additional indebtedness in the future |
| The terms of the agreements governing our indebtedness do not fully prohibit us or our subsidiaries from doing so |
| Subject to borrowing base limitations, including an excess availability reserve, which may be adjusted from time to time in the discretion of the administrative agent for the lenders under our asset based facility, and our satisfaction of certain conditions to borrowing under our asset based facility, including, among other things, conditions related to the continued accuracy of our representations and warranties and the absence of any unmatured or matured defaults (including under financial covenants) or any material adverse change in our business or financial condition, our asset based facility permits additional borrowings thereunder |
| As of December 31, 2005, we had approximately dlra65 million of undrawn commitments thereunder of which approximately dlra37 million was available to be borrowed |
| If new debt is added to our subsidiaries’ current debt levels, the related risks that we and they now face could intensify |
| Restrictions and covenants in debt agreements limit our ability to take certain actions |
| The indenture governing the 111/2prca Senior Secured Notes and the credit agreement for our asset based facility contain a number of significant restrictions and covenants that limit our ability and our subsidiaries’ ability, among other things, to: • borrow money; • use assets as security in other borrowings or transactions; • pay dividends on capital stock or purchase capital stock; • sell assets; • enter into certain transactions with affiliates; and • make certain investments or acquisitions |
| We are currently restricted by the terms of the indenture from paying dividends on our Series B Preferred Stock |
| As discussed above, the credit agreement for our asset based facility requires us to satisfy certain financial covenants and other conditions to borrowing |
| Also, the availability of borrowings under our asset based facility are subject to a borrowing base limitation, including the excess availability and hedging reserves and our satisfaction of certain conditions to borrowing |
| Subject to certain limited exceptions, our accounts receivable and inventory, our cash and cash equivalents and certain other collateral, are pledged to secure on a first priority basis our asset based facility and certain other obligations and, subject to certain exceptions, are not permitted to be pledged to secure other indebtedness we or our subsidiaries may otherwise be able to incur |
| Events beyond our control, such as prevailing economic conditions, changes in consumer preferences and changes in the competitive environment, could hinder any improvement in, or further impair, our operating performance, which could affect our ability and that of our subsidiaries to comply with the terms of our debt instruments |
| It is possible that we and our subsidiaries will not be able to comply with the provisions of our respective debt instruments, including any applicable financial covenants in the credit agreement for our asset based facility |
| Breaching any of these covenants, conditions or restrictions or the failure to comply with our obligations after the lapse of any applicable grace periods could result in a loss of funding availability or a default under the applicable debt instruments, including the credit agreement for our asset based facility |
| If there were an event of default, holders of such defaulted debt could cause all amounts borrowed under these instruments to be due and payable immediately |
| It is possible that our assets or cash flow or that of our subsidiaries would not be sufficient to fully repay borrowings under the outstanding debt instruments, either upon maturity or if accelerated upon an event of default |
| It is also possible that if we were required to repurchase the 111/2prca Senior Secured Notes or any other debt securities upon a change of control we would not be able to refinance or restructure the payments on such debt |
| Further, if we are unable to repay, refinance or restructure our indebtedness under our asset based facility, the 13 _________________________________________________________________ [66]Table of Contents lenders under our asset based facility could proceed against the collateral securing that indebtedness |
| In that event, any proceeds received upon a realization of such collateral would be applied first to amounts due under our asset based facility before any proceeds would be available to make payments on the 111/2prca Senior Secured Notes |
| In addition, any event of default or declaration of acceleration under one debt instrument could also result in an event of default under one or more of our or our subsidiaries’ other debt instruments, including the 111/2prca Senior Secured Notes |
| Due to the restrictions, conditions and covenants contained in the credit agreement for our asset based facility, we may need to seek additional amendments or waivers from our lenders in order to avoid a loss of funding availability or a default resulting from an inability to improve our results of operations or to permit our entry into certain transactions we may desire to consummate in the future |
| In the past, we have had to seek amendments and waivers to financing facilities, including our asset based facility, and in certain cases we have agreed to pay the lenders a fee to obtain their consent |
| We may be required to pay the lenders under our asset based facility a fee for their consent to any further amendments or waivers we may seek in the future |
| It is also possible that we will not be able to obtain any amendment or waiver we may seek in the future |
