MZ Milacron

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

 

Commission File Number: 1-8485

 

 

(513) 487-5000

 

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  o      No  þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes  o      No  þ

 

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  þ      No  o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o      No  þ

 

As of June 30, 2007, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was approximately $43.2 million based on the closing sale price as reported on the New York Stock Exchange.

 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

 

 

 

 

MILACRON INC.
2007 FORM 10-K

 

 

TABLE OF CONTENTS

 

 

In 2007, Ohio Plastics, LLC, purchased 57.5% of Milacron’s Series B Preferred Stock triggering a “change in ownership” for U.S. Federal income taxes which limits the amount of pre-change net operating loss carryforwards that we can utilize per year. As a result, we recorded a $63 million charge to the tax provision in 2007 to establish full deferred tax valuation allowances against our U.S. deferred tax assets. The decline in the North America economy, the deferred tax valuation allowance charge, restructuring charges of $12.5 million, pension plan curtailment costs of $1.9 million and $1.9 million of other costs related to the change in preferred stock ownership drove a consolidated net loss in 2007 of $87.1 million, or $19.25 per share.

 

Manufacturing Efficiency and Cost Structure

 

We are committed to better serving our customers and improving our financial performance through continuous cost reduction, greater working capital efficiency, increased manufacturing productivity and enhanced product quality.

 

Our focus is on reducing our overall costs and improving our operational efficiency through strategic global sourcing and manufacturing. In North America and Western Europe, we have been exiting the manufacture of low-cost, commodity parts and concentrating on making critical, high-tech components that add value and give us a competitive advantage. We are also consolidating our own manufacturing capacity and making our facilities more efficient. In 2007, we closed or sold two manufacturing plants in North America and one in Western Europe, while eliminating the need for manufacturing and administrative positions and reducing our overall cost structure. Thanks to these and other recently completed restructuring measures, we realized incremental savings from operations of $12 million in 2007 and we expect up to $8 million of additional savings in 2008.

 

In Asia, Eastern Europe and other faster-growing markets, we continue to expand our sales and manufacturing presence. And on a global basis, we are seeking new suppliers who offer greater flexibility, lower cost and higher quality, while consolidating existing supplier relationships and making other improvements to our supply chain.

 

Product Research and Development

 

We design and manufacture innovative, value-added products to reinforce our leading global positions and achieve sales growth. We continually invest in research and development to improve the performance of our existing products, to bring new products to market and to remain at the technological forefront of the plastics processing and metalworking fluids industries. To these ends, we invested $19.3 million, or 2.4% of sales, in R&D in 2007 compared to $20.5 million, or 2.5% of sales, in 2006.

 

Patents

 

Milacron holds a number of patents pertaining to both plastics technologies and industrial fluids, none of which are material to their respective business segments.

 

Website

 

We maintain an Internet website at www.milacron.com. Our site provides company, product and service information, as well as investor information, including our annual report on Form 10-K and other filings on Forms 10-Q and 8-K and any amendments thereto, our latest earnings and news releases, stock information, investor presentations and conference call access and replays. Information filed with the Securities and Exchange Commission (the “SEC”) is made available as soon as reasonably practicable after it is filed. The information contained on our website is not incorporated by reference in this report.

 

Employees

 

Milacron’s average employment level from continuing operations was approximately 3,350 in 2007. Of these, approximately half were outside the U.S. As of year-end 2007, our employment was about 3,300.

Segment Information

 

Segment and geographic information for the years ended December 31, 2007 and 2006 is included in the notes to Milacron’s Consolidated Financial Statements in Part II, Item 8 of this Form 10-K.

 

Plastics Technologies

 

Products and Services.   We believe Milacron is the world’s broadest-line supplier of machinery, mold bases and related tooling and supplies to process plastics. Our extensive applications engineering expertise and comprehensive aftermarket service and support further differentiate us from our competitors. With combined 2007 sales of $684 million, our plastics technologies businesses are organized in three segments:

 

Machinery technologies — North America

 

 

Machinery technologies — Europe

 

 

Mold technologies

 

 

Milacron strives to be a “one-stop” supplier of complete end-to-end plastics processing solutions. We offer full lines of advanced injection molding, blow molding and extrusion systems, aftermarket replacement parts, and specialty auxiliary equipment for plastics processing. Milacron is a manufacturer of mold bases and related tooling and components for injection mold making and injection molders, and we make complete molds for blow molding. We are also a supplier of aftermarket MRO items for plastics processing and mold making, and we provide retrofit and rebuild services for older equipment manufactured by Milacron and others.

 

Injection molding is a very versatile process used to make a wide variety of plastic products, ranging from auto parts and electronic devices to consumer goods, medical equipment and containers. We believe Milacron is the largest supplier of injection molding machinery to the North American market and the third largest worldwide. We are a recognized technology leader in all-electric injection molding and in co-injection, multi-component-material-color, high-tonnage, and low-pressure foam/gas-assisted injection molding, offering systems that significantly reduce the customer’s cost per part. Our patented PC-based control technology for plastics molding machines assures high-quality part production and brings the power of the Internet and improved communications to the shop floor.

 

In blow molding, we believe Milacron is the number-one supplier of systems to produce HDPE (high density polyethylene) containers, as well as one of the world’s largest producers of industrial blow molding equipment to make hollow or semi-hollow products such as automotive components, toys, furniture, luggage and storage and shipping containers. In addition to providing turnkey, state-of-the-art systems, we are an integrated supplier of molds and related tooling for blow molding.

 

Our high-output, twin-screw extruders are North American market leaders for producing a wide variety of PVC (polyvinyl chloride) and plastic composite products, such as siding, decking, fencing and pipe, used in commercial and home construction markets. Smaller models of our single-screw extruders serve such end markets as plastics film and medical tubing. We also supply a leading line of new and rebuilt high-performance screws and barrels, which are the productivity and value components in the extrusion business, for all makes and models of

extruders. We continued to make good progress in 2007 in reintroducing our advanced extrusion systems and technologies to markets outside North America.

 

For North American injection mold makers and injection molders, Milacron is the leading supplier of durable mold bases, mold base components, ejector pins, nozzles, screw tips and MRO supplies. We are the number-three supplier of mold bases, components and MRO supplies in Europe and on a global basis. Independent mold makers are our largest customer category. We provide the widest range of standard and special mold tooling and the latest advances in mold technologies such as quick-change molds, hot runner systems and stack molds to reduce cycle times, increase output and improve productivity. Offering high-quality MRO products at competitive prices, we strive to become an extension of our customers’ businesses by meeting their day-to-day needs for small tools, gauges, temperature regulators, lubricants, safety supplies and thousands of other items.

 

We leverage our size and geographic presence to provide rapid, comprehensive, high-quality service and support to our customers worldwide. Through our integrated service and supply network, we offer 24/7 technical support and repair services. Our customers have access to repair and maintenance services onsite or via the Internet as well as next-day parts availability on a global basis.

 

Markets.   One of the largest industries in the world, plastics processing is a major contributor to the vitality of industrialized economies and to the continuing growth of developing areas. Plastic part production has grown steadily for over half a century, as plastics and plastic composites continue to replace traditional materials such as metal, wood, paper and glass. Plastics have increasingly become the material of choice in many, if not most, manufactured goods.

 

Advancements in material development and in processing equipment capabilities continue to make plastic products more functional and less expensive, thus spurring secular growth. Thanks to superior strength-to-weight ratios, plastics are increasingly used in transportation-related applications. Additionally, consumer demand for safer, more convenient products continues to drive general demand for plastic products.

 

Milacron competes in a global market, estimated to be $13 billion on an annualized basis, for plastics equipment and supplies. Our product mix generally parallels the major segments of this market. About two-thirds of the market consists of capital equipment, which is highly sensitive to general economic cycles and capital spending patterns. In addition, demand is often shaped by other factors such as fluctuations in resin pricing and availability, oil and other energy costs, the impact of interest rates on new housing starts and auto sales, the introduction of new products or models, and consumer confidence and spending. Changes in currency exchange rates may also affect our customers’ businesses and, in turn, the demand for processing equipment. To reduce our dependency on capital goods cycles, we continue to look for ways to expand our durable and consumable product offerings as well as our aftermarket services on a global basis.

 

Although not always understood by those outside the industry, plastics generally are more environmentally friendly and energy conserving than comparable products made out of metal, wood, paper or glass. In addition, many polymer suppliers, machinery makers and processors are actively developing and improving methods of recycling plastics. As a member of the trade association, The Society of the Plastics Industry, Milacron continues to work with other leading companies to make plastics a part of the solution to the challenges of energy and environmental conservation.

 

Geographic Sales.   About 55% of our plastics technologies products and services in 2007 were sold to customers in North America. European sales made up about 28% of the total, with the remainder coming from Asia and the rest of the world.

 

Distribution.   Milacron maintains sales, marketing and customer service facilities in major cities and regions across North America, Europe and Asia. We also sell through large networks of distributors and/or sales and service offices in all major countries.

 

We sell our plastics machinery and systems through a combination of direct sales force and independent agents who are spread geographically throughout our key markets. We sell our mold bases, supplies and components through a direct distribution network in North America and Europe, through a large network of joint venture sales

and service offices in Asia, over the Internet and via telemarketing. We market our MRO supplies through both printed and electronic catalogs as well as over the Internet.

 

Customers.   Our plastics technologies customers are involved in making a wide range of everyday products from food and beverage containers to refrigerator liners; from electronic and medical components to digital cameras and razors; from milk bottles to wood-fiber composite plastic decking. Key end markets in order of 2007 sales were packaging, automotive, building materials, consumer goods, appliances and housewares, custom molders, electrical and electronics, industrial machinery and components and medical.

 

Production Facilities.   For our three plastics technologies segments, Milacron maintains the following principal production facilities:

 

 

 

 

The above facilities provide approximately 1.8 million square feet of manufacturing, warehousing and office space. All facilities are in good repair and are considered suitable for the purposes for which they are used. The level of utilization of the facilities in relation to their practical capacities varies but, in all instances, is sufficient to justify their continued operation.

 

The following owned facilities were pledged as collateral to secure our obligations under the indenture governing our 11 1 / 2 % Senior Secured Notes due 2011 and the financing agreement governing our $105 million asset based revolving credit facility: (i) Lewistown, Pennsylvania, (ii) Youngwood, Pennsylvania, (iii) Mt. Orab, Ohio and (iv) Madison Heights, Michigan.

 

Competition.   The markets for plastics technologies are global, highly competitive and include principally North American, European and Asian competitors. We believe Milacron has the number-one position in the North American market and that we are one of the largest suppliers worldwide. A few of our competitors are larger than we are, most are smaller, and only a few compete in more than one product category. Principal competitive factors in the plastics technologies industry are product features, technology, performance, reliability, quality, delivery, price and customer service.

Industrial Fluids

 

Products and Services.   With 2007 sales of $124 million, our industrial fluids segment provides metalworking industries worldwide with a wide variety of coolants, lubricants, forming fluids, process cleaners and corrosion inhibitors used in the shaping of metal products. Customers count on our extensive knowledge of chemistry and metalworking applications to maximize their productivity.

