| STANDARD MOTOR PRODUCTS INC Item 1A Risk Factors |
| 13 ITEM 1A RISK FACTORS OUR INDUSTRY IS HIGHLY COMPETITIVE, AND OUR SUCCESS DEPENDS ON OUR ABILITY TO COMPETE WITH SUPPLIERS OF AUTOMOTIVE AFTERMARKET PRODUCTS, SOME OF WHICH MAY HAVE SUBSTANTIALLY GREATER FINANCIAL, MARKETING AND OTHER RESOURCES THAN WE DO While we believe that our business is well positioned to compete in our two primary market segments, Engine Management and Temperature Control, the automotive aftermarket industry is highly competitive, and our success depends on our ability to compete with suppliers of automotive aftermarket products |
| In the Engine Management business, our competitors include AC Delco, Delphi Corporation, Denso Corporation, Federal-Mogul Corporation, Robert Bosch Corporation, Visteon Corporation and Wells Manufacturing Corporation |
| In the Temperature Control business, we compete with AC Delco, Delphi Corporation, Denso Corporation, Jordan