| It is also possible that we will need to seek bondholder consent for certain transactions we may desire to consummate in the future |
| There can be no assurance that such consent will be received |
| An “ownership change” for US federal income tax purposes will cause utilization of our pre-change tax loss carryforwards and other tax attributes to be substantially delayed, which could increase income tax expense and decrease available cash in future years |
| The conversion of certain of our debt obligations into common stock and the subsequent exchange of this common stock and certain other debt obligations for convertible preferred stock on June 10, 2004 triggered an “ownership change” for US federal income tax purposes |
| As a consequence of the ownership change, the timing of our utilization of our pre-change US tax loss carryforwards and other tax attributes will be limited to an amount of approximately dlra23 million per year |
| The allowable limitation is cumulative for years in which it is not fully utilized |
| At December 31, 2005, the cumulative limitation amounts to approximately dlra35 million which consists of dlra12 million from 2004 and dlra23 million from 2005 |
| This delay could increase tax expense and decrease available cash in future years |
| The above limitations do not apply to any post-change in control net operating losses incurred |
| Risks Relating to Our Business If we fail to continue to comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 or to remedy any material weaknesses in our internal controls that we may identify in the future, such failure could result in material misstatements in our financial statements, cause investors to lose confidence in our reported financial information and have a negative effect on the trading price of our common stock |
| During 2004, we conducted our initial evaluation of the company’s internal control over financial reporting based on the criteria established in “Internal Control — Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) |
| We assessed the effectiveness of the company’s internal control over financial reporting as of December 31, 2004 |
| As of that date, three material weaknesses, as defined in standards established by the Public Company Accounting Oversight Board (United States), were identified |
| A material weakness is a deficiency in internal control over financial reporting that results in more than a remote likelihood that a material misstatement of annual or interim financial statements will not be prevented or detected |
| The identified weaknesses were as follows: • inadequate levels of review of complex and judgmental accounting issues; • inadequate segregation of incompatible duties with respect to manual and computer-based business processes at the corporate and operating levels; and • insufficient controls with respect to the accounting for inventories, primarily at one major North American manufacturing facility |
| 14 _________________________________________________________________ [67]Table of Contents During 2005, we successfully remediated these material weaknesses and no additional material weaknesses were identified on our assessment as of December 31, 2005 |
| However, there can be no assurance that material deficiencies will not be identified in the future |
| In the event that a material weakness is identified, we will employ qualified personnel and adopt and implement policies and procedures to address any material weaknesses that we identify |
| However, the process of designing and implementing effective internal controls is a continuous effort that requires us to anticipate and react to changes in our business and the economic and regulatory environments and to expend significant resources to maintain a system of internal controls that is adequate to satisfy our reporting obligations as a public company |
| There can be no assurance that the measures we will take will remediate any material weaknesses that we may identify or that we will implement and maintain adequate controls over our financial process and reporting in the future |
| Any failure to remediate any material weaknesses that we may identify or to implement new or improved controls, or difficulties encountered in their implementation, could harm our operating results, cause us to fail to meet our reporting obligations or result in material misstatements in our financial statements |
| Any such failure also could adversely affect the results of the periodic management evaluations and, in the case of a failure to remediate any material weaknesses that we may identify, would adversely affect the annual auditor attestation reports regarding the effectiveness of our internal control over financial reporting that are required under Section 404 of the Sarbanes-Oxley Act of 2002 |
| Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our capital stock |
| Many of our customers are in cyclical industries that have historically experienced significant downturns, which has resulted in substantially reduced demand for our products |
| The success of our business depends on the profitability of our customers’ business |
| Many of our customers are in businesses that are highly cyclical in nature and sensitive to changes in general economic conditions, such as the automotive, building materials, electronics and consumer durables industries |
| Their demand for our products and services changes as a result of general economic conditions (including increases in their cost structures), interest rates and other factors beyond our control |
| The performance of our business is directly related to the production levels of our customers |