 

Coolants are required in the vast majority of metalworking operations, including cutting, grinding, stamping and forming, to achieve desired part quality and output through higher metal-removal rates and longer tool life. Our family of premium fluids offers superior performance while meeting the demands of today’s toughest metalworking operations. We enhance our customers’ competitiveness by prolonging tool life, reducing coolant usage, and improving metal-removal and metalforming productivity. For over half a century, our specialty has been synthetic (water-based) and semi-synthetic fluids, which provide excellent lubricity and are generally more environmentally friendly than traditional mineral oil-based products. In recent years, we have developed advanced “green” fluids, made from renewable oils and synthetic esters, which match or exceed the performance characteristics of mineral oil-based fluids, but with improved health and safety features and environmental advantages.

 

We add value for our customers by helping them maintain the safety and effectiveness of their fluids and by offering them our expertise in fluid/operation synergies to optimize their metalworking processes. Fluid optimization can provide our customers with significant productivity gains and cost savings.

 

Traditionally, our strength has been in the area of metalcutting and grinding, but we also blend and sell stamping and metalforming fluids, process cleaners, corrosion inhibitors and other specialty products for metalworking, all of which represent good growth opportunities for us.

 

Markets.   Key markets for our industrial fluids include the whole spectrum of metalworking industries: from automotive, aircraft and machinery makers and job shops to manufacturers of appliances, agricultural equipment and consumer and sporting goods. Milacron fluids are also used in the production of glass and mirrors and in high-tech processes such as silicon wafer slicing and polishing.

 

The markets in which our industrial fluids compete total $2.5 billion on an annualized, global basis. Over one-third of the market consists of metalcutting and grinding fluids, with metalforming fluids and process cleaners each accounting for about one-quarter of the market. Demand for our fluids is generally directly proportional to levels of industrial production, although we specifically target higher-growth areas such as machining and forming exotic alloys and aluminum. Factors affecting our customers’ production rates and ultimately the demand for our fluids include auto and machinery sales, consumer spending and confidence, interest rates, energy prices and currency exchange rates.

 

When it comes to industrial fluids, Milacron places very high importance on employee safety and environmental protection. In a proactive approach to continually improve the health and environmental effects of metalworking fluids, we work both locally and internationally with suppliers, customers and regulatory authorities, and we support and participate in research and educational programs regarding metalworking fluids.

 

Geographic Sales.   About 48% of our 2007 industrial fluid sales were made to customers in North America, while another 44% were to European customers. The remaining sales were to customers in Asia and the rest of the world.

 

Distribution.   Milacron’s industrial fluids are sold primarily through industrial distributors, with some direct sales, as well as through printed catalogs. We produce most of what we sell, and most of what we make is sold under our own brand names. In addition, some of our fluids are sold under brand names of other companies through their own market channels.

 

Customers.   Our metalworking fluids are involved in making all kinds of products: from automotive power train components to aluminum soft drink cans, from air conditioners and glass mirrors to bearings, golf clubs and a wide variety of industrial components.

 

Markets for our industrial fluids in order of importance based on 2007 sales were automotive, industrial components, industrial machinery, job shops, aerospace, appliances and housewares, oil and primary metals, off-

road equipment, consumer goods, and electrical and electronics. The largest customer category, automotive, accounted for 35% of fluid sales in 2007.

 

Production Facilities.   For our industrial fluids segment, Milacron maintains the following principal production facilities:

 

 

The above facilities provide approximately 220,000 square feet of manufacturing, warehousing and office space. All facilities are in good repair and are considered suitable for the purposes for which they are used. The level of utilization of the facilities in relation to their practical capacities varies but, in all instances, is sufficient to justify their continued operation.

 

The following owned facilities were pledged as collateral to secure our obligations under the indenture governing our 11 1 / 2 % Senior Secured Notes due 2011 and the financing agreement governing our $105 million asset based revolving credit facility: (i) Cincinnati, Ohio, (ii) Sturgis, Michigan and (iii) Livonia, Michigan.

 

Competition.   We believe Milacron holds a leadership position in world markets for synthetic metalworking fluids. Our competitors range from large petrochemical companies to smaller companies specializing in similar fluids. Principal competitive factors in this business include market coverage, product performance, delivery, price and customer service.

Executive Officers of the Registrant

 

The following information is included in accordance with the provisions for Part III, Item 10:

 

 

 

The parenthetical figure below the name of each individual indicates his age at most recent birthday prior to December 31, 2007.

 

There are no family relationships among the executive officers of the Registrant.

 

Officers of the company are elected each year by the Board of Directors.

 

Our substantial indebtedness could have important consequences. For example, it could:

 

 

Our asset based facility is subject to the borrowing base limitation, including an excess availability reserve. Failure to achieve compliance with covenants contained in any of our debt 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 acceleration of debt under the other agreements. If we were unable to meet our expenses, pension funding requirements and debt obligations, we would need to refinance all or a portion of our indebtedness, sell assets or raise equity.

 

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. If new debt is added to our subsidiaries’ current debt levels, the related risks that we and they now face could intensify. In March 2008, certain of our European subsidiaries entered into a new five-year asset-based revolving credit program for up to €27 million in aggregate financing. See the note to the Consolidated Financial Statements captioned “Subsequent Events” for more information regarding this new credit program.

 

Restrictions and covenants in debt agreements limit our ability to take certain actions.

 

The indenture governing the 11 1 / 2 % Senior Secured Notes and the credit agreement for our asset based credit facility contain a number of significant restrictions and covenants that limit our ability and our subsidiaries’ ability to, among other things:

 

 

We are currently restricted by the terms of the indenture from paying cash dividends on our common stock as well as our Series B Preferred Stock.

 

Failure to comply with the terms of one of our debt instruments could result in an event of default that would result in the acceleration of that instrument as well as all or most of our other indebtedness.

 

Breaching any of our 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. Further, if we are unable to repay, refinance or restructure our indebtedness under our asset based facility, the lenders under the 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 the asset based facility before any proceeds would be available to make payments on the 11 1 / 2 % 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 11 1 / 2 % Senior Secured Notes.

 

Our principal U.S. defined benefit pension plan is underfunded, which will require us to make cash contributions to the plan for the next several years, which, in turn, will reduce the cash available for our business, and adverse capital market or interest rate conditions may increase our net pension liability.

 

Contributions required in 2008 and beyond will be based on the provisions of the Pension Protection Act of 2006, (the Act) which became effective on January 1, 2008. The funding provisions of the Act have the effect of increasing future contributions in relation to the amounts that would have been required under the legislation that the Act replaced. The amount of future contributions will be dependent on, among other things, the funded status of the plan and on the interest rates required to be used for funding purposes. Contributions required for 2008 are estimated to be $30 million to $35 million with approximately $20 million due in September. Contributions for 2009 are estimated to be $15 million to $20 million. However, contributions for 2010 and beyond cannot be reasonably quantified at this time.

 

There is also a risk that the Pension Benefit Guaranty Corporation (the PBGC) may conclude that its risk with respect to our defined benefit plan may become unreasonably high if the plan continues to operate, if we are unable to satisfy our funding requirement or if the plan becomes unable to pay benefits. In such circumstances, the PBGC could terminate the plan and take control of its assets. In such event, we may be required to make an immediate payment to the PBGC of all or a substantial portion of the underfunding as calculated under PBGC assumptions, including a low discount rate. If such payment is not made, the PBGC could place liens on a material portion of our assets which 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 debt agreements 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 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 would not be granted.

 

“Ownership changes” for U.S. 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 sale of a portion of our convertible preferred stock on October 2, 2007 triggered an “ownership change” for U.S. federal income tax purposes. As a consequence of the ownership change, the timing of our utilization of pre-change U.S. tax loss carryforwards and other tax attributes will be limited in the future. The amount of the annual limitation is expected to be approximately $5.7 million. The limitation has the potential to significantly increase tax expense and increase the amounts payable for income taxes in future years and thereby limit the amount of cash available to service our indebtedness and for use in our operations.

 

Risks Relating to Our Business

 

Many of our customers are in cyclical industries that have historically experienced significant downturns, which 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 and demand for their products), interest rates and other factors beyond our control. The performance of our business is directly related to the production levels of our customers. As an example, in 2006 and 2007, the automotive industry experienced a significant slowdown and closures of operating facilities, which has adversely affected the sale of our plastics machinery — particularly injection molding machines — and metalworking fluids. Declines in economic conditions in the industries served by our customers may continue to have a negative effect on our business and ability to increase operating cash flows.

 

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 improve or could deteriorate.

 

Many of the industries in which we operate are highly competitive. 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.

 

Further increases in our cost structure could have an adverse effect on our operating results and cash flows.

 

Our costs are subject to fluctuations, particularly for raw materials and purchased components used in our business, including the cost of labor and steel and the cost of oil and chemicals used in the production of metalworking fluids. Our success is dependent, in part upon our ability to manage these fluctuations through pricing actions, costs savings projects and global sourcing actions. While we have responded by further reducing our cost structure and increasing the prices we charge our customers, these measures may not always be sufficient to offset the effects of the cost increases we experience.

 

Our significant international operations depend to a great extent on the economy of the European and Asian markets and subject us to risks such as unfavorable political, regulatory, labor and tax conditions.

 

We are a global business with a significant portion of our operations and sales outside the U.S. Our financial targets depend in part on achieving significant growth in developing regions, including the Eastern European and Asian markets. Our results could be negatively impacted if expected growth in these regions is not realized. In some cases, 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 political and economic stability, consumer prices, employment levels, gross domestic product, interest and foreign exchange rates. 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. Our success will depend in part on our ability to manage through these uncertainties.

 

Our overall success as a global business depends, in part, upon our ability to successfully manage 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 an adverse effect on our ability to generate cash flow and grow our business.

 

We are subject to litigation that could have an adverse effect upon our business, financial condition, results of operations or reputation.

 

These suits and proceedings concern issues including product liability, patent infringement, environmental matters and personal injury matters, some of which seek substantial dollar amounts. In certain suits, multiple plaintiffs allege personal injury involving products, supplied 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. 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.

 

If our common stock is delisted, it may lack a market.

 

On September 18, 2007, we were informed by the New York Stock Exchange (NYSE) that the company had fallen below the NYSE’s continued listing standard related to average market capitalization. This standard requires that a company with stockholders’ equity of less than $75 million maintain total market capitalization of not less than $75 million over a thirty trading-day period. Under NYSE guidelines, we must return to compliance within 18 months following receipt of notification. In December 2007, we submitted to the NYSE a detailed plan to remedy the non-compliance through improved operating performance and other actions. While we believe the remediation will be successful, there can be no assurance that we will be able to return to compliance with the NYSE’s guidelines. If we are unsuccessful, it is possible that our stock will be delisted by the NYSE. Were this to happen, the market for our common stock could become more limited and it is possible that the per-share price would drop.

 

The interests of our principal shareholders may conflict with those of other shareholders.

