| OILGEAR CO Item 1A Risk Factors |
| As with any business, the Company’s business and operations involve risks and uncertainties |
| In addition to the other discussions in, or incorporated by reference into, this Report, particularly those set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Forward Looking Statements” in Item 7 of this report, the following factors should be considered: The demand for our products is cyclical and a downturn in the US or world economy would be likely to have a material adverse effect on our sales and earnings |
| The demand for the value engineered fluid power components and controls that we manufacture is directly related to overall industrial demand, which in turn generally reflects the overall US and world economy |
| Our ability to generate sales could be likely to substantially diminish if there is an economic downturn in the US or overseas |
| Our sales also depend in part upon our customers’ replacement or repair cycles |
| Adverse economic conditions may cause customers to forego or postpone new purchases in favor of repairing existing machinery |
| As a result, it is not always possible for us to properly forecast future demand and we may incur additional expenses and inefficiencies in connection with rapid changes in levels of business |
| Historically, sales of products that we manufacture and sell have been subject to cyclical variations caused by changes in general economic conditions and other factors |
| During periods of expansion in industrial activity we generally have benefited from increased demand for our products |
| Conversely, during recessionary periods, we have been adversely affected by reduced demand for our products |
| Furthermore, an economic recession may impact 5 _________________________________________________________________ [55]Table of Contents leveraged companies, such as Oilgear, more than competing companies with less leverage, and may have a material adverse effect on our financial condition, results of operations and cash flows |
| Some of our products are sold to a relatively small number of customers; if we lose any of those customers, sales and operating results could decline |
| In some of our product lines our sales are concentrated to a small number of customers, especially with respect to pumps |
| Currently we have large contracts with two significant customers, and the loss of any of these significant customers could substantially affect our sales and profitability |
| Our financial resources may not be sufficient to permit us to effectively compete in some of our core product lines, and intense competition may result in reduced sales and profitability |
| We sell our products in highly competitive markets |
| Many of our competitors have greater financial, marketing, manufacturing and distribution resources than we do |
| We cannot assure you that our products and services will continue to compete successfully with those of our competitors or that we will be able to retain our customer base or improve or maintain our profit margins on sales to our customers, all of which could materially and adversely affect our financial condition, results of operations and cash flows |
| Our products must be kept current to meet our customers’ needs |
| To remain competitive, we therefore must develop new and innovative products on an on-going basis |
| If we fail to make innovations, or the market does not accept our new products, our sales and results would suffer |
| We invest in the research and development of new products, principally in the areas of developing new products for our axial piston pump line and in customizing products for specific customer applications |
| However these expenditures do not always result in products that will be accepted by the market |
| To the extent they do not, whether as a function of the product or the business cycle, we will have increased expenses without significant sales to benefit us |
| We could be subject to product liability claims, product recalls and increased warranty costs, which could negatively impact our profitability and corporate image |
| A significant product defect, product liability judgment or product recall may negatively impact our profitability for a period of time depending on publicity, product availability, scope, competitive reaction and consumer attitudes |
| Even if a product liability claim is unsuccessful or is not fully pursued, the negative publicity surrounding any assertion that our products are unsafe or unreliable could adversely affect our reputation with existing and potential customers and our corporate image |
| We provide our customers warranty coverage on products we manufacture |
| Although we maintain warranty reserves in an amount based primarily on the number of units shipped and on historical and anticipated warranty claims, there can be no assurance that future warranty claims will follow historical patterns or that we can accurately anticipate the level of future warranty claims |
| An increase in the rate of warranty claims or the occurrence of unexpected warranty claims could materially and adversely affect our financial condition, results of operations and cash flows |
| Commodity and energy price increases or material shortages may reduce our profits |
| We use iron and steel castings, bearings, steel and other commodities as raw materials |
| Commodity and energy prices are subject to significant volatility caused by market fluctuations, supply and demand, currency fluctuation, production and transportation disruption, world events and changes in governmental programs |
| Commodity and energy price increases will raise both our raw material costs and operating costs |
| We may not be able to increase our product prices enough to offset these increased costs |
| Increasing our prices also may reduce sales volume and profitability |
| In addition, even though we can generally obtain our supplies from multiple suppliers, there can be occasional shortages of a particular raw material |
| An unavailability or shortage of a raw 6 _________________________________________________________________ [56]Table of Contents material could negatively affect our ability to manufacture products using that raw material and thus affect net shipments |
| There are many laws and regulations applicable to the manufacturing industry |
| Compliance with those requirements is costly to us and can affect our operations |
| Failure to comply could also be costly and disruptive |