| In particular, prices for plastic resins used to make plastic products and parts increased significantly in 2005 and can be expected to remain at high levels for the foreseeable future |
| When resin prices increase, our customers’ profit margins decrease, resulting in lower demand for our products |
| Therefore, our business is affected by fluctuations in the price of resin which has had an adverse effect on our business and ability to generate operating cash flows |
| The costs of other materials and services used by our customers also increased during 2005, a factor which has also adversely affected our sales volume and profitability |
| As a result of the significant downturn in the US manufacturing sector that began in 2001, consolidated sales from continuing operations fell from peak levels of dlra994dtta3 million in 1999 and dlra974dtta5 million in 2000 to dlra755dtta2 million in 2001, dlra693dtta2 million in 2002, dlra739dtta7 million in 2003, dlra774dtta2 million in 2004 and dlra808dtta9 million in 2005 |
| Our net loss from all operations including goodwill impairment charges, restructuring costs, refinancing costs, discontinued operations and cumulative effect of change in method of accounting was dlra35dtta6 million in 2001, dlra223dtta2 million in 2002, dlra190dtta9 million in 2003, dlra51dtta8 million in 2004 and dlra14dtta0 million in 2005 |
| While demand is gradually improving, we have experienced a prolonged decrease in our plastics machinery sales because of the slowdown in many of our plastics technologies businesses end markets |
| For the year ended December 31, 2005, sales in our three plastics technologies businesses were dlra696dtta7 million, compared to dlra904dtta2 million in 1999, dlra873dtta8 million in 2000, dlra662dtta4 million in 2001, dlra597dtta2 million in 2002, dlra635dtta5 million in 2003 and dlra665dtta2 million in 2004 |
| While sales have continued to improve in relation to the low point that occurred in 2002, they have not yet reached the levels attained in 1999 and 2000 |
| From continuing operations, we lost dlra28dtta6 million in 2001, dlra18dtta7 million in 2002, dlra183dtta7 million in 2003, dlra51dtta3 million in 2004 and dlra16dtta5 million in 2005 |
| The loss from continuing operations for 2003 includes a noncash goodwill impairment charge of dlra65dtta6 million (with no tax benefit) and an income tax charge of approximately dlra71 million to establish valuation allowances related to US deferred tax assets |
| The losses for 2003 and 2004 include refinancing costs of dlra1dtta8 million and dlra21dtta4 million, respectively, in both cases, with no tax benefit |
| Declines in economic conditions in 15 _________________________________________________________________ [68]Table of Contents the industries served by our customers has and may continue to have a material adverse effect on our business and ability to generate positive operating cash flows |
| If a large portion of our North American and Western European customers continue to outsource their manufacturing activities to areas where we do not currently have manufacturing operations, we may encounter difficulties keeping these customers |
| In recent years, many companies have been outsourcing their manufacturing activities to lower cost regions such as Asia and Eastern Europe |
| The toy industry and the electronics industry, for example, have outsourced much of their manufacturing to areas outside the United States and Western Europe |
| Retaining business from outsourcing customers involves challenges such as being able to compete for their business with competitors that have more proximate operations, incurring extra costs to supply those customers, and in some cases being able to establish our own manufacturing operations closer to those customers, as we did in China in 2004 with the formation of a joint venture to manufacture injection molding machines |
| However, the establishment of new manufacturing operations involves significant investment and time |
| If our customers continue to outsource to lower cost areas, we may not be able to expand our operations rapidly enough to meet their needs on a cost-effective basis or at all |
| Additionally, if our competitors further expand their operations to China and other areas where manufacturing activities are outsourced before we do, they may increase their customer base at our expense |
| We operate in highly competitive industries, many of which are currently subject to intense price competition, and if we are unable to compete successfully our results of operations could fail to further improve or could deteriorate |
| Many of the industries in which we operate are highly competitive |
| Our products may not compete successfully with those of our competitors |
| The markets for plastics machinery and related products are highly competitive and include a number of North American, European and Asian competitors |
| Principal competitive factors in the plastics machinery industry are: price, product features, technology, performance, reliability, quality, delivery and customer service |
| We also face many competitors in the industrial fluids segment of our business |
| Principal competitive factors in our industrial fluids segment include price, market coverage, technology, performance, delivery and customer service |
| We may encounter difficulties in our restructuring and cost-savings efforts, which could prevent us from achieving our anticipated cost savings |
| Over the past several years we have taken significant actions to realign our cost structure to improve customer service and respond to the lower levels of demand we have experienced in our plastics technologies businesses |
