Item 1A. Risk Factors
ITEM 1A . RISK FACTORS .
In the ordinary course of our business, we face various market, operational, strategic, financial and general risks. These risks could have a material impact on our business, financial condition, and results of operations. Please consider each of the risks described below, along with other information contained in this Annual Report on Form 10-K, when making any investment decisions with respect to our securities.
Our Enterprise Risk Management process seeks to identify and address material risks. We believe that risk-taking is an inherent aspect of operating a global business and, in particular, one focused on growth and cost-competitiveness. Our goal is to proactively manage risks in a structured approach in conjunction with strategic planning, while preserving and enhancing shareholder value. However, the risks set forth below and elsewhere in this report, as well as other risks currently unknown or deemed immaterial at the date of this report, could adversely affect us and cause our financial results to vary materially from recent or anticipated future results.
A.
MARKET RISKS
COVID-19 Pandemic and Future Public Health Crises
The ongoing COVID-19 pandemic, and any future widespread outbreak of an illness or other public health threat, could adversely affect our business, financial position, results of operations and cash flows.
In March 2020, the World Health Organization declared the outbreak of the novel coronavirus, COVID-19, a pandemic. The spread of COVID-19 and the resulting work and travel restrictions, including international border closings, have disrupted, and may continue to disrupt, global supply chains and have negatively impacted the global economy. As a result of this pandemic, we experienced significant impacts on our operations. Local government requirements or customer shutdowns caused us to suspend production at many of our manufacturing facilities around the world in March and April 2020. All of the temporarily-closed facilities reopened in the first or second quarter of fiscal 2021 and have generally returned to more normal production levels. However, since reopening, production at certain of our manufacturing facilities has been negatively affected at times by employee absences related to COVID-19.
Our business operations could be further affected if any of our key management or leadership personnel are incapacitated or if a significant portion of our workforce is unable to work effectively due to illness, quarantines, government actions or similar pandemic-related impediments. The COVID-19 threat has caused us to modify certain business practices (including employee work locations and limitations on physical participation in meetings) in ways that could be detrimental to our business, including, among others, working remotely and associated cybersecurity risks.
At this time, we are unable to quantify or predict the ultimate impacts on our business, the full extent of which will depend largely on future developments and the length and severity of the pandemic, all of which are unpredictable and outside of our control. If we, our suppliers, or our customers experience further shutdowns or other significant business disruptions, our ability to conduct business in the manner and on the timelines presently planned could be materially and negatively impacted, which could have a material adverse effect on our business, financial position, results of operations and cash flows.
Likewise, an outbreak of a disease or public health threat in the future could create economic and financial disruptions and adversely affect our businesses around the world. Potential impacts of the COVID-19 pandemic and any future epidemics, pandemics, or other health crises include, but are not limited to, (i) staffing shortages if portions of our workforce are unable to work effectively due to illness, quarantines, government actions, facility closures, or other restrictions; (ii) short- or long-term disruptions in our supply chain and our ability to deliver products to our customers; (iii) deterioration in the markets that we or our customers operate in, which may result in lower sales or a lack in the ability of our customers to pay us; and (iv) significant volatility or negative pressure in the financial markets, which could adversely affect our access to capital and/or financing.
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Customer and Supplier Matters
Our vehicular customers continually seek price reductions from us. These price reductions adversely affect our results of operations.
We face continuous price-reduction pressure from our vehicular OEM customers. Virtually all of these OEMs impose aggressive price-reduction initiatives upon their suppliers, even if contrary to contractual terms, and we expect such actions to continue in the future. In response, we must continually reduce our operating costs in order to maintain profit margins that are acceptable to us. We have taken, and will continue to take, steps to reduce our operating costs to offset customer price reductions; however, price reductions adversely affect our profit margins and are expected to do so in the future. In addition, we must balance our ongoing need to reduce operating costs against any potential compromise in the high quality of our products and our ability to provide the highest standard of service to our customers. If we are unable to avoid price reductions for our customers, or if we are unable to offset price reductions through improved operating efficiencies and manufacturing processes, sourcing alternatives, technology enhancements and other cost reduction initiatives, our results of operations could be adversely affected.