| Our facilities and products are subject to many laws and regulations relating to safety, import-export regulations, etc, domestically and abroad |
| Compliance with these laws and regulations can be costly and affect our operations |
| Also, if we fail to comply with applicable laws and regulations, we could be subject to administrative penalties and injunctive relief, civil remedies, fines and recalls of our products |
| Environmental compliance may be costly to us |
| Our operations are subject to extensive and increasingly stringent laws and regulations which pertain to the discharge of materials into the environment and the handling and disposition of wastes |
| These rules operate at the federal and state levels in the United States, and there are analogous laws at many of our overseas locations |
| Environmental regulations, and the potential failure to comply with them, could have serious consequences, including the costs of compliance and defense, interference with our operations, civil and administrative penalties and negative publicity |
| We manufacture and sell some of our products outside of the United States, which may present additional risks to our business |
| For the year ended December 31, 2005 approximately 56prca of our net sales were attributable to products manufactured or sold outside of the United States |
| International operations generally are subject to various risks, including political, military, religious and economic instability, local labor market conditions, the imposition of foreign tariffs, the impact of foreign government regulations, the effects of income and withholding tax, governmental expropriation and differences in business practices |
| We may incur increased costs and experience delays or disruptions in product deliveries and payments in connection with international manufacturing and sales that could cause loss of revenue |
| Unfavorable changes in the political, regulatory and business climate and currency devaluations of various foreign jurisdictions could have a material adverse effect on our financial condition, results of operations and cash flows |
| We are exposed to the risk of foreign currency fluctuations |
| Some of our operations are conducted by subsidiaries in foreign countries |
| The results of the operations and the financial position of these subsidiaries are reported in the relevant foreign currencies and then translated into US dollars at the applicable exchange rates for inclusion in our consolidated financial statements, which are stated in US dollars |
| The exchange rates between many of these currencies and the US dollar have fluctuated significantly in recent years and may fluctuate significantly in the future |
| Such fluctuations may have a material effect on our results of operations and financial position and may significantly affect the comparability of our results between financial periods |
| In addition, we incur currency transaction risk whenever one of our operating subsidiaries enters into a transaction using a currency other than its functional currency |
| Our operations and profitability could suffer if we experience labor relations problems |
| We employ approximately 355 people who work under collective bargaining agreements and have labor agreements with two union locals in North America |
| In addition, some of our European employees belong to European trade unions |
| These collective bargaining or similar agreements expire at various times in the next several years |
| We believe that we have satisfactory relations with our unions and, therefore, anticipate reaching new agreements on satisfactory terms as the existing agreements expire |
| However, we may not be able to reach new agreements without a work stoppage or strike and any new agreements that are reached may not be reached on terms satisfactory to us |
| One of the issues that could make future labor negotiations more difficult, and increase our overall 7 _________________________________________________________________ [57]Table of Contents compensation expense, is rising health care costs, particularly in the US A prolonged work stoppage or strike at any one of our manufacturing facilities, or the continued upward trend in health care costs, could have a material adverse effect on our financial condition, results of operations and cash flows |
| Additionally, approximately 393 of our employees are currently non-union |
| Any unionization of the Company’s non-union employees could also result in additional costs and expenses |
| We depend on certain key personnel, and the loss or retirement of these persons may harm our business |
| Our success depends in large part on the continued service and availability of our key management and technical personnel, and on our ability to attract and retain qualified new personnel |
| The competition for these individuals can be significant, and the loss of key employees could harm our business |
| In addition, as some of these persons approach retirement age, we need to provide for smooth transitions, and our operations and results may be negatively affected if we are not able to do so |
| World events and natural disasters are beyond our control and could affect our results |
| World events, such as the attacks of September 11, 2001 and their aftermath, the Iraq conflict and the situations in North Korea and Iran, can adversely affect national, international and local economies |
| Economies can also be affected by other events and natural disasters, such as the Southeast Asian tsunami and Hurricane Katrina, or epidemics such as the avian flu |
| These events and conditions, which are beyond our control, could adversely affect our revenues and profitability if they affect the economy, and could particularly affect us if they occur in locations in which we or our customers have significant operations |
| Our leverage may impair our operations and financial condition |
| As of December 31, 2005, our total consolidated debt was dlra24dtta3 million |
| Our debt could have important consequences, including increasing our vulnerability to general adverse economic and industry conditions; requiring a substantial portion of our cash flows from operations be used for the payment of interest rather than to fund working capital, capital expenditures and general corporate requirements; limiting our ability to obtain additional financing; and limiting our flexibility in planning for, or reacting to, changes in our business and the product sectors that we serve |