| During 2005, we announced that we will be implementing additional plans to further reduce our costs and streamline our operations |
| However, we may not be able to fully implement these plans or achieve anticipated cost reductions |
| In addition, our anticipated cost savings are based upon certain estimates that may prove to be inaccurate |
| Our ability to achieve the anticipated cost savings could be adversely affected by a number of factors, including, for example, compliance with foreign labor and other laws and regulations and disruptions to our operations that may occur in implementing planned restructurings |
| Further increases in our cost structure will have an adverse effect on our operating results on cash flows |
| During 2005, we experienced significant increases in the costs of raw materials used in our business, particularly for steel and for chemicals used in the production of metalworking fluids |
| We also experienced higher transportation and utility costs due principally to significant increase in oil prices |
| As discussed elsewhere in this Item 1A, our pension costs continued to increase in 2005 and can be expected to increase further in 2006 |
| In combination, these factors adversely affected our profitability in 2005 and can be expected to continue to do so in the future |
| While we have responded by further reducing our cost structure and increasing the prices we charge our customers, these measures were not always sufficient to offset the effects of the cost increases we experienced |
| Our asset based facility includes a covenant that requires us to maintain minimum levels of EBITDA in 2006 in certain circumstances and achieve specified fixed charge coverage ratios beginning in 2007 |
| If we are unable to minimize 16 _________________________________________________________________ [69]Table of Contents the effects of historical and future cost increases with further selling price increases, it is possible that we will be unable to comply with these covenants |
| Our significant international operations subject us to risks such as unfavorable political, regulatory, labor and tax conditions |
| Our business is subject to risks related to the different legal, political, social and regulatory requirements and economic conditions of many jurisdictions |
| For the year ended December 31, 2005, markets outside the US represented the following percentages of our consolidated sales: Europe 26prca; Canada and Mexico 7prca; Asia 7prca; and the rest of the world 4prca |
| We expect sales from international markets to continue to represent a significant portion of our total sales |
| Risks inherent in our international operations include the following: • agreements may be difficult to enforce and receivables difficult to collect through a foreign country’s legal system; • foreign countries may impose additional withholding taxes or otherwise tax our foreign income, impose tariffs or adopt other restrictions on foreign trade or investment, including currency exchange controls; • general economic and political conditions in the countries in which we operate could have an adverse effect on our earnings from operations in those countries; • fluctuations in exchange rates may affect product demand and may adversely affect the profitability in US dollars or products and services provided by us in foreign markets where payment for our products and services is made in the local currency; • unexpected adverse changes in foreign laws or regulatory requirements may occur; and • compliance with a variety of foreign laws and regulations may be difficult |
| Our overall success as a global business depends, in part, upon our ability to succeed in differing and unpredictable legal, regulatory, economic, social and political conditions |
| We may not be able to continue to succeed in developing and implementing policies and strategies that will be effective in each foreign market where we do business |
| Any of the foregoing factors may have a material adverse effect on our ability to generate cash flow and grow our business |
| Our operations are conducted worldwide and our results of operations are subject to currency translation risk and currency transaction risk that could adversely affect our financial condition and results of operations |
| The financial condition and results of operations of each of our foreign operating subsidiaries are reported in the relevant local currency and then translated to US dollars at the applicable currency exchange rate for inclusion in our consolidated financial statements |
| Exchange rates between these currencies and US dollars in recent years have fluctuated significantly and may do so in the future |
| For the year ended December 31, 2005, we generated approximately 44prca of our sales in foreign currencies, particularly the euro |
| Significant changes in the value of the euro relative to the US dollar could have an adverse effect on our financial condition and results of operations and our ability to meet interest and principal payments on euro-denominated debt and US dollar denominated debt |
| For the year ended December 31, 2004, we experienced favorable translation effects on new orders of dlra24 million and sales of dlra25 million in relation to 2003 |
| In 2005, favorable currency effects in relation to 2004 were dlra4 million for new orders and dlra3 million for sales despite a weakening of the euro versus the US dollar over the course of the year |
| The effects on earnings were not material in either 2004 or 2005 |