Fluctuations in costs of materials, including aluminum, copper, steel and stainless steel (nickel), other raw materials and purchased components, could place significant pressure on our results of operations.
Increases in the costs of raw materials and other purchased components, which may be impacted by a variety of factors, including changes in trade laws, tariffs and inflation, could have a significant adverse effect on our results of operations. In the short-term, our ability to adjust for cost increases is limited when prices are fixed for current orders. In these cases, if we are not able to recover such cost increases through price increases to our customers, such cost increases will have an adverse effect on our results of operations. With regard to our longer-term sales programs, we have sought to reduce the risk of cost increases by including provisions within our customer contracts, where possible, which provide for adjustments to customer prices, on a prospective basis, based upon increases and decreases in the cost of key raw materials. However, where these contract provisions are applicable, there can often be a three-month to one-year lag until the time of the price adjustment. To further mitigate our exposure, from time to time we enter into forward contracts to hedge a portion of our forecasted aluminum and copper purchases. However, these hedges may only partially offset increases in material costs, and significant increases could have an adverse effect on our results of operations.
We could be adversely affected if we experience shortages of components or materials from our suppliers.
In an effort to manage and reduce our cost of purchased goods and services, we, like many suppliers and customers, have been consolidating our supply base. As a result, we are dependent upon limited sources of supply for certain components used in the manufacture of our products. We select our suppliers based upon total value (including price, delivery and quality), taking into consideration their production capacities, financial condition and willingness and ability to meet our demand. In some cases, it can take several months or longer to find a supplier due to qualification requirements. However, strong demand, the potential effects of trade laws and tariffs, capacity constraints, financial instability, public health crises, such as pandemics and epidemics, including the ongoing COVID-19 pandemic, or other circumstances experienced by our suppliers could result in shortages or delays in their supply of product to us, or a significant price increase resulting in our need to resource. For example, the COVID-19 pandemic and other factors have contributed to a global shortage of semiconductor chips, which has negatively impacted automotive and other markets, and in turn, order levels for certain products we provide to our automotive customers. In addition, recent storms in Texas intensified already-constrained resin supply and, as a result, we experienced delays due to our suppliers’ inability to procure critical materials used in the production of certain of our products. If such shortages continue or worsen, or if we were to experience significant or prolonged shortages of any critical components or materials from our suppliers and could not procure the components or materials from other sources, we would be unable to meet our production schedules and we would miss product delivery dates, which would adversely affect our sales, results of operations and customer relationships.
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Our net sales and profitability could be adversely affected from business losses or declines with major customers.
Deterioration of a business relationship with a major customer could cause our sales and profitability to suffer. In certain of our businesses, a large portion of sales are attributable to a relatively small number of customers. In our vehicular businesses, the failure to obtain new business on new models or to retain or increase business on redesigned existing models could adversely affect our business and financial results. In addition, as a result of the relatively long lead times required for many of our complex vehicular components, it may be difficult in the short term for us to obtain new sales to replace any unexpected decline in sales of existing products. The loss of a major customer in any of our businesses, the loss of business with respect to one or more of the vehicle models that use our vehicular products, or a significant decline in the production levels of such vehicles could have an adverse effect on our business, results of operations and financial condition.
Continual customer pressure to absorb costs adversely affects our profitability.
Vehicular customers often request that we pay for design, engineering and tooling costs that are incurred prior to the start of production and recover these costs through amortization in the piece price of the product. Some of these costs cannot be capitalized, which adversely affects our profitability until the programs for which they have been incurred are launched. If a given program is not launched, or is launched with significantly lower volumes than planned, we may not be able to recover the design, engineering and tooling costs from our customers, further adversely affecting our results of operations.
Competitive Environment
We face strong competition.
The competitive environment continues to be dynamic as many of our customers, faced with intense international competition, have expanded their sourcing of components. As a result, we experience competition from suppliers in other parts of the world that enjoy economic advantages, such as lower labor costs, lower health care costs, lower tax rates, lower costs associated with legal compliance, and, in some cases, export or raw materials subsidies. In addition, consolidation and vertical integration within the supply base have introduced new or restructured competitors to our markets. Increased competition could adversely affect our business and our results of operations.
B.
OPERATIONAL RISKS
Complexities of Global Presence
We are subject to risks related to our international operations.