 

Our Series B Preferred Stock is convertible into 5.7 million common shares which represents 51.0% of our as-converted common equity as of March 12, 2008. As of that date, Ohio Plastics, LLC, an affiliate of Bayside Capital, Inc. (Bayside) owned 57.5% of the Series B Preferred Stock representing 29.3% of our as-converted common equity. Pursuant to the provisions of the certificate of designation of the Series B Preferred Stock, the holders thereof have elected 7 of the 13 members of our board of directors, all of whom are employees of Bayside or its parent, H.I.G Capital. By virtue of its stock ownership, Bayside has 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 amendments of our charter and bylaws. See the note to the Consolidated Financial Statements captioned “Shareholders’ Equity” for more information regarding our Series B Preferred Stock.

 

 

 

PART II

 

elsewhere in this Form 10-K) contain restrictions prohibiting the payment of cash dividends on our common stock. The terms of our 4% Cumulative Preferred Stock and our Series B Preferred Stock require that accrued and unpaid dividends on such stock be paid prior to any dividend or distribution on, or repurchase of, our common stock. As of March 10, 2008, there were no unpaid dividends outstanding on the 4% Cumulative Preferred Stock and there were $27.00 per share of accrued and unpaid dividends outstanding on the Series B Preferred Stock.

 

The following table summarizes stock repurchases and reacquisitions for the quarter ended December 31, 2007.

 

 

 

Information on equity compensation plans is presented under Item 12 of this Form 10-K.

 

Milacron pioneered the development and introduction of synthetic (water-based) industrial fluids in the late 1940s. Our largest customer for fluids is the automotive industry, followed by makers of industrial components and machinery, aircraft, appliances and housewares, and energy extraction.

 

Plastics Markets — Background and Recent History

 

Since the end of World War II, plastics and plastic composites have increasingly replaced traditional materials such as metal, wood, glass and paper throughout manufacturing. Since 1970, global consumption of plastics resins has grown at a compounded annual rate of 6%, compared to 2% for steel and 3% for aluminum (Sources: BASF AG, Association of Plastics Manufacturers in Europe, International Iron & Steel Institute, U.S. Geological Survey).

 

Plastic part production, like industrial production in general, has historically shown sustained growth. In every year from 1980 to 2000, plastic part production in the U.S. increased over the prior year, averaging 7% compounded annual growth (Source: U.S. Federal Reserve Board). Growth in plastics consumption and production has generally created increasing demand for our plastics machinery and related supplies. Between 1980 and 2000, our sales of plastics equipment and supplies in North America grew at 8% compounded annually excluding acquisitions (11% including acquisitions).

 

In the 1990s, Milacron, like many other U.S. companies, benefited from a strong, growing economy. Our plastics technologies sales were approaching $1 billion with good profitability. At the end of the decade, however, the U.S. manufacturing sector fell into its most severe and prolonged downturn since the 1930s. The plastics processing portion of the manufacturing sector was very severely impacted and to this day has not recovered. Shipments of injection molding machines in North America fell from a $1.2 billion 12-month moving total in 2000 to under $700 million by the end of 2001. It has stayed at very low levels ever since, experiencing only a partial recovery in 2004 and 2005 (Source: The Society of Plastics Industry).

 

In 2007, all of Milacron’s businesses in North America, including industrial fluids, continued to be negatively impacted by high oil and resin prices, by the shakeout among auto part molders serving the U.S. Big Three car manufacturers and by the slowdown in residential home building. Despite a series of responsive actions, including a number of plant closings, headcount reductions and other measures, severely depressed sales volumes led to a consolidated loss from continuing operations in 2007. Also, as a result of the slow down in North America and the emergence of other economies in the world, we have focused on expanding our presence outside of our traditional markets. In 2007, we saw significant growth outside of North America, Canada and Western Europe.

 

Industrial Fluids — Recent History

 

During the severe manufacturing recession of 2000-2003, overall demand for our metalworking fluids declined only by 10%, as our largest customer group, automakers, maintained high levels of production both in North America and worldwide. Profitability in the fluids business, although impacted, held up fairly well throughout this period, with operating earnings in the range of 13% to 15% of sales. In 2004 and 2005, sales of our metalworking fluids grew modestly, but profitability in this segment declined due to significant increases in product liability insurance and related expenses, as well as higher material costs and pension expense. In 2006 and 2007, we were able to improve profitability on minimal sales growth.

 

Consolidated 2007 Results

 

Sales and new orders in 2007 were down slightly compared to 2006, reflecting continued weakness in the U.S. automotive manufacturing sector and housing markets, offset in part by our growth in European, Asian and other emerging markets. Our net loss for the year was $87.1 million, which included $12.5 million in restructuring charges, $1.9 million in costs related to a change in preferred stock ownership and $1.9 million in pension plan curtailment cost, in all cases, with no tax benefit. Our net loss also included a $63.0 million provision for income taxes for deferred tax valuation allowances related to the change in preferred stock ownership. This compared to a net loss in 2006 of $39.7 million, which included $17.4 million in restructuring charges and $1.8 million in refinancing costs, in both cases, with no tax benefit.

Opportunities and Challenges

 

As we enter 2008, energy and various other material prices remain at record high levels and in North America, the economy continues to suffer from the U.S. auto part and housing sectors. For our part, we will continue to develop new and better products and services, especially in the aftermarket sectors of our businesses. We will also strengthen our performance and customer focus in our home markets of North America and western Europe, while expanding our presence outside the United States, Canada and western Europe. Overall for 2008, we are projecting continued growth outside of North America and improved profitability, which should be helped by the benefits from the restructuring measures taken in 2007 and those expected to be taken in 2008.

 

Presence Outside the U.S.

 

For 2007, markets outside the U.S. represented the following percentages of our consolidated sales: Europe 30%; Canada and Mexico 7%; Asia 9%; and the rest of the world 6%. As a result of this geographic mix, foreign currency exchange rate fluctuations affect the translation of our sales and earnings, as well as consolidated shareholders’ equity. During 2007, the weighted-average exchange rate of the euro was stronger in relation to the U.S. dollar than in 2006. As a result, Milacron experienced favorable currency translation effects on new orders and sales of approximately $29 million each and on operating earnings of approximately $1.6 million.

 

During 2007, the euro strengthened against the U.S. dollar by approximately 9% which caused the majority of a $1.6 million favorable foreign currency translation adjustment to consolidated shareholders’ deficit.

 

If the euro should weaken against the dollar in future periods, we could experience a negative effect in translating our European new orders, sales and earnings when compared to historical results.

 

Significant Accounting Policies and Judgments

 

The Consolidated Financial Statements discussed herein have been prepared in accordance with U.S. generally accepted accounting principles, which require us to make estimates and assumptions that affect the amounts that are included therein. The following is a summary of certain accounting policies, estimates and judgmental matters that we believe are significant to our reported financial position and results of operations. Additional accounting policies are described in the note to the Consolidated Financial Statements captioned “Summary of Significant Accounting Policies” (presented in Item 8 of this Form 10-K) which should be read in connection with the discussion that follows. We regularly review our estimates and judgments and the assumptions regarding future events and economic conditions that serve as their basis. While we believe that the estimates used in the preparation of the Consolidated Financial Statements are reasonable in the circumstances, the recorded amounts could vary under different conditions or assumptions.

 

Deferred Tax Assets and Valuation Allowances

 

At December 31, 2006, we had significant deferred tax assets related to U.S. and non-U.S. 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 purposes. These charges included the write-down of goodwill and a charge to equity related to unrecognized retirement benefit plan losses. At December 31, 2006, we had provided valuation allowances against all net deferred tax assets except $63 million in the U.S. that were offset by qualified tax planning strategies and $8 million of non-U.S. 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 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 considered our short-term and long-range internal operating plans, which were 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, 2007, we had non-U.S. net operating loss carryforwards — principally in the Netherlands, Germany, Italy and Belgium — totaling $197 million and related deferred tax assets of $50 million. Valuation allowances totaling $37 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 carryforwards in these jurisdictions will be utilized. However, there is currently insufficient positive evidence in some non-U.S. jurisdictions — primarily Germany, Italy and Belgium — to conclude that no valuation allowances are required.

 

At December 31, 2007, we had a U.S. federal net operating loss carryforward of $174 million, which will expire between 2023 and 2028. Deferred tax assets related to this loss carryforward, as well as to our federal tax credit carryforward ($16 million) and additional state and local loss carryforwards ($7 million), totaled $84 million. Additional deferred tax assets totaling approximately $72 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 realized 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 carryforward beyond 2028. However, our ability to utilize U.S. federal net operating loss carryforwards and other tax assets is limited as described below.

 

The sale of 287,500 shares of Series B Preferred Stock on October 2, 2007 caused an “ownership change” as defined by the Internal Revenue Code and regulations that will have the effect of substantially delaying the timing of the utilization of certain of the U.S. loss carryforwards and other tax attributes. The company has calculated the amount of the annual limitation to be approximately $5.7 million. The $5.7 million limitation applies to each year and is cumulative for years in which the limitation is not fully utilized. The limitation at the end of 2007 was approximately $1.4 million of available pre-change net operating losses with no limitations on deductibility.

 

As discussed above, at December 31, 2006 and through the third quarter of 2007, we relied on qualified tax planning strategies to conclude that valuation allowances were not required with respect to a portion of our U.S. deferred tax assets. However, because of the limitation imposed by the U.S. Internal Revenue Code due to the “change in ownership”, we concluded that we are no longer able to rely on qualified tax planning strategies. As a result, we recorded a charge to the provision for income taxes of $63 million in the fourth quarter of 2007 to provide the required valuation allowances. Therefore, at December 31, 2007, U.S. deferred tax assets net of deferred tax liabilities totaling $156 million were fully offset by valuation allowances of the same amount. We will continue to evaluate the extent to which valuation allowances are required on a quarterly basis. However, the reversal of the valuation allowance is not expected to occur until we achieve sustained profitability.

 

Accounts Receivable, Inventory and Warranty Reserves

 

Our internal accounting policies require that each of our operations maintain appropriate reserves for uncollectible receivables, inventory obsolescence and warranty costs in accordance with U.S. generally accepted accounting principles. Because of the diversity of our customers and product lines, the specific procedures used to calculate these reserves vary by location but in all cases must conform to company guidelines. Reserves are required to be reviewed and adjusted as necessary on a quarterly basis.

 

Allowances for doubtful accounts are generally established using specific percentages of the gross receivable amounts based on their age as of a particular balance sheet date. Because of the product line and customer diversity noted above, each business unit is required to base the percentages it applies to its aged receivables on its unique history of collection experience. The percentages used are reviewed for continued reasonableness on a quarterly basis. The amounts calculated through this process are then adjusted for known credit risks and collection problems. Write-offs of accounts receivable for our operations have averaged $2.9 million in the last two years. While we believe that our reserves for doubtful accounts are reasonable in the circumstances, adverse changes in general economic conditions or in the financial condition of our major customers could result in the need for additional reserves in the future.