| If the euro should continue to weaken against the US dollar in the future, we will experience a negative effect in translating our European new orders, sales and earnings when compared to historical results |
| In addition to currency translation effects, we incur currency transaction risk whenever one of our operating subsidiaries enters into either a purchase or a sales transaction using a different currency from the currency in which it records revenues |
| Given the volatility of exchange rates, we may not be able to effectively manage our currency transaction and translation risks and any volatility in currency exchange rates may have an adverse effect on our financial condition or results of operations and, therefore, on our ability to make principal and interest payments on our indebtedness when due |
| 17 _________________________________________________________________ [70]Table of Contents Our operations depend to a great extent on the economy of the European and Asian markets |
| These economies may not be as stable as that of the US Our operations depend upon the economies of the European and Asian markets |
| These markets include countries with economies in various stages of development or structural reform, some of which are subject to rapid fluctuations in terms of consumer prices, employment levels, gross domestic product, interest and foreign exchange rates |
| We may be subject to such fluctuations in the local economies |
| To the extent such fluctuations have an effect on the ability of our consumers to pay for our products, the growth of our products in such markets could be impacted negatively |
| Certain of our targeted markets are in countries in which the rate of inflation is significantly higher than that of the US It is possible that significant increases in the rates of inflation in such countries could not be offset, in whole or in part, by corresponding price increases by us even over the long-term |
| Our principal US pension plan is underfunded, which we expect will require us to make cash contributions to the plan, which, in turn, will reduce the cash available for our business, and adverse equity market or interest rate conditions may increase our pension liability and expense |
| As of December 31, 2005, the projected benefit obligation under our Milacron Retirement Plan exceeded the plan’s fair value of assets by dlra165 million, based on a discount rate of 5dtta75prca |
| In 2004 and 2005, we were required to make contributions to this plan of dlra4dtta2 million and dlra2dtta4 million, respectively |
| We will be required to make significant additional contributions to the plan in the future in order to comply with minimum funding requirements imposed by the Employee Retirement Income Security Act of 1974, as amended, and the Internal Revenue Code of 1986, as amended |
| The amount of any such required contributions will be determined annually based on an actuarial valuation of the plan as performed by the plan’s actuaries |
| Based on an actuarial valuation for the plan completed as of January 1, 2005, contributions are expected to be dlra2dtta7 million in 2006 |
| This amount is not expected to change significantly, if at all |
| We currently expect that the minimum required contribution in 2007 will be approximately dlra50 million |
| However, actual contributions for years after 2006 cannot be reasonably determined at this time because of the potential effects of new legislation pending in the US Congress |
| If enacted, this legislation is expected to have the effect of increasing the total required contribution amounts but allowing them to be made over a longer period of time than under current law |
| Enactment of the legislation could significantly change the estimated minimum required contribution for 2007 of dlra50 million |
| In addition, interest rate relief measures that had been in place under the Pension Funding Act of 2004 expired on December 31, 2005 and have not yet been replaced |
| These relief measures allowed plan sponsors to use higher interest rates based on corporate bond yields to establish funding requirements than would otherwise have been the case |
| In this regard, current law would have required the yield in 30 year Treasury securities to be used if interest rate relief had not been in place |
| In the absence of interest rate relief or new legislation, funding requirements beyond 2006 could increase substantially |
| We are evaluating various alternatives, some of which have the potential of permitting us to satisfy our funding obligations over a longer period of time, but there is no assurance that these measures will be available or prove to be feasible |
| Additionally, there is a risk that if the Pension Benefit Guaranty Corporation concludes that its risk with respect to our pension plan may increase unreasonably if the plan continues to operate, if we are unable to satisfy the minimum funding requirement for the plan or if the plan becomes unable to pay benefits, then the Pension Benefit Guaranty Corporation could terminate the plan and take control of its assets |
| In such event, we may be required to make an immediate payment to the Pension Benefit Guaranty Corporation of all or a substantial portion of the underfunding as calculated by the Pension Benefit Guaranty Corporation based upon its own assumptions |
| The underfunding calculated by the Pension Benefit Guaranty Corporation could be substantially greater than the underfunding we have calculated because, for example, the Pension Benefit Guaranty Corporation may use a significantly lower discount rate |
| If such payment is not made, then the Pension Benefit Guaranty Corporation could place liens on a material portion of our assets and the assets of any members of our controlled group |