We have manufacturing and technical facilities located in North America, South America, Europe, and Asia. In fiscal 2021, 58 percent of our sales were generated from non-U.S. operations. Consequently, our global operations are subject to complex international laws and regulations and numerous risks and uncertainties, including changes in monetary and fiscal policies, including those related to tax and trade, cross-border trade restrictions or prohibitions, import or other charges or taxes, fluctuations in foreign currency exchange and interest rates, inflation, changing economic conditions, public health crises, including the ongoing COVID-19 pandemic, unreliable intellectual property protection and legal systems, insufficient infrastructures, social unrest, political instability and disputes (including, for example, the continuing uncertainty related to the withdrawal of the United Kingdom from the European Union, commonly referred to as “Brexit”), incompatible business practices, and international terrorism. Changes in policies or laws governing the terms of foreign trade, and in particular increased trade restrictions, tariffs or taxes on imports from countries where we either manufacture products, such as Mexico, or buy raw materials, such as China, could have a material adverse effect on our results of operations. In addition, compliance with multiple and often conflicting laws and regulations of various countries can be challenging and expensive.
Embargoes or sanctions imposed by the U.S. government or those abroad that restrict or prohibit sales to or purchases from specific persons or countries or based upon product classification may expose us to potential criminal and civil sanctions to the extent that we are alleged or found to be in violation, whether intentional or unintentional. We cannot predict future regulatory requirements to which our business operations may be subject or the manner in which existing laws might be administered or interpreted.
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In addition, the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act and other similar anti-corruption laws generally prohibit companies and their intermediaries from making payments to improperly influence foreign government officials or other persons for the purpose of obtaining or retaining business. In recent years, there has been a substantial increase in the global enforcement of anti-corruption laws. In the event that we believe our employees or agents may have violated applicable anti-corruption laws, or if we are subject to allegations of any such violations, we may have to expend significant time and financial resources towards the investigation and remediation of the matter, which could disrupt our business and result in a material adverse effect on our financial condition, results of operations and reputation.
Challenges of Maintaining a Competitive Cost Structure
We may be unable to maintain competitive cost structures within our business.
In recent years, we have engaged in various restructuring activities in our CIS, HDE and Automotive segments in order to optimize our manufacturing footprint and cost structure. These restructuring activities have included targeted headcount reductions that support our objective of reducing operational and SG&A cost structures and the consolidation and/or closure of manufacturing facilities in North America, Europe and Asia. In addition, we continue to focus on reducing costs for materials and services through targeted adjustments and negotiations with our supply base. Our successful execution of these initiatives, and our ability to identify and execute future opportunities to optimize our cost structures, is critical to enable us to establish a cost environment that will increase and sustain our long-term competitiveness. Any failure to do so could, in turn, adversely affect our results of operations and financial condition.
Challenges of Program Launches
We continue to launch a significant number of new programs at our facilities across the world. The success of these launches is critical to our business.
We design technologically advanced products, and the processes required to produce these products can be difficult and complex. We spend significant time and financial resources to ensure the successful launch of new products and programs. Due to our high level of launch activity, particularly within our HDE segment, we must appropriately manage these launches and deploy our operational and administrative resources to take advantage of the resulting increase in our business. If we do not successfully launch new products and programs, we may lose market share or damage relationships with our customers, which could negatively affect our business. In addition, any failure in our manufacturing strategy for these new products or programs could result in operating inefficiencies or asset impairment charges, which could adversely affect our results of operations.
Information Technology (IT) Systems
We may be adversely affected by a substantial disruption in, or material breach of, our IT systems.
We are dependent upon our IT infrastructure, including network, hardware, and software systems, to conduct our business. Despite network and other cybersecurity measures we have in place, our IT systems could be disrupted or we could experience a security breach from computer viruses, break-ins or similar disruptions. A substantial disruption in our IT systems for a prolonged time period, or a material breach of our IT systems, could result in delays in receiving inventory and supplies or filling customer orders, and/or the release of otherwise confidential information, including personal information that is protected by the General Data Protection Regulation, adversely affecting our customer service and relationships as well as our reputation, and could lead to significant remediation expenses and litigation risks. Our systems, and the systems of our service providers or others, could be breached, damaged or interrupted by cyber-attacks or other man-made intentional or unintentional events, or by natural disasters or occurrences, many of which may, despite our best efforts, be beyond our ability to effectively detect, anticipate or control. This impact may be heightened by the increased disbursement of our workforce resulting from our own and from government efforts to mitigate the spread of the COVID-19 pandemic. Any such events and the related delays, problems or costs could have a material adverse effect on our business, financial condition, results of operations and reputation.