Reserves for inventory obsolescence are generally calculated by applying specific percentages to inventory carrying values based on the level of usage and sales in recent years. As is the case for allowances for doubtful accounts, each business unit selects the percentages it applies based on its unique history of inventory usage and obsolescence experience and forecasted usage. The preliminary calculations are then adjusted based on current economic trends, expected product line changes, changes in customer requirements and other factors. In 2007, our operations recorded new inventory obsolescence reserves totaling $2.0 million and utilized $4.4 million of such reserves in connection with the disposal of obsolete inventory and the sale of manufacturing facilities. We believe that our reserves are appropriate in light of our historical results and our assumptions regarding the future. However, adverse economic changes or changes in customer requirements could necessitate the recording of additional reserves through charges to earnings in the future.

 

Our warranty reserves are of two types — “normal” and “extraordinary.” Normal warranty reserves are intended to cover routine costs associated with the repair or replacement of products sold in the ordinary course of business during the warranty period. These reserves are accrued using a percentage-of-sales approach based on the ratio of actual warranty costs over a representative number of years to sales revenues from products sold with warranties over the same period. The percentages are required to be reviewed and adjusted as necessary at least annually. Extraordinary warranty reserves are intended to cover major problems related to a single machine or customer order or to problems related to a large number of machines or other type of product. These reserves are intended to cover the estimated costs of resolving the problems based on all relevant facts and circumstances. In recent years, costs related to extraordinary warranty problems have not been significant. In 2007, our operations accrued warranty reserves totaling $3.8 million and incurred warranty-related costs totaling $3.0 million. While we believe that our warranty reserves are adequate in the circumstances, unforeseen problems related to unexpired warranty obligations could result in a requirement for additional reserves in the future.

 

Impairment of Goodwill and Long-Lived Assets

 

We test goodwill for impairment based on the provisions of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (SFAS No. 142), using probability-weighted cash flows discounted at market interest rates. SFAS No. 142 requires that goodwill be tested for impairment annually or whenever certain indicators of impairment are present.

 

SFAS No. 142 requires that the first phase of testing goodwill for impairment be based on a business unit’s “fair value,” which is generally best determined through market prices. Due to the absence of market prices for our businesses and as permitted by SFAS No. 142, we have elected to base our testing on discounted cash flows as discussed above. Although the discount rates and other input variables may differ, the model we use in this process is the same model we would use to evaluate the fair value of acquisition candidates and the fairness of offers to purchase businesses that we are considering for divestiture. The cash flows we use are derived from the annual long-range planning process that we complete in the third quarter of each year. In this process, each business unit is required to develop reasonable sales, earnings and cash flow forecasts for the next three years based on current and forecasted economic conditions. Each business unit’s plan is reviewed by corporate management and the entire plan is reviewed with our board of directors. For purposes of testing for impairment, the cash flow forecasts are adjusted as needed to reflect information that becomes available concerning changes in business levels, general economic trends and other factors. The discount rates are obtained from an outside source based on the Standard Industrial Classification codes in which our businesses operate. These discount rates are then judgmentally adjusted for “plan risk” (the risk that a business will fail to achieve its forecasted results), “country risk” (the risk that economic or political instability in the non-U.S. countries in which we operate will cause a business unit’s projections to be inaccurate) and other factors. Finally, a growth factor beyond the three-year period for which cash flows are planned is selected based on expectations of future economic conditions. Virtually all of the assumptions used are susceptible to change due to global and regional economic conditions as well as competitive factors in the industries in which we operate. In recent years, many of our cash flow forecasts have not been achieved, particularly in the market for capital equipment in the plastics processing industry. Unanticipated changes in discount rates from one year to the next can also have a significant effect on the results of the calculations. While we believe the estimates and assumptions we use are reasonable in the circumstances, various economic factors could cause the results of our testing to vary significantly.

While we recorded goodwill impairment charges in 2002 and 2003, our annual reviews as of October 1, 2004 through October 1, 2007 did not result in additional charges.

 

We review the carrying values of our long-lived assets other than goodwill annually under the provisions of Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” These reviews are conducted by comparing the estimates of undiscounted future cash flows that are included in our long-range internal operating plans to the carrying values of the related assets. To be conservative, no growth in operating cash flows beyond the third year is currently assumed. Under this methodology, impairment would be deemed to exist if the carrying values exceeded the expected future cash flow amounts. In 2007, we reviewed the aggregate carrying values of selected groups of our long-lived assets. The assets included in these reviews consisted principally of property, plant and equipment and, where applicable, intangible assets other than goodwill. Based on these reviews, it was determined that the maximum period of time to recover the carrying values of the tested groups of assets through undiscounted cash flows is approximately 3 years and that the weighted-average recovery period is approximately 7% of the remaining average lives of the assets. Based on the results of the reviews, no impairment charges were recorded in 2007.

 

Self-Insurance Reserves

 

Through our wholly-owned insurance subsidiary, Milacron Assurance Ltd. (MAL), we are primarily self-insured for many types of risks, including general liability, product liability, environmental claims and workers’ compensation for certain U.S. employees. MAL, which is incorporated in Bermuda and is subject to the insurance laws and regulations of that jurisdiction, establishes reserves commensurate with known or estimated exposures under the policies it issues to us. Exposure for general and product liability claims is supplemented by reinsurance coverage in some cases and by excess liability coverage in all policy years. Workers’ compensation claims in excess of certain limits are insured with commercial carriers. At December 31, 2007, MAL and the company had reserves for known claims and incurred but not reported claims under all coverages totaling approximately $17.3 million and expected recoveries from excess carriers and other third parties of $1.0 million. Expected recoveries represent the excess of total reserves for known exposures and incurred but not reported claims over the limits on the policies MAL issues to us. These amounts are classified as assets because unless other payment arrangements are negotiated, we (as the insured party) expect that we would first pay any indemnity claims and expenses in excess of MAL’s limits and then pursue reimbursement from the excess carriers. Of the $17.3 million in reserves at December 31, 2007, $14.9 million is included in long-term accrued liabilities in the Consolidated Balance Sheet at that date. The remaining $2.4 million is included in accrued and other current liabilities. The expected recoveries from excess carriers and other third parties are included in other current assets.

 

MAL’s reserves are established based on known claims, including those arising from litigation, and our best estimates of the ultimate liabilities thereunder (after consideration of excess carriers’ liabilities and claims against third parties) and on estimates of the cost of incurred but not reported claims. For certain types of exposures, MAL and the company utilize actuarially calculated estimates prepared by outside consultants to ensure the adequacy of the reserves. Reserves are reviewed and adjusted at least quarterly based on all evidence available as of the respective balance sheet dates or as further information becomes available or circumstances change. While the ultimate amount of MAL’s exposure to claims is dependent on future events that cannot be predicted with certainty, we believe that the recorded reserves are appropriate based on current information. It is possible that our ultimate liability could substantially exceed our recorded reserves as of December 31, 2007, but the amount of any such excess cannot be reasonably determined at this time. Were we to have significant adverse judgments or determine, as cases progress, that significant additional reserves should be recorded, our future operating results, financial condition and liquidity could be adversely affected.

 

Pensions

 

We maintain defined benefit and defined contribution pension plans that provide retirement benefits to substantially all U.S. employees and certain non-U.S. employees. The most significant of these plans is the principal defined benefit plan for certain U.S. employees and retirees (the U.S. Plan), which is a funded plan with $394.0 million in assets. Two other non-U.S. defined benefit plans are also funded with a combined $4.4 million in assets.

Excluding expense related to supplemental early retirement benefits and plan curtailment costs, pension expense for the U.S. Plan was $11.2 million for 2007 and $12.8 million in 2006. Pension expense for the U.S. Plan for 2008 is expected to be approximately $2.5 million. The reduction is due to the freezing of benefits under the U.S. Plan as of December 31, 2007, the effects of which will be partially offset by a reduction in the estimated long-term rate of return on plan assets assumption. Employees whose benefits were frozen under the U.S. Plan are now eligible for benefits under our U.S defined contribution retirement plan (the Retirement Savings Plan) and costs for this plan are expected to increase by approximately $4 million in 2008 compared to 2007. Expense for the defined benefit plan for 2009 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. The following paragraphs discuss the significant factors that affect the amount of recorded pension income or expense and the reasons for the change in costs identified above.

 

A significant factor in determining the amount of expense to be recorded for the funded U.S. Plan is the expected long-term rate of return on assets assumption. In 2006 and 2007, we used a rate of return of 8.75% and in our 2008 projections we have lowered the rate to 8.50%. We develop the long-term rate of return assumption based on the current mix of investments included in the plan’s assets and on the historical returns on those types of investments, judgmentally adjusted to reflect current expectations of future returns. In evaluating future returns on equity securities, the existing portfolio is stratified to separately consider, among other things, large and small capitalization investments, as well as international securities. The change from the 8.75% rate of return assumption to the lower 8.50% rate will have the effect of increasing the amount of pension expense that would otherwise be recorded in 2008 by approximately $1.0 million.

 

In determining the amount of pension expense to be recognized, the expected long-term rate of return is applied to a calculated value of plan assets that recognizes changes in fair value over a three-year period. This practice is intended to reduce year-to-year volatility in recorded pension expense but it can have the effect of delaying the recognition of differences between actual returns on assets and expected returns based on the long-term rate-of-return assumption. At December 31, 2007, the market value of the U.S. Plan’s assets was $394 million whereas the calculated value of these assets was $387 million. The difference between these amounts is not significant because aggregate actual returns on plan assets in recent years have generally approximated the applicable expected long-term rate of return assumptions in use. If significant asset-related losses are incurred in 2008, it will have the effect of increasing the amount of pension expense to be recognized in future years beginning in 2009.

 

In addition to the expected rate of return on plan assets, recorded pension expense includes the effects of interest on the plan’s liabilities to participants. In 2007 and prior years, pension expense also included the effect of service cost or the cost of benefits earned during the year. In 2008 and future years, the U.S. Plan will not incur service costs due to the freezing of plan benefits. These amounts are determined actuarially based on current discount rates and assumptions regarding matters such as future salary increases and mortality. Differences in actual experience in relation to these assumptions are generally not recognized immediately but rather are deferred together with asset-related gains or losses. When the combined cumulative asset-related and liability-related gains or losses exceed the greater of 10% of total liabilities or the calculated value of plan assets, the excess is amortized and included in pension expense. At December 31, 2002, the discount rate used to value the liabilities of the U.S. Plan was 7.25%. The discount rate was 6.00% at December 31, 2006 and at December 31, 2007 as modeled by the plan’s actuary. The effect of the lower discount rate and the significant variances in relation to the long-term rate of return assumption that occurred in 2001 and 2002 have resulted in cumulative losses in excess of the 10% corridor. Pension expense for the U.S. plan for 2006 and 2007 includes approximately $10 million each year for the amortization of previously unrecognized losses. Expense for amortization of previously unrecognized losses is expected to be approximately $7 million in 2008 with the decrease from 2007 being due principally to the effect of freezing benefits under the U.S. Plan.

 

Additional changes in the key assumptions discussed above would affect the amount of pension expense expected to be recorded for years subsequent to 2008. Specifically, a one-quarter percent increase in the rate of return on plan assets assumption would have the effect of decreasing pension expense by approximately $1.0 million. A comparable decrease in the rate of return on plan assets would have the opposite effect. In addition, a one-quarter percent increase in the discount rate would decrease expense by approximately $1.5 million.