| Such action could adversely affect our financial condition and results of operations |
| In addition, failure to fund the pension plan as required by law (or incurring certain liens in connection with a failure to fund or seeking a waiver from funding obligations) would be a breach of the terms of our asset based facility and therefore a default |
| If such default is not cured or waived, our indebtedness could be accelerated which would have a material adverse effect on our liquidity and financial position |
| Finally, funding the pension plan might require the sale of significant business assets which 18 _________________________________________________________________ [71]Table of Contents would adversely affect our ability to generate cash in the future |
| In addition, such sales of assets would generally require lender and, possibly, bondholder consent and it is possible that such consent will not be granted |
| As a result of the decline in the financial markets, we changed our assumption for the expected rate of return on plan assets in 2003 from 9dtta5prca to 9prca |
| The rate will be further lowered to 8dtta75prca for 2006 |
| The change from the 9dtta5prca rate of return assumption to the lower 9prca rate had the effect of increasing the amount of pension expense that would otherwise have been reportable in 2005 by more than dlra1dtta8 million |
| The change to the 8dtta75prca rate for 2006 will have the effect of increasing pension expense by $ |
| 9 million in relation to the amount that would be recorded using the 9prca rate |
| Before deducting charges of dlra4dtta7 million for supplemental retirement benefits, we recorded pension income of dlra9dtta4 million related to this plan in 2002, of which dlra7dtta6 million related to continuing operations |
| In 2003, however, pension income decreased to dlra0dtta6 million, once again excluding charges for supplemental benefits of dlra3dtta2 million |
| In 2004, we recorded pension expense of dlra6dtta7 million, substantially all of which related to continuing operations |
| Pension expense increased further to dlra12dtta3 million in 2005 |
| Pension expense for 2006 and beyond is dependent on a number of factors including returns on plan assets and changes in the plan’s discount rate and therefore cannot be predicted with certainty |
| At this time, however, we expect pension expense to be approximately dlra13 to dlra14 million in 2006 |
| Because of the significant decrease in the value of the assets of the funded plan for certain US employees and retirees during 2001 and 2002 and decreases in the plan’s discount rate, we recorded a minimum pension liability adjustment of dlra118 million effective December 31, 2002 |
| This resulted in a dlra95 million after-tax reduction in shareholders’ equity |
| At December 31, 2003, the reduction in shareholders’ equity was decreased by dlra14 million (with no tax effect) due to an increase in plan assets in 2003 that was partially offset by an increase in liabilities that resulted from a lower discount rate |
| However, the amount of the adjustment to shareholders’ equity related to this plan was increased by dlra6 million in 2004 and dlra18 million in 2005 (in both cases, with no tax benefit) due principally to further discount rate reductions |
| These adjustments were recorded as a component of accumulated other comprehensive loss and therefore did not affect reported earnings or loss |
| However, they resulted in after-tax reductions of shareholders’ equity, including dlra105 million at December 31, 2005 |
| Adverse market conditions or additional discount rate reductions would result in an increase in the plan’s underfunded position, which would result in further minimum pension liability adjustments |
| We may be unable to respond in an effective and timely manner to technological changes in our industry and could lose customers as a result |
| Our success in the future will depend in part upon our ability to maintain and enhance our technological capabilities, develop and market products and applications that meet changing customer needs and successfully anticipate or respond to technological changes of our competitors in a cost-effective and timely manner |
| Our inability to anticipate, respond to or utilize changing technologies could cause us to lose customers |
| We may not be able to adequately protect our intellectual property and proprietary rights, which could harm our future success and competitive position |
| Our future success and competitive position depend in part upon our ability to obtain and maintain certain proprietary technologies used in our principal products |
| We have not always been successful in preventing the unauthorized use of our existing intellectual property rights by our competitors |
| For example, in the past we have determined that certain of our competitors were using our patented designs in the designs of their machines |
| We negotiated royalty payments from these competitors which totaled dlra8dtta3 million in 2000, dlra1dtta1 million in 2001, dlra4dtta5 million in 2002, $ |
| It is possible we will not be able to discover unauthorized use of our proprietary technologies in the future or that we will not be able to receive any payments therefor |
| If we are not successful in protecting our intellectual property it may result in the loss of valuable technologies or require us to make payments to other companies for utilizing their intellectual property rights |
| We generally rely on patent, trade secret and copyright laws as well as confidentiality agreements with other parties to protect our technologies; however, some of our technologies may not be protected |