| The agreements governing our debt include covenants that restrict, among other things, our ability to incur additional debt; pay dividends on or repurchase our equity; make investments; and consolidate, merge or transfer all or substantially all of our assets |
| In addition, our principal credit facilities require us to maintain specified financial ratios and satisfy certain financial condition tests, including the maintenance of certain levels of tangible net worth, debt service coverage and interest coverage |
| It also is an event of default under our principal loan agreements if David A Zuege ceases to be the President and CEO of the Company |
| Our ability to comply with these covenants may be affected by events beyond our control, including prevailing economic, financial and industry conditions |
| These covenants may also require that we take action to reduce our debt or act in a manner contrary to our business objectives |
| We cannot assure you that we will meet any future financial tests or that the lenders will waive any failure to meet those tests |
| Additionally, our principal debt instruments call for the guarantee of portions of such debt by one or more of our subsidiaries, including our overseas subsidiaries |
| The regulations regarding subsidiary guarantees in the US and other countries are subject to certain legal interpretations and accounting determinations that can limit the amount of debt a subsidiary can guarantee for a parent or affiliate entity |
| We cannot assure you that the provision by our subsidiaries of the guaranties requested under our loan agreements currently comply with applicable legal requirements or will comply with such future requirements |
| If we default under our debt agreements, our lenders could elect to declare all amounts outstanding under our debt agreements to be immediately due and payable and could proceed against any collateral securing the debt, which includes substantially all of our assets and the assets of our subsidiaries |
| Under those circumstances, in the absence of readily-available refinancing on favorable terms, we might elect or be compelled to enter bankruptcy proceedings, in which case our shareholders could lose the entire value of their investment in our common stock |
| 8 _________________________________________________________________ [58]Table of Contents Our future required cash contributions to our pension plans may increase if new pension funding requirements are enacted into law |
| Congress is considering legislation to reform funding requirements for underfunded pension plans on a prospective basis |
| The proposed legislation as currently drafted would, among other things, increase the percentage funding target from 90prca to 100prca and require the use of a more current mortality table in the calculation of minimum yearly funding requirements |
| This proposed legislation is preliminary and could change significantly before it is enacted into law |
| Our future required cash contributions to our two underfunded US defined benefit pension plans may increase based on the funding reform provisions that are ultimately enacted into law |
| As a public company we are subject to accounting, reporting and other regulatory requirements, including under the Sarbanes-Oxley Act of 2002, the cost of which increases our operating expenses |
| As a small publicly traded company the costs and expenses associated with the regulatory requirements applicable to us comprise a greater percentage of gross operating margin, and therefore our profitability, than is generally the case with larger entities |
| In addition to the costs incurred in connection with the SEC’s general reporting requirements and the corporate governance requirements of the Nasdaq Stock Market, we are subject to many of the provisions of the Sarbanes-Oxley Act of 2002 |
| Under current SEC rules we are scheduled to become subject to the internal control over financial reporting requirements of Section 404 of Sarbanes-Oxley in fiscal 2007 |
| We expect the costs of Section 404 compliance to be substantial and to have a material adverse effect on our earnings for at least that year and, possibly, subsequent periods |
| We are not currently required to complete the review of our internal controls under Section 404 of Sarbanes-Oxley; we may still identify material weaknesses |
| Section 404 of Sarbanes-Oxley and rules adopted by the Public Company Accounting Oversight Board (“PCAOB”) require us to provide a report about our internal controls and procedures for financial reporting beginning with our fiscal year ending December 31, 2007 |
| The report must state management’s responsibility for establishing and maintaining effective internal controls and procedures for financial reporting and contain their conclusions on the effectiveness of these controls |
| In addition, our independent registered public accounting firm will be required to attest to, and report on, management’s evaluation |
| We have not yet undertaken or completed such a full review to ensure compliance with Section 404 of the Sarbanes-Oxley Act |
| However, during the past two years we have identified certain material weaknesses in our accounting and disclosure controls as further discussed in Item 9A and have made improvements to our internal control over financial reporting as a result of such determinations |
| These material weaknesses were identified separately from a Section 404 review and we may yet identify additional material weaknesses when we undertake this review |
| We may also need to expend significant additional resources on any necessary remediations of these deficiencies |
| There are other factors that could affect the market price of our common stock |
| Our shares are traded on the Nasdaq Capital Market (formerly the SmallCap Market) and the price of our common stock is determined on the open market |
| A variety of factors other than our financial performance can negatively affect our share price, including the fact that our shares are not heavily traded and we do not have analyst coverage |
| The absence of analyst coverage generally means that some of the persons trading in our securities do not have ready access to as much information about our industry or our business as would otherwise be the case |
| Any decrease in the overall stock market would be likely to cause our share price to decrease as well |
| Additionally, as a Wisconsin corporation we are subject to various provisions of the Wisconsin Business Corporation Law which would tend to make an uninvited takeover more costly to a potential acquiror |