Conversely, a one-quarter percent decrease in the discount rate would have the effect of increasing pension expense by $1.4 million.

 

At December 31, 2006, we adopted the recognition and disclosure provisions of Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (SFAS No. 158) which requires that we recognize the underfunded status of defined benefit postretirement plans as liabilities in our Consolidated Balance Sheet. For all of our defined benefit plans, adoption of the standard had the effect of increasing current liabilities by $4.0 million, increasing noncurrent liabilities by $16.9 million, decreasing other noncurrent assets by $2.4 million and increasing shareholders’ deficit by $23.3 million, in all cases in relation to the amounts that would have otherwise been reported. The current liability relates to plans that are unfunded and represents projected benefit payments by these plans, funded by the company, for the next twelve months. The U.S. Plan is funded and has assets sufficient to pay projected benefits for the next twelve months and therefore, no current liability has been recorded for this plan.

 

Sales of all segments to non-U.S. markets were $422 million, or 52% of sales, in 2007 compared to $375 million, or 46% of sales, in 2006.

 

The backlog of unfilled orders was $129 million at December 31, 2007 compared to $106 million at December 31, 2006. The increase was in our machinery technology businesses with approximately $5 million of the increase being related to favorable foreign currency translation effects.

 

Margins, Costs and Expenses

 

The consolidated manufacturing margin was 20.2% in 2007 and benefitted from recent cost reduction and global sourcing efforts, a full year’s effect of pricing actions taken in 2006 and a more favorable mix of products sold as our overall sales declined. Insurance costs in margin were 0.4% of sales in 2007 compared to 1.2% in 2006. The consolidated manufacturing margin was 18.5% in 2006 and included higher than normal inventory write-downs and raw material and purchased product costs that outpaced pricing actions. Raw material and purchased product costs stabilized somewhat in 2007 but continued to increase throughout the year. In 2007, margins included $.2 million of restructuring costs compared to $.5 million in 2006.

 

Total selling and administrative expense increased to $145 million in 2007 compared to $140 million in 2006, primarily related to the effect of foreign currency translation. Selling expense increased by $6 million compared to 2006 due to higher direct sales costs for commissions and discounts, offset in part by lower costs for trade shows. Selling and administrative expense increased from 17.1% of sales in 2006 to 17.9% in 2007.

 

Interest expense net of interest income was $31.4 million in 2007 compared to $30.0 million in 2006. In 2007, the interest expense increase was related to higher average levels of short-term borrowings. In 2006, an interest rate swap had the effect of decreasing interest expense by $.3 million. We capitalized $.7 million of interest in 2007 and in 2006.

 

Restructuring Costs

 

During the last two years, we have initiated numerous restructuring initiatives for the purpose of reducing our cost structure and improving operating efficiency. These actions and certain other actions that we initiated prior to 2006 are described in detail in the note to the Consolidated Financial Statements captioned “Restructuring Costs” that are presented in Item 8 of this Form 10-K. In total, these actions resulted in restructuring costs of $12.5 million in 2007 and $17.4 million in 2006. The net cash costs were $4.2 million in 2007 and $7.9 million in 2006.

The costs and related cash effects of the actions initiated in 2006 and 2007 as well as certain other actions that were initiated in 2001 through 2004 are summarized in the table that follows.

 

 

The non-cash restructuring costs incurred in 2006 and 2007 consist principally of $4.3 million of supplemental early retirement benefits that will be paid by our defined benefit pension plan for certain U.S. employees, $.8 million to adjust inventories related to discontinued product lines to expected realizable values and $2.6 million to adjust the carrying values of facilities, production equipment and other assets to be disposed of to expected realizable values.

 

Change in Preferred Stock Ownership Costs

 

In 2007, we charged $1.9 million to expense related to the purchase of all of the Series B Preferred Stock held by Glencore Finance AG, amounting to 57.5% of the outstanding Series B Preferred Stock, by Ohio Plastics, LLC,

an affiliate of Bayside Capital, Inc. This sale, which is more fully discussed in the note to the Consolidated Financial Statements captioned “Income Taxes,” triggered an “ownership change” for U.S. federal income tax purposes.

 

The $1.9 million of expense was primarily related to the early vesting of certain shares of restricted stock granted to non-officer employees and to legal and other consulting costs arising from the transaction.

 

The ownership change for income tax purposes limits our ability to utilize pre-change net operating loss carryforwards. Therefore, we are unable to rely on tax planning strategies and we recorded an additional $63.0 million charge to the provision for income taxes to record valuation allowances related to deferred tax assets previously covered by tax planning strategies.

 

Pension Plan Curtailment Costs

 

As of December 31, 2007, we froze the benefits payable under the U.S. defined benefit pension plan for certain employees and retirees. Related to freezing the plan, we charged $1.9 million to expense to write-off prior service costs associated with previous plan amendments. These service costs were being amortized to expense over the remaining service life of the plan’s active participants.

 

Results By Segment

 

The following sections discuss the operating results of our business segments which are presented in tabular form in Part II, Item 8 of this Form 10-K. Segment operating earnings and losses as discussed below do not include restructuring costs, change in preferred stock ownership costs or pension plan curtailment costs.

 

Machinery technologies — North America — The machinery technologies — North America segment had 2007 new orders of $378 million and sales of $367 million compared to 2006 new orders and sales of $411 million and $402 million, respectively. New orders and sales in the North American market for injection molding machines were stable throughout 2007, but declined from 2006 levels as the North American market was affected by the ongoing consolidation in the U.S. automotive supplier market, especially suppliers to the Detroit Three. This consolidation is depressing new machine demand and flushing used equipment into the marketplace, which is putting pressure on total sales as well as on pricing. Sales of injection molding machines were down $58 million, or 24.0%, compared to 2006. This sales decline was offset in part by higher sales of extrusion systems, up $9 million or 12.9%, compared to 2006, and by higher sales in our India injection molding unit, up $12 million or 46.3%, while sales of blow molding systems were relatively flat with last year. Increased extrusion system sales were driven by higher export sales primarily to Mexico, Europe and Asia. Operating earnings for the segment were $10.8 million in 2007, a decrease of $6.3 million from prior year. Lower sales volumes placed significant downward pressure on operating earnings, but the decline was offset in part by cost savings actions taken in 2007. In 2007, the segment’s restructuring costs were $3.6 million compared to $2.2 million in 2006. In 2007 and 2006, restructuring costs were primarily associated with temporary early retirement programs.

 

Machinery technologies — Europe — In 2007, the machinery technologies - Europe segment had new orders of $188 million compared to new orders of $154 million in 2006 and had sales of $181 million compared to sales of $153 million in 2006. Foreign currency translation increased new orders and sales by $15 million each compared to last year. Sales of injection molding machines were up $22 million and sales of blow molding systems were up $13 million compared to last year. The segment’s operating earnings were $3.3 million in 2007 compared to a prior year operating loss of $4.9 million. Operating results benefited from higher sales volumes and savings from our restructuring actions. Restructuring charges were $3.1 million in 2007 and $8.3 million in 2006. In both years, restructuring charges included costs related to the reorganization of the German injection molding machinery facility and to the second phase of a sales office consolidation in Europe.

 

Mold technologies — The mold technologies segment’s new orders were $148 million in 2007 and $158 million in 2006. Sales declined $11 million from $159 million in 2006 to $148 million in 2007. Sales in Europe increased $6 million, while sales in North America were down $11 million. The declines in North America were primarily related to the automotive and related tool and die and mold making sectors. Foreign currency translation increased new orders and sales by $5 million in the year. Operating earnings decreased to $1.9 million in 2007 compared to $3.0 million in 2006, due primarily to the impact of lower sales volumes, offset in part by savings

related to restructuring actions taken in 2007 and prior years. Lower insurance costs for 2007 also favorably affected operating earnings by $2.7 million compared to last year. In 2007, the segment had restructuring expense of $5.6 million, primarily related to the consolidation and sale of manufacturing facilities, including a $3.1 million charge for the sale of our Fulda, Germany manufacturing facility. In 2006, the segment had restructuring expense of $5.4 million related principally to reorganization of North American operations, the further downsizing at the Fulda plant and the consolidation of European operations.

 

Industrial Fluids — The industrial fluids segment had new orders and sales of $124 million each in 2007 compared to $117 million each in 2006. Orders and sales increased $7 million in Europe. Growth in Europe and Asia was offset by a slight decline in North America. Foreign currency translation provided $5 million of the growth in 2007, for both new orders and sales. Segment operating profit increased $5.8 million to $16.6 million in 2007. Compared to 2006, results for 2007 benefited from $3.9 million of lower insurance costs for product liability and the full effect of pricing increases taken to offset last year’s expense increases in energy, transportation and material costs — especially for chemicals and steel for drums. Restructuring costs were $.1 million in 2007 and $.2 million in 2006.

 

Loss From Continuing Operations Before Income Taxes

 

In 2007, our pretax loss from continuing operations was $26.6 million compared to a loss of $37.2 million in 2006. The loss for 2007 decreased $10.6 million primarily due to improved manufacturing margins. Restructuring costs decreased $4.9 million for the year, but 2007 included additional charges related to the change in preferred stock ownership and to the pension plan curtailment. In 2006, the loss included a $1.8 million refinancing charge.

 

Income Taxes

 

In 2007, we recorded a net income tax expense of $61.7 million compared to an expense of $2.6 million in 2006. As was previously discussed (see Significant Accounting Policies and Judgments — Deferred Tax Assets and Valuation Allowances), we were unable to record tax benefits with respect to our losses in the U.S. and certain other jurisdictions in 2007. Additionally, included in the net $61.7 million is a charge of $63.0 million related to recording valuation allowances due to the discontinuance of the use of tax planning strategies. The writedown was associated with an “ownership change” for U.S. federal income tax purposes related to Ohio Plastics, LLC’s purchase of 57.5% of the outstanding Series B Preferred Stock.

 

In 2006, we recorded a net income tax expense of $2.6 million. Our U.S. operations recorded a net tax benefit of $2.4 million, comprised of a decrease in valuation allowances of $4.0 million and a net reduction of tax carryback claims by $1.6 million. Our non-U.S. operations recorded income tax expense of $5.0 million for 2006, consisting of $4.0 million related to profitable non-U.S. operations and a $.9 million reduction in our deferred tax assets in Holland relating to an income tax rate reduction. Tax benefits in jurisdictions relating to non-profitable operations were fully offset by valuation allowances. In the aggregate, the mix of losses with no tax benefits and the expenses incurred in profitable jurisdictions resulted in a tax expense of $2.6 million on a pre-tax loss of $37.2 million.

 

Loss From Continuing Operations

 

Including restructuring costs and the previously discussed tax expense, our loss from continuing operations in 2007 was $88.3 million or $19.48 per share. In 2006, we had a loss from continuing operations of $39.8 million, or $10.17 per share. The loss per common share amounts in 2007 and in 2006 include the effect of preferred stock dividends and the amortization effect of a Series B Preferred Stock beneficial conversion feature. See the note to the Consolidated Financial Statements captioned “Shareholders’ Equity” for more information regarding the Series B Preferred Stock beneficial conversion feature.