| In addition, we cannot be assured that: • any of our patents will not be invalidated, circumvented or licensed to others; • any of our pending or future patent applications will be issued within the scope of the claims sought by us, if at all; 19 _________________________________________________________________ [72]Table of Contents • others will not develop technologies that are similar or superior to our technologies, duplicate our technologies or design around our patents; or • steps taken by us to protect our technologies will prevent misappropriation of such technologies |
| We also own or have rights to various trademark registrations and trademark registration applications in the United States and certain international jurisdictions that we use in connection with our business |
| Policing unauthorized use of our trademarks is difficult and expensive, and it is possible that we will not be able to prevent misappropriation of our trademark rights in all jurisdictions, particularly in countries whose laws do not grant the same protections as does the United States |
| We are subject to litigation that could have an adverse effect upon our business, financial condition, results of operations or reputation |
| We are a defendant in or otherwise a party to numerous lawsuits and other proceedings that result from, and are incidental to, the conduct of our business |
| These suits and proceedings concern issues including product liability, patent infringement, environmental matters and personal injury matters |
| In several such lawsuits and proceedings, some of which seek substantial dollar amounts, multiple plaintiffs allege personal injury involving products, including metalworking fluids and tools, supplied and/or managed by us |
| We are vigorously defending these claims and, based on current information, believe we have recorded appropriate reserves in addition to excess carrier insurance coverage and indemnity claims against third parties |
| The projected availability under our asset based credit facility is currently expected to be adequate to cover our cash needs under these claims, assuming satisfaction or waiver of the conditions to borrowing thereunder |
| However, it is possible that our ultimate liability could substantially exceed our current reserves, but the amount of any such excess cannot reasonably be determined at this time |
| Were we to have significant adverse judgments or determine as the cases progress that significant additional reserves should be recorded, our future operating results and financial condition, particularly our liquidity, could be adversely affected |
| Our operations may subject us to potential responsibilities and costs under environmental laws that could have an adverse effect on our business, financial condition and results of operations |
| Our operations are subject to environmental laws and regulations in the US and abroad relating to the protection of the environment and health and safety matters, including those governing discharges of pollutants to the air and water, the management and disposal of hazardous substances and wastes and the clean-up of contaminated sites |
| The operation of manufacturing plants entails risks under environmental laws and regulations |
| We could incur significant costs, including clean-up costs, fines and sanctions, and claims by third parties for property damage and personal injury, as a result of violations of or liabilities under these laws and regulations |
| We are currently involved in a limited number of remedial investigations and actions at various locations, including former plant facilities and off-site disposal sites |
| While, based on information currently known to us, we believe that we maintain adequate reserves with respect to these matters, our liability could exceed forecasted amounts, and the imposition of additional clean-up obligations or the discovery of additional contamination at these or other sites could result in additional costs |
| In addition, potentially significant expenditures could be required to comply with environmental laws and regulations, including requirements that may be adopted or imposed in the future |
| A significant softening of the US economy could require us to change our assumptions regarding our deferred tax assets, which could materially increase our income tax expense and adversely affect our results of operations |
| At December 31, 2005, we had significant deferred tax assets related to US and non-US net operating loss and tax credit carryforwards and related to charges that have been deducted for financial reporting purposes but which are not yet deductible for income tax reporting |
| These charges include the write-down of goodwill and a charge to equity related to minimum pension funding |
| At December 31, 2005, we had provided valuation allowances against all net deferred tax assets except dlra62 million in the US that are offset by qualified tax planning strategies and available carrybacks and dlra9 million of non-US assets to be realized through future income expectations and tax planning strategies |
| Valuation allowances serve to reduce the recorded deferred tax assets to amounts reasonably expected to be realized in the future |
| The establishment of valuation allowances and their 20 _________________________________________________________________ [73]Table of Contents subsequent adjustment requires a significant amount of judgment because expectations as to the realization of deferred tax assets — particularly those assets related to net operating loss carryforwards — are generally contingent on the generation of taxable income, the reversal of deferred tax liabilities in the future and the availability of qualified tax planning strategies |