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Environmental, Health and Safety Regulations
We could be adversely impacted by the costs of environmental, health and safety regulations.
Our operations are subject to various federal, state, local and foreign laws and regulations governing, among other things, emissions to air, discharge to waters and the generation, handling, storage, transportation, treatment and disposal of waste and other materials. The operation of our manufacturing facilities entails risks in these areas and there can be no assurance we will avoid material costs or liabilities relating to such matters. Our financial responsibility to clean up contaminated property may extend to previously-owned or used property, properties owned by unrelated companies, as well as properties we currently own and use, regardless of whether the contamination is attributable to prior owners. In addition, potentially significant expenditures could be required in order to comply with evolving environmental, health and safety laws, regulations or other requirements that may be adopted or imposed in the future.
Claims and Litigation
We may incur material losses and costs as a result of warranty and product liability claims and litigation or other legal proceedings.
In the event our products fail to perform as expected, we are exposed to warranty and product liability claims and may be required to participate in a recall or other field campaign of such products. Many of our vehicular customers offer extended warranty protection for their vehicles and require their supply base to extend warranty coverage as well. If our customers demand higher warranty-related cost recoveries, or if our products fail to perform as expected, it could have a material adverse impact on our results of operations and financial condition. We are also involved in various legal proceedings from time to time incidental to our business. If any such proceeding has a negative result, it could adversely affect our business, results of operations, financial condition and reputation.
C.
STRATEGIC RISKS
Business Exit Strategy
The optimization of our company’s future profitability depends, in part, upon the success of our evaluation of strategic alternatives for our Automotive segment’s business operations.
We previously disclosed our evaluation of strategic alternatives for the businesses within our Automotive segment. As of March 31, 2021, we classified the liquid- and air-cooled automotive businesses within the Automotive segment as held for sale on our consolidated balance sheet. The sale of the air-cooled automotive business to Schmid Metall GmbH closed on April 30, 2021. The sale of the liquid-cooled automotive business to Dana Incorporated is subject to the receipt of governmental and third-party approvals and satisfaction of other closing conditions. There can be no assurance that the pending sale will be consummated.
We are also evaluating strategic alternatives for the other Automotive segment business operations and are committed to exiting this business in a manner that is in the best interest of our shareholders. It is possible that our exit strategy may ultimately include winding-down or closing the remaining business operations within the Automotive segment.
If our evaluation process does not result in the successful consummation of strategic alternatives, or if we are otherwise unable through such consummation to realize our goals for the Automotive segment, we may not be able to optimize our future profitability, which could adversely affect our results of operations and financial condition.
Growth Strategies
Inability to identify and execute on growth opportunities may adversely impact our business and operating results.
We are pursuing growth, through both organic and inorganic opportunities. Under our new CEO’s leadership, we are implementing a new strategy, which we refer to as our “80/20 strategy,” to examine our businesses using data analytics in order to focus our resources on products and markets with the highest growth and best returns. In addition, we will continue to review our business portfolio and pursue acquisitions to accelerate growth. If we are unable to successfully implement the 80/20 strategy, we may not achieve the financial or operational successes anticipated. In addition, there can be no assurance we will be able to identify attractive acquisition targets and/or organic growth opportunities. If we are unable to successfully complete acquisitions and execute on organic opportunities in the future, our growth may be limited. In addition, future acquisitions will require integration of operations, sales and marketing, information technology, finance, and administrative functions. If we are unable to successfully integrate acquisitions and operate these businesses profitably, we may not achieve the financial or operational success expected from the acquisitions.
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D.
FINANCIAL RISKS
Liquidity and Access to Cash
Our indebtedness may limit our use of cash flow to support operating, development and investment activities, and failure to comply with our debt covenants could adversely affect our liquidity and financial results.