 

Discontinued Operations

 

In 2007, discontinued operations provided income of $1.2 million compared to income of $.1 million in 2006. The income in both years related to reserve adjustments related to prior year divestitures.

Net Loss

 

Including all of the previously discussed matters, our net loss for 2007 was $87.1 million, or $19.25 per share. In 2006 our net loss was $39.7 million, or $10.15 per share. The per-share amounts for both years include the effects of preferred stock dividends and the effects of the Series B Preferred Stock beneficial conversion feature.

 

 

 

 

The above table excludes the contingent liabilities of up to $4.7 million related to the loan guarantees that are discussed above.

 

Liquidity and Sources of Capital

 

At December 31, 2007, we had cash and cash equivalents of $40.8 million, an increase of $2.3 million from December 31, 2006. Substantially all of the cash was held in foreign accounts in support of our operations outside of North America. Were any of the non-U.S. cash to be repatriated, it could result in withholding taxes in foreign jurisdictions and could have U.S. income tax consequences.

 

Operating activities provided $10 million of cash in 2007 due principally to improved working capital levels as higher advance billings and deposits and higher trade payables outpaced growth in inventory levels. Operating activities in 2007 also included the recovery of a receivable related to a prior liability claim. Operating activities used $19 million of cash in 2006 due principally to a $30 million voluntary contribution to the funded defined benefit pension plan for certain U.S. employees and retirees, partially offset by the liquidation of assets for non-qualified retirement plans. The usage of cash was also due in part to a reduction in liabilities and an increase in inventories that resulted from higher order levels.

 

Investing activities used $9 million of cash in 2007 including $10 million for capital expenditures, offset in part by proceeds from the sale of equipment. The proceeds on the sale of idled manufacturing facilities were approximately $3 million and are included in operating activities as a reduction of restructuring cash flows.

Capital expenditures in 2007 included approximately $2 million related to the implementation of an Enterprise Resource Planning (ERP) system, a major portion of which was placed into service January 1, 2008. Investing activities used $11 million of cash in 2006, including $14 million for capital expenditures which was partially offset by $3 million from the sale of an idle plant facility and other surplus assets. Capital expenditures in 2006 included approximately $9 million related to the implementation of the ERP system.

 

Financing activities used $1 million of cash in 2007 due principally to the repayment of long-term debt, offset in part by additional short-term borrowings. Financing activities provided $19 million of cash in 2006 due principally to increases in net short-term borrowings.

 

Our current ratio was 1.6 at December 31, 2007 compared to 1.7 at December 31, 2006.

 

On December 19, 2006, we entered into a new five year asset based revolving credit facility for which General Electric Capital Corporation acts as administrative agent, collateral agent and a lender. The new asset based facility replaced a $75 million asset based facility that was terminated by us. The termination of the previous facility was concurrent with, and contingent upon, the effectiveness of the new facility. The new facility provides increased liquidity and better terms than the previous facility with up to $105 million of borrowing availability and no financial maintenance covenants as long as we comply with certain minimum availability thresholds, as described below. In addition to terminating our previous asset based facility, we also terminated an interest rate swap that was entered into on July 30, 2004.

 

The security underlying the new asset based facility is substantially the same as that granted in connection with the previous facility. The borrowings under the asset based facility are secured by a first priority security interest, subject to permitted liens, in, among other things, U.S. and Canadian accounts receivable, cash and cash equivalents, inventory and, in the U.S., certain related rights under contracts, licenses and other general intangibles, subject to certain exceptions. The asset based facility is also secured by a second priority security interest on the assets that secure the 11 1 / 2 % Senior Secured Notes due 2011 on a first priority basis.

 

The availability of loans under our asset based facility is generally limited to a borrowing base equal to specified percentages of eligible U.S. and Canadian accounts receivable and U.S. inventory as well as permitted overadvances and is subject to other conditions to borrowing and limitations, including an excess availability reserve (the minimum required availability) of $10 million and other reserve requirements. The facility has a stated maturity of December 19, 2011.

 

The terms of our asset based facility impose a daily cash “sweep” on cash received in our U.S. bank accounts from collections of our accounts receivable. This daily cash “sweep” is automatically applied to pay down any outstanding borrowings under our asset based facility. The terms of our asset based facility also provide for the administrative agent, at its option and at any time, to impose a daily cash “sweep” on cash received in our Canadian bank accounts from collections of our accounts receivable. Since the cash we receive from collection of receivables is subject to the automatic “sweep” to repay the borrowings under the asset based facility on a daily basis, we rely on borrowings under it as our primary source of cash for use in our North American operations. Our liquidity could be materially affected if we have no additional availability or are unable to satisfy the borrowing conditions, 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 the company’s business or financial condition.

 

Our asset based facility contains customary conditions precedent to any borrowings, as well as customary covenants, including, but not limited to, maintenance of unused availability under the borrowing base based on reserves (including the excess availability reserve and other reserves) established by the administrative agent. Our asset based facility requires us to maintain a $10 million excess availability reserve and contains a limit on annual capital expenditures and a springing financial covenant requiring us to maintain a minimum fixed charge coverage ratio, to be tested quarterly, in the event that excess availability is less than $5 million.

 

Based on the assets included in the borrowing base as of December 31, 2007, including a $10 million over-advance facility, but without giving effect to reserves, outstanding borrowings and issuances of letters of credit (in all cases, as discussed below), we had approximately $77 million of borrowing-based availability, subject to the customary ability of the administrative agent for the lenders to reduce advance rates, impose or change collateral

value limitations, establish reserves and declare certain collateral ineligible from time to time in its reasonable credit judgment, any of which could reduce our borrowing availability at any time. At December 31, 2007, $32 million of the asset based facility was utilized, including borrowings of $24 million and letters of credit of $8 million. Under the terms of the facility, our additional borrowing capacity based on the assets included in the borrowing base at December 31, 2007 was approximately $34 million after taking into account the minimum availability and existing reserve requirements.

 

Failure to meet or exceed the covenants of the asset based facility would constitute an event of default under the facility, which would permit the lenders to accelerate indebtedness owed thereunder (if such indebtedness remained unpaid) and terminate their commitments to lend. The acceleration of the indebtedness under the asset based facility would also create a cross-default under our 11 1 / 2 % Senior Secured Notes due 2011 if the principal amount of indebtedness accelerated, together with the principal amount of any other such indebtedness under which there had been a payment default or the maturity had been so accelerated, aggregated $15 million or more. Such cross-default would permit the trustee under the indenture governing the 11 1 / 2 % Senior Secured Notes due 2011 or the holders of at least 25% in principal amount of the then outstanding notes to declare the notes to be due and payable immediately. Events of default under the asset based facility and the 11 1 / 2 % Senior Secured Notes due 2011 in addition to those described above, including, without limitation, the failure to make required payments in respect of such indebtedness in a timely manner, may result in the acceleration of indebtedness owed under these instruments. The acceleration of obligations under our outstanding indebtedness would have a material adverse effect on our business, financial condition and results of operations.

 

At December 31, 2007, we had other lines of credit with various U.S. and non-U.S. banks totaling approximately $33 million, of which approximately $12 million was available under certain circumstances.

 

In March 2008, certain of our operations in Europe signed a five-year, asset based revolving credit program through Lloyds TSB Group plc to provide as much as €27 million of aggregate financing for working capital purposes. This new asset based lending program will allow us to replace shorter-term credit commitments while providing incremental financing for our global working capital needs, including meeting our pension funding obligations. Because of the substantial inter-company indebtedness created by our U.S. refinancing of European bonds in 2004, we will be able to apply the proceeds to these obligations in a tax-efficient manner The credit program consists of two parts: (i) asset-secured loans to our subsidiaries in Germany, Holland and Belgium and (ii) an accounts receivable factoring facility between our German operations and Lloyds TSB Commerce Finance. Based upon current asset levels, total borrowing and factoring capacity under the new program, when fully operational, is expected to exceed €20 million. Principal terms of the program have been filed with the Securities and Exchange Commission.

 

Our debt and credit are rated by Standard & Poors (S&P) and Moody’s Investors Service (Moody’s). On December 20, 2007, Moody’s lowered the rating on our $225 million of Senior Secured Notes due 2011 and our “corporate family” to Caa2 and affirmed a negative outlook. On June 7, 2007, S&P affirmed its rating on our corporate credit at CCC+ and affirmed its outlook as developing. However, S&P lowered its rating on Senior Secured Notes to CCC-.

 

None of our debt instruments include ratings triggers that would accelerate maturity or increase interest rates in the event of a ratings downgrade. Accordingly, any potential ratings downgrades would have no significant short-term effect, although they could potentially affect the types and cost of credit facilities and debt instruments available to us in the future.

 

Before funding our U.S. defined benefit pension plan, we expect to generate positive cash flow from operations during 2008. However, operating cash flows may or may not be sufficient to meet the U.S. defined benefit plan funding requirements. We believe that our current cash position, cash flow from operations and available credit lines, including our asset based revolving credit facilities, will be sufficient to meet our capital expenditure and benefit plan requirements for 2008.

 

Cautionary Statement

 

We wish to caution readers about all of the forward-looking statements in the “Management’s Discussion and Analysis” section and elsewhere. These include all statements that speak about the future or are based on our

interpretation of factors that might affect our businesses. We believe the following important factors, among others, and the risk factors described earlier in this document could affect our actual results in 2008 and beyond and cause them to differ materially from those expressed in any of our forward-looking statements:

 

 

 

 

 

Not applicable.

 

 

See notes to consolidated financial statements.

MILACRON INC. AND SUBSIDIARIES

 

 

See notes to consolidated financial statements.

 

See notes to consolidated financial statements.

 

See notes to consolidated financial statements.

MILACRON INC. AND SUBSIDIARIES

 

 

MILACRON INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Income Taxes

 

The company provides deferred income taxes for cumulative temporary differences between the financial reporting basis and income tax basis of its assets and liabilities. Provisions are made for all currently payable federal and state and local income taxes at applicable tax rates. Provisions are also made for any additional taxes on anticipated distributions from non-U.S. subsidiaries.

 

Earnings Per Common Share

 

Basic earnings per common share data are based on the weighted-average number of common shares outstanding during the respective periods. When required under U.S. generally accepted accounting principles, diluted earnings per common share data are based on the weighted-average number of common shares outstanding adjusted to include the effects of certain restricted shares, the conversion of the Series B Preferred Stock and the contingent warrants.

 

For all periods presented, loss per common share data reflect the effects of a one-for-ten reverse stock split that became effective on May 16, 2007 (see Shareholders’ Equity).

 

Cash and Cash Equivalents

 

The company considers all highly liquid investments with a maturity of three months or less to be cash equivalents.

 

Inventory Valuation

 

Inventories are stated at the lower of cost or market, including provisions for obsolescence commensurate with known or estimated exposures. The principal methods of determining costs are average or standard costs, which approximate first-in, first-out (FIFO).