| Tax planning strategies represent prudent and feasible actions that management would take to create taxable income to keep a tax attribute from expiring during the carryforward period |
| Determinations of the amounts related to tax planning strategies assume hypothetical transactions, some of which involve the disposal of substantial business assets, and certain variables which are judgmental and subjective |
| In determining the need for valuation allowances, we consider our short-term and long-range internal operating plans, which are based on the current economic conditions in the markets and countries in which we operate, and the effect of potential economic changes on our various operations |
| At December 31, 2005, we had non-US net operating loss carryforwards — principally in The Netherlands, Germany and Italy — totaling dlra185 million and related deferred tax assets of dlra57 million |
| Valuation allowances totaling dlra48 million had been provided with respect to these assets |
| We believe that it is more likely than not that portions of the net operating loss carrryforwards in these jurisdictions will be utilized |
| However, there is currently insufficient positive evidence in some non-US jurisdictions — primarily Germany and Italy — to conclude that no valuation allowances are required |
| At December 31, 2005, we had a US federal net operating loss carryforward of dlra116 million, which will expire between 2023 and 2026 |
| Deferred tax assets related to this loss carryforward, as well as to federal tax credit carryforwards (dlra16 million) and additional state and local loss carryforwards (dlra10 million), totaled dlra66 million |
| Additional deferred tax assets totaling approximately dlra117 million had also been provided for book deductions not currently deductible for tax purposes, including the writedown of goodwill, postretirement health care benefit costs and accrued pension liabilities |
| The deductions for financial reporting purposes are expected to be deducted for income tax purposes in future periods, at which time they will have the effect of decreasing taxable income or increasing the net operating loss carryforward |
| The latter will have the effect of extending the ultimate expiration of the net operating loss carryforwards beyond 2026 |
| The transaction entered into with Glencore Finance AG and Mizuho International plc on June 10, 2004 caused an “ownership change” as defined by the Internal Revenue code and regulations and will substantially delay the timing of the utilization of certain of the pre-change US loss carryforwards and other tax attributes that are discussed in the preceding paragraph |
| The company has calculated an annual limitation of approximately dlra23 million that can be used to offset post-change taxable income |
| The annual limitation is cumulative for any portion not used in prior post-change years |
| Therefore, the cumulative limitation at the end of 2005 was approximately dlra35 million which consisted of dlra12 million from 2004 and dlra23 million from 2005 |
| This delay will increase tax expense and decrease available cash in future years |
| As of December 31, 2005, US deferred tax assets net of deferred tax liabilities totaled dlra183 million and US valuation allowances totaled dlra121 million |
| We continue to rely on the availability of qualified tax planning strategies to conclude that valuation allowances are not required with respect to a portion of our US deferred tax assets |
| At December 31, 2005, valuation allowances had not been recorded with respect to dlra62 million to US deferred tax assets based on qualified tax planning strategies of dlra59 million and tax carrybacks of dlra3 million |
| We will continue to reassess our conclusions regarding qualified tax planning strategies and their effect on the amount of valuation allowances that are required on a quarterly basis |
| This could result in an increase or decrease in income tax expense and a corresponding decrease or increase in shareholders’ equity in the period of the adjustment |
| If we are unable to retain key employees, our performance may be hindered |
| Our ability to provide high-quality products and services depends in part on our ability to retain our skilled personnel in the areas of management, product engineering, servicing and sales |
| Certain of our businesses rely heavily on key personnel in the engineering, design and formulation of our products |
| Our results of operations could be adversely affected if we are unable to retain key employees or recruit replacements |
| 21 _________________________________________________________________ [74]Table of Contents The interests of our principal shareholders may conflict with those of other shareholders |
| As of March 1, 2006, Glencore Finance AG, Mizuho International plc and Triage Offshore Funds, Ltd |
| collectively owned 100prca of the shares of our outstanding Series B Preferred Stock, which represents approximately 53prca of our outstanding equity (on an as-converted basis) |
| In addition, Glencore, Mizuho and Triage have special voting and approval rights as holders of shares of Series B Preferred Stock |
| By virtue of such stock ownership, Glencore, Mizuho and Triage have the power to significantly influence our affairs and to influence, if not decide, the outcome of matters required to be submitted to shareholders for approval, including the election of our directors and amendment of our charter and bylaws |
| As of March 1, 2006, the company had been advised by Mizuho that it intended to sell its shares of Series B Preferred Stock |