As of March 31, 2021, we had total outstanding indebtedness of $340 million, of which $5 million was classified as held for sale on our consolidated balance sheet. Our indebtedness and related debt service obligations (i) require that significant cash flow from operations be used for principal and interest payments, which reduces the funds we have available for other business purposes; (ii) limit our flexibility in planning for or reacting to changes in our business and market conditions; and (iii) expose us to interest rate risk, since the majority of our debt obligations carry variable interest rates.
Our credit and Senior Note agreements contain financial covenants that, among other things, require us to maintain a minimum interest coverage ratio and impose a maximum leverage ratio. Failure to comply with debt covenants could result in an event of default, which, if not cured or waived, could result in us being required to repay these borrowings before their due date. If we are forced to refinance these borrowings on less favorable terms, our results of operations and financial condition could be adversely affected by increased costs and interest rates.
The planned phase out of the London Interbank Offer Rate (“LIBOR”) could have an adverse effect on our financial condition and access to capital.
Our revolving credit facility and current term loans utilize LIBOR to set the interest rate on outstanding borrowings. The United Kingdom’s Financial Conduct Authority announced that after 2021 it would no longer persuade or compel panel banks to submit the rates required to calculate LIBOR. On November 30, 2020, the ICE Benchmark Administration, the administrator of LIBOR, announced a consultation on the extension of most tenors of USD LIBOR until June 2023. The proposed extension would not apply to the rate’s other denominations, including the euro. Meanwhile, U.S. banking regulators have advised that most USD LIBOR originations should end no later than 2021 and it is expected that LIBOR may be replaced with the Secured Overnight Financing Rate (“SOFR”), a new index calculated on a daily basis by reference to short-term repurchase agreements for U.S. Treasury securities. It is currently uncertain whether SOFR or other alternative reference rates will attain market acceptance as replacements for LIBOR. As a result, it is not possible to predict the effect of these changes, other reforms, or the establishment of alternative reference rates. Should a suitable replacement for LIBOR not be available, however, the rates under our variable rate indebtedness could increase and access to capital could be limited.
Market trends and regulatory requirements may require additional funding for our pension plans.
Our defined benefit pension plans in the U.S. are frozen to new participants. Our funding policy is to contribute annually, at a minimum, the amount necessary on an actuarial basis to provide for benefits in accordance with applicable laws and regulations. Our domestic plans have an unfunded liability totaling $41 million as of March 31, 2021. During fiscal 2022, we anticipate making funding contributions totaling $13 million related to these domestic plans. Funding requirements for our defined benefit plans are dependent upon, among other things, interest rates, underlying asset returns, mortality rate assumptions, and the impact of legislative or regulatory changes. Should changes in actuarial assumptions or other factors result in the requirement of significant additional funding contributions, our financial condition could be adversely affected.
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Goodwill and Intangible Assets
Our balance sheet includes significant amounts of goodwill and intangible assets. An impairment of a significant portion of these assets would adversely affect our financial results.
Our balance sheet includes goodwill and intangible assets totaling $271 million at March 31, 2021. We perform goodwill impairment tests annually, as of March 31, or more frequently if business events or other conditions exist that require a more frequent evaluation. In addition, we review intangible assets for impairment whenever business conditions or other events indicate that the assets may be impaired. If we determine the carrying value of an asset is impaired, we write down the asset to fair value and record an impairment charge to current operations.
We use judgment in determining if an indication of impairment exists. For our annual goodwill impairment tests, we use significant estimates and assumptions, including revenue growth rates and operating profit margins to calculate estimated future cash flows, risk-adjusted discount rates, business trends and market conditions. We cannot predict the occurrence of future events or circumstances, including lower than forecasted revenues, market trends that fall below our current expectations, actions of key customers, increases in discount rates, and the continued economic uncertainty and impacts associated with the COVID-19 pandemic, which could adversely affect the carrying value of goodwill and intangible assets. An impairment of a significant portion of goodwill or intangible assets could have a material adverse effect on our financial results.
Income Taxes
We may be subject to additional income tax expense or become subject to additional tax exposure.