 

Property, Plant and Equipment

 

Property, plant and equipment, including amounts related to capital leases, are stated at cost or, for assets acquired through business combinations, at fair value at the dates of the respective acquisitions. For financial reporting purposes, depreciation is generally determined on the straight-line method using estimated useful lives of the assets. Depreciation expense was $15.4 million in 2007 and $15.7 million in 2006.

 

The ranges of depreciation lives that are used for most assets are as follows:

 

 

Property, plant and equipment that are idle and held for sale are valued at the lower of historical cost less accumulated depreciation or fair value less cost to sell. Carrying costs through the expected disposal dates of such

 

MILACRON INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

assets are accrued at the time expected losses are recognized. For assets expected to be sold at a gain, carrying costs are charged to expense as incurred.

 

Goodwill

 

Goodwill, which represents the excess of acquisition cost over the fair value of net assets acquired in business combinations, is reviewed annually for impairment. The company has elected to conduct its annual impairment reviews as of October 1 of each year and base its assessments of possible impairment on the discounted present value of the operating cash flows of its various reporting units. The company has identified eight reporting units for purposes of testing goodwill for impairment.

 

Long-Lived Assets

 

The company evaluates its long-lived assets, including certain intangible assets, for impairment annually or when facts and circumstances suggest that the carrying amounts of these assets might not be recoverable.

 

Warranty Reserves

 

The company maintains warranty reserves intended to cover future costs associated with its warranty obligations. These reserves are based on estimates of the amounts of those costs. Warranty costs are of two types - normal and extraordinary. Normal warranty costs represent repair costs incurred in the ordinary course of business and reserves are generally calculated using a percentage of sales approach based on past experience. Extraordinary warranty costs are unique major problems associated with a single machine, customer order or a set of problems related to a large number of machines or other type of product. Extraordinary warranty reserves are estimated based on specific facts and circumstances. The company’s policy is to adjust its warranty reserves quarterly.

 

Self-Insurance Reserves

 

Through its wholly owned insurance subsidiary, Milacron Assurance Ltd. (MAL), the company is primarily self-insured for many types of risks, including general liability, product liability, environmental claims and workers’ compensation for certain domestic employees. MAL, which is fully consolidated in the Consolidated Financial Statements and subject to the insurance laws and regulations of Bermuda, establishes reserves for known or estimated exposures under the policies it issues to the company. MAL’s exposure for general and product liability claims is limited by reinsurance coverage in some cases and by excess liability coverage in all policy years. Workers’ compensation claims in excess of certain limits are insured with commercial carriers.

 

MAL’s reserves are established based on known claims, including those arising from litigation, and estimates of the ultimate exposures thereunder (after consideration of expected recoveries from excess liability carriers and claims against third parties) and on estimates of the cost of incurred but not reported claims. Expected recoveries represent the excess of total reserves for known exposures and incurred but not reported claims over the limits on the policies MAL issues to the company. For certain types of exposures, MAL and the company utilize actuarially calculated estimates prepared by outside consultants to ensure the adequacy of the reserves. Reserves are reviewed and adjusted at least quarterly based on all available information as of the respective balance sheet dates or as further information becomes available or circumstances change. MAL’s reserves are included in accrued and other current liabilities and long-term accrued liabilities in the Consolidated Balance Sheets. Expected recoveries from excess carriers are included in other current assets and other noncurrent assets, and represent the excess of total reserves for known exposures and incurred but not reported claims over the limits on the policies MAL issues to the company. These amounts are classified as assets because unless other payment arrangements are negotiated, the company (as the insured party) expects that it would first pay any indemnity claims and expenses in excess of MAL’s limits and then pursue reimbursement from the excess carriers.

 

MILACRON INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Retirement Benefit Plans

 

The company maintains various defined benefit and defined contribution pension plans covering substantially all U.S. employees and certain non-U.S. employees. For defined benefit plans, pension benefits are based primarily on length of service and compensation. The company’s policy is to fund the plans in accordance with applicable laws and regulations. The company also sponsors a defined benefit postretirement health care plan under which such benefits are provided to certain U.S. employees.

 

The benefit obligations related to defined benefit pension plans and the postretirement health care plan are actuarially measured as of January 1 of each year. The amounts so determined are then progressed to year end based on known or expected changes. The assets of the funded defined benefit pension plans, including the defined pension plan for certain U.S. employees and retirees, are valued as of December 31 of each year.

 

Derivative Financial Instruments

 

The company enters into foreign currency forward exchange contracts, which are a type of derivative financial instrument, on an ongoing basis commensurate with known or expected exposures. The purpose of this practice is to minimize the potentially adverse effects of foreign currency exchange rate fluctuations on the company’s operating results. These contracts are typically designated as cash flow hedges with any gains or losses resulting from changes in their fair value being recorded as a component of other comprehensive loss pending completion of the transactions being hedged.

 

On December 14, 2006, the company terminated an interest rate swap that it had entered into on July 30, 2004. The interest rate swap, a form of derivative financial instrument, was entered into for the purpose of achieving a better balance between fixed-rate and floating-rate debt. The amounts paid or received under this arrangement were recorded as adjustments of interest expense. Changes in the fair value of the arrangement were also applied as adjustments of interest expense.

 

The company does not currently hold other types of derivative financial instruments and does not engage in speculation.

 

Changes in Methods of Accounting

 

Effective January 1, 2007, the company adopted Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN No. 48). This interpretation of Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes,” prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance regarding the derecognition of tax benefits, their classification in the statement of financial position and accounting for possible interest and penalties. Additionally, a new disclosure framework for uncertain tax positions is required beginning in 2007.

 

The adoption of FIN No. 48 resulted in a de minimis cumulative effect adjustment to opening accumulated deficit and accrued income taxes. The cumulative adjustment also resulted in a decrease in deferred tax assets and valuation allowances in the amount of $.7 million. The gross amount of uncertain tax benefits at adoption amounted to $2.8 million which increased by a net $17.4 in 2007 resulting in a balance of $20.2 million at December 31, 2007. Consistent with past practice, interest and penalties are classified as income tax expense as accrued. However, the amounts are immaterial in the periods presented primarily due to net operating loss carryforwards reflected as deferred tax assets.

 

Resolution of controversies related to uncertain tax benefits are contingent on reaching satisfactory settlement agreements with the relevant taxing authorities. In 2007, the company reached a favorable settlement with a non-U.S. taxing jurisdiction related to $1.5 million of uncertain tax benefits and recorded the related benefit. The resolution of the issues underlying uncertain tax benefits may cause a decrease or increase in the company’s

 

MILACRON INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

effective tax rate. The company’s tax returns are open under the respective statutes of limitations in most of the jurisdictions in which the company has major operations for periods generally beginning with the 2003 tax year.

 

Effective January 1, 2006, the company adopted Statement of Financial Accounting Standards No. 123 (Revised 2004), “Share-Based Payment,” (SFAS No. 123R) using the modified prospective transition method. Accordingly, amounts for prior periods were not restated. The company had previously accounted for stock options and restricted stock awards under the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and the related interpretations.

 

Prior to the adoption of SFAS No. 123R, no compensation expense related to stock options was recognized in earnings because all of the options granted under the company’s 1997 and 2004 Long-Term Incentive Plans and a predecessor plan had exercise prices equal to the fair market value of the underlying common shares at the respective grant dates. Under the provisions of SFAS No. 123R, expense related to stock options must be recognized in an entity’s primary financial statements over the vesting period or periods based on their fair value (as defined in the standard) as of the grant date. The conversion of $30.0 million of then-outstanding notes into 1.5 million common shares on April 15, 2004 resulted in a change in control under the provisions of the 1997 Long-Term Incentive Plan which triggered the vesting of all outstanding stock options. Since that date, only 1,400 additional stock options have been granted of which 1,050 were not fully vested as of January 1, 2006. The company began to include the expense related to these stock options in the Consolidated Statements of Operations in 2006 but the effect of doing so is de minimis based on their grant date fair value of $27.20 per share.

 

Under the provisions of SFAS No. 123R, the company continues to recognize expense related to restricted (unvested) stock and deferred shares over the respective vesting periods. The provisions of these awards and activity for 2007 are presented in the note captioned “Share-Based Compensation”. Prior to 2006, the company had accounted for forfeitures of these awards as they occurred. However, SFAS No. 123R requires that estimates of future forfeitures be made as of the grant dates and revised as necessary over the vesting periods. Accordingly, the company made estimates of future forfeitures for those awards outstanding as of January 1, 2006. The effect was to reduce the cumulative expense recognized to date by approximately $.1 million. This amount is included as income in other expense-net in the Consolidated Statement of Operations for 2006 (rather than being reported as the cumulative effect of a change in method of accounting) based on its immateriality.

 

As was customary under the prior rules, the company previously classified the offsets to the expense recognized for restricted stock and deferred shares as liabilities in the Consolidated Balance Sheets. The recorded liabilities were then transferred to shareholders’ equity when the awards vested. In connection with the adoption of SFAS No. 123R, liability balances as of December 31, 2005 totaling $1.3 million were reclassified to capital in excess of par value in shareholders’ equity as of January 1, 2006.

 

Excluding the adjustment for forfeitures, the adoption of SFAS No. 123R had the effect of increasing the company’s 2006 loss before income taxes and net loss by less than $.1 million. Including the adjustment for forfeitures, the effect on the respective loss amounts was a de minimis decrease. In both cases, there was no effect on the applicable loss per common share amounts.

 

Effective December 31, 2006, the company adopted the recognition and related disclosure provisions of Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans,” (SFAS No. 158). As required, the adoption was on a prospective transition method and prior periods were not restated. This standard amends Statements of Financial Accounting Standards No. 87, 88, 106 and 132(R). The standard requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position. The adoption of SFAS No. 158 increased shareholders’ deficit by $23.3 million and increased liabilities by $20.9 million, in both cases in relation to the amounts that would otherwise have been reported at December 31, 2006 under previous requirements. See the note captioned “Retirement Benefit Plans” for additional information regarding the company’s postretirement benefit plans.

 

MILACRON INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

SFAS No. 158 includes a second provision that is effective as of December 31, 2008. The measurement date provision of the standard requires an employer to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position and prohibits retrospective application. Because the company currently measures plan assets and benefit obligations as of its year end, this provision will not affect the company’s financial position or results of operation.

 

Recently Issued Pronouncements

 

In September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements,” (SFAS No. 157). SFAS No. 157 is effective for fiscal years and interim periods that begin after November 15, 2007 on a prospective basis. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principals and expands disclosure about fair value. The effects of adopting this standard are still being determined.

 

In February 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” (SFAS No. 159). SFAS No. 159 is elective for fiscal years that begin after November 15, 2007 on a prospective basis. SFAS No. 159 allows companies to measure certain financial assets and financial liabilities at fair market value and to report changes in the fair market value in earnings. The company does not intend to elect fair value reporting for its financial assets and financial liabilities in the near future.

 

In December 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements,” (SFAS No. 160). SFAS No. 160 is effective for fiscal years and interim periods beginning after December 15, 2008 on a prospective basis. The effects of adopting this standard are not expected to have a material effect on the company’s financial statements. SFAS No. 160 requires that entities provide sufficient disclosures that clearly identify and distinguish between interests of the parent and interests of noncontrolling owners. SFAS No. 160 also changes the deconsolidation and acquisition accounting for noncontrolling interests.

 

Discontinued Operations

 

The components of the line captioned “Discontinued operations net of income taxes” in the Consolidated Statements of Operations for 2007 and 2006 are presented in the table that follows. In both years, the amounts presented represent adjustments of previously recorded reserves for post-sale exposures based on more current information.

 

 

MILACRON INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Restructuring Costs

 

In November 2002, the company announced restructuring initiatives intended to improve operating efficiency and customer service. One of these actions involved the transfer of all manufacturing of container blow molding machines and structural foam systems from the plant in Manchester, Michigan to the company’s more modern and efficient facility near Cincinnati, Ohio. The mold making operation has also been moved to a smaller location near Manchester. These operations are included in the machinery technologies — North America segment. The relocations, which involved the elimination of 40 positions, resulted in restructuring costs of $14.3 million, including $.6 million in 2006. The amount for 2006 includes a charge to further reduce the carrying value of the Manchester facility based on a revised estimate of its fair value. The remainder of the expense for 2006 relates to costs to complete the move of the mold making operation and carrying costs for the Manchester facility pending its sale. The facility was subsequently sold in the third quarter of 2006 for proceeds that approximated its adjusted carrying value. Of the total cost of $14.3 million, $1.5 million relates to employee severance costs, $7.0 million to facility exit costs (including adjustments to the carrying values of the Manchester building and other assets that were disposed of), $1.9 million to inventory adjustments related to product lines discontinued in connection with the relocation and $3.9 million to other move-related costs, including employee, inventory and machinery and equipment relocation. Net of $1.8 million of proceeds from the sale of the Manchester facility, the net cash cost of the relocations was $4.6 million. The non-cash cost of $9.7 million relates principally to adjustments related to inventories of discontinued product lines and assets disposed of as a result of the plant closure.

 

In 2004, the company initiated headcount reductions in its European mold base and components business. These reductions represented a continuation of actions initiated in 2003 and employment level reductions in Germany and were undertaken due to continued slow economic conditions in Europe. The company incurred additional costs for these actions in 2006 related principally to the resolution of legal issues related to earlier terminations.

 

In the fourth quarter of 2005 the company also initiated the closure of a small metalworking fluids blending operation in Germany. The closure resulted in expense of $.3 million, including $.1 million in 2006. The cash cost in 2006 was $.1 million and an additional $.1 million was spent in 2007. In the fourth quarter of 2006, the company initiated the closure of a second fluids blending facility located in the United Kingdom at a cost of $.2 million. In 2006, $.1 million of the total cost was charged to expense and an additional $.1 million was expensed in 2007. The cash cost will be approximately $.2 million, of which $.1 million was spent in 2007.

 

In the fourth quarter of 2005, the company announced that it planned to further reduce its cost structure by consolidating certain operations in both North America and Europe. One such action — the reorganization of the European sales offices of the machinery technologies — Europe segment — was initiated in 2005 and was continued in 2006 and 2007. Expense related to this action totaled $.3 million in 2005 and an additional $1.7 million was charged to expense in 2006. Expense of $2.0 million was recorded in 2007 to substantially complete the consolidation. The amount for 2007 includes $1.3 million related to the sale of two additional sales subsidiaries and the closure of a third. The cost reduction measures announced in 2005 and implemented in 2006 also included the overall reorganization of European operations of the mold technologies segment, including product line rationalization and the streamlining of marketing and administrative functions. Expense related to these actions totaled $1.8 million in 2006 and $1.1 million in 2007. The net cash costs related to the sales office and mold base and components reorganizations are expected to be approximately $5.3 million. Of this amount, $1.9 million was spent in 2006 and an additional $3.4 million was spent in 2007. Severance and other termination benefits represent approximately one quarter of both the total expense and cash cost of these initiatives.

 

In the first quarter of 2006, the company initiated a plan to reduce the cost structure of its injection molding machine manufacturing facility in Malterdingen, Germany. The business has been restructured based on a rationalized global product portfolio, thereby eliminating complexity and reducing the overall cost structure. The restructuring resulted in 82 headcount reductions, including approximately 70 that occurred in 2006. The cost of the restructuring was $7.6 million, all of which relates to severance and other termination benefits. Of this

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

amount, $6.5 million was charged to expense in 2006 and an additional $1.1 million was expensed in 2007. The cash cost — all of which relates to termination benefits — was also $7.6 million. A total of $5.2 million was spent in 2006 and the remaining $2.4 million was spent in 2007.

 

In the second quarter of 2006, the company initiated a plan to reorganize and further downsize its special mold base machining facility in Fulda, Germany at a cost of $1.8 million, all of which was charged to expense in 2006, including $1.3 million for benefits related to the termination of 21 employees. The cash cost of the plant reorganization was $1.3 million, all of which was spent in 2006. As discussed further below, the Fulda facility was subsequently sold in the fourth quarter of 2007.

 

In the third quarter of 2006, the company initiated a reorganization of the mold technologies segment’s operations in North America. In one action, the company initiated the elimination of most of the manufacturing activities at the segment’s facility in Charlevoix, Michigan and the outsourcing of a majority of the mold components the facility produces. The cost of this action — which resulted in the elimination of 51 positions — was $1.8 million, substantially all of which was recorded in 2006. The total cost includes $.3 million for severance and other termination benefits and $1.5 million to adjust the carrying values of assets to be disposed of to reflect fair value. After deducting expected proceeds from sales of these assets, the cash cost is expected to be approximately $.6 million. In another action, the company initiated the downsizing of the administrative workforce at the segment’s North American headquarters in Madison Heights, Michigan in 2006. This action resulted in the elimination of 13 positions at a cost of $.1 million, all of which related to termination benefits. In order to further reduce headcount, the company offered special early retirement benefits to certain employees early in 2007 which resulted in expense of $.2 million. In the third quarter of 2007, the company initiated the closure of the mold base manufacturing facility in Melrose Park, Illinois and the transfer of its production to other mold technologies facilities in North America. Expense related to the closure was $.6 million which is net of a gain of $.5 million on the sale of the facility. The gross expense of $1.1 million related principally to severance and other termination benefits and the relocation of equipment. The net cash cost will be $.1 million, most of which was recorded in 2007.

 

In the third quarter of 2006, the company completed the liquidation of a sales branch in Japan which resulted in a non-cash charge of $1.3 million, a large portion of which related to the recognition of prior periods’ foreign currency translation adjustments and other deconsolidation effects.

 

In the fourth quarter of 2006, the company initiated a program to reduce headcount at its principal North American plastics machinery facility — principally in the injection molding machinery business — by offering supplemental early retirement benefits to eligible employees. A total of 34 employees accepted the offer in 2006 which resulted in a non-cash charge of $1.5 million. The offer of supplemental benefits was extended to additional groups of employees in the second quarter of 2007 which resulted in incremental expense related to 11 employees of $.9 million. The supplemental retirement benefits will be paid by the funded defined benefit pension plan for certain U.S. employees and retirees. In the third quarter of 2007, the company continued the headcount reduction program at its principal manufacturing facility by outsourcing certain functions at a cost of $.1 million for employee termination benefits.

 

In the first quarter of 2007, the operating assets of two European sales offices of the company’s MRO (maintenance, repair and operating supplies) business were sold which resulted in expense of $.2 million. This business is included in the mold technologies segment. The cash proceeds were $.5 million and the cash costs related to the sales were $.2 million.

 

In the fourth quarter of 2007, the company completed the sale of its special mold base facility in Fulda, Germany that resulted in 50 headcount reductions. The restructuring activity resulted in expense of $3.1 million in 2007, which mostly related to the loss on the sale of the fixed assets and inventory. The sale will result in net cash proceeds of $2.2 million, most of which was recorded in 2007.

 

In the fourth quarter of 2007, the company initiated a program to reduce headcount at several of its North American facilities by offering supplemental early retirement benefits to eligible employees. At the plastics

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

machinery operation, principally the injection molding machinery business, the program resulted in 40 headcount reductions at a cost of $2.3 million, all of which was recorded in 2007. The total cash cost is expected to be $.7 million, with $.2 million being recorded in 2007 and the remainder in 2008. At the Corporate facility, the program resulted in 3 additional headcount reductions. The total cost amounted to $.1 million, all recorded in 2007, with no cash cost. At the mold making operation in Tecumseh, Michigan, the program resulted in 7 headcount reductions at a cost of $.3 million, all of which was recorded in 2007. There was no cash cost in 2007, as it will all be incurred in 2008 and beyond.

 

Additional restructuring actions are expected to be implemented in 2008. In total, the actions initiated in 2005 through 2008 are expected to result in restructuring charges of approximately $31 million and cash costs of approximately $13 million spread from 2006 through 2008.

 

The table that follows summarizes the costs of the various restructuring actions that are described above.

 

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The following table presents the components of the line captioned “Restructuring costs” in the Consolidated Statements of Operations for the years 2007 and 2006.

 

 

The amounts on the line captioned “Inventory adjustments related to product line discontinuation” are included in cost of products sold in the Consolidated Statements of Operations.

 

As presented in the above table, the costs under the line captioned “Costs charged to expense as incurred” do not meet the conditions for accrual under U.S. generally accepted accounting principles upon announcement of the restructuring event and are therefore expensed when the related contractual liabilities are incurred. Accordingly, no reserves related to these costs were established.

 

The status of the reserves for the initiatives discussed above is summarized in the following tables.

 

 

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Approximately $1.0 million of the $1.9 million of restructuring reserves remaining at December 31, 2007 is expected to be utilized in the first half of 2008. A large portion of the remaining $.9 million represents supplemental retirement benefits for certain employees in Belgium that will be paid at a rate of approximately $.1 million per year for the next several years.

 

Change in Preferred Stock Ownership Costs

 

During 2007, the company charged to expense $1.9 million of costs associated with the October 2, 2007 purchase of all of the Series B Preferred Stock held by Glencore Finance AG, amounting to 57.5% of the outstanding Series B Preferred Stock, by Ohio Plastics, LLC, an affiliate of Bayside Capital, Inc. The $1.9 million of costs were primarily for the early vesting of certain shares of restricted stock granted to non-officer employees and legal and other consulting costs arising from the transaction. The sale, which is more fully discussed in the note to the Consolidated Financial Statements captioned “Income Taxes,” triggered an “ownership change” for U.S. federal income tax purposes. The ownership change for income tax purposes will further limit the company’s ability to utilize pre-change net operating loss carryforwards and the company recorded a $63.0 million charge to the provision for income taxes to record valuation allowances related to deferred tax assets previously covered by tax planning strategies.

 

Pension Plan Curtailment Costs

 

As discussed further below, as of December 31, 2007 the company froze the benefits payable under the U.S. defined benefit plan for certain employees and retirees. Related to freezing the plan, the company charged $1.9 million to expense to write-off unamortized prior service costs associated with previous plan amendments. These costs were being amortized to expense over the remaining service life of the plan’s active participants.

 

Research and Development

 

Charges to operations for research and development activities are summarized below.

 

Research and Development