The subjectivity of or changes in tax laws and regulations in jurisdictions where we have significant operations could materially affect our results of operations and financial condition. We are also subject to tax audits in each jurisdiction in which we operate. Unfavorable or unexpected outcomes from one or more tax audits could adversely affect our results of operations and financial condition.
President Biden recently unveiled a new infrastructure plan, which includes a proposal to increase the federal corporate tax rate from 21 percent to 28 percent as part of a package of tax reforms to help fund the spending proposals in the plan. The proposed infrastructure plan is in the early stages of the legislative process but is expected to proceed this year due to the Democratic Party’s majority in both houses of Congress. If adopted as proposed, the increase of the corporate tax rate would adversely affect our results of operations in future periods.
In addition, as of March 31, 2021, our net deferred tax assets totaled $19 million. Each quarter, we evaluate the probability that our deferred tax assets will be realized and determine whether valuation allowances or adjustments thereto are needed. This determination involves judgement and the use of significant estimates and assumptions, including expectations of future taxable income and tax planning strategies. Future events or circumstances, such as lower taxable income or unfavorable changes in the financial outlook of our operations in certain jurisdictions, could require us to establish further valuation allowances, which could have a material adverse effect on our results of operations and financial condition.
E.
GENERAL RISKS
Customers and Markets
We are dependent upon the health of the customers and markets we serve.
We are highly susceptible to unfavorable trends or disruptions in the markets we serve, as our customers’ sales and production levels are affected by general economic conditions, including access to credit, the price of fuel and electricity, employment levels and trends, interest rates, labor relations issues, regulatory requirements, government-imposed restrictions relating to health crises or other unusual events, trade agreements and other market factors, as well as by customer-specific issues. Any significant decline in production levels for current and future customers could result in asset impairment charges and a reduction in our sales, thereby adversely impacting our results of operations and financial condition.
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Exposure to Foreign Currencies
As a global company, we are subject to foreign currency rate fluctuations, which affect our financial results.
Although our financial results are reported in U.S. dollars, a significant portion of our sales and operating costs are realized in foreign currencies. Our sales and profitability are affected by movements of the U.S. dollar against foreign currencies in which we generate sales and incur expenses. To the extent that we are unable to match sales in foreign currencies with costs paid in the same currency, exchange rate fluctuations in any such currency could have an adverse effect on our financial results. During times of a strengthening U.S. dollar, our reported sales and earnings from our international operations will be lower because the applicable local currency will be translated into fewer U.S. dollars. In certain instances, currency rate fluctuations may create pricing pressure relative to competitors quoting in different currencies, which could result in our products becoming less competitive. Significant long-term fluctuations in relative currency values could have an adverse effect on our results of operations and financial condition.
Reliance upon Technology Advantage
If we cannot differentiate ourselves from our competitors with our technology, our existing and potential customers may seek lower prices and our sales and earnings may be adversely affected.
Price, quality, delivery, technological innovation, and application engineering development are the primary elements of competition in our markets. If we fail to keep pace with technological changes and cannot differentiate ourselves from our competitors with our technology or fail to provide high quality, innovative products and services that both meet or exceed customer expectations and address their ever-evolving needs, we may experience price erosion, lower sales, and lower profit margins. Significant technological developments by our competitors or others also could adversely affect our business and results of operations.
Developments or assertions by or against us relating to intellectual property rights could adversely affect our business.
We own and license significant intellectual property, including a large number of patents, trademarks, copyrights and trade secrets. Our intellectual property plays an important role in maintaining our competitive position in a number of the markets we serve. As we maintain or expand our operations in jurisdictions where the enforcement of intellectual property rights is less robust, the risk of others duplicating our proprietary technologies increases, despite our efforts to protect them. Developments or assertions by or against us relating to intellectual property rights could adversely affect our business and results of operations.
Attracting and Retaining Talent
Our continued success is dependent on being able to attract, develop and retain qualified personnel.
Our ability to sustain and grow our business requires us to hire, develop, and retain skilled and diverse personnel in managerial, leadership and administrative functions. We depend significantly on the engagement of our employees and their skills, experience and industry knowledge to support our objectives and initiatives. Difficulty attracting, developing, and retaining qualified personnel, particularly in light of tight global labor markets, could adversely affect our business and results of operations.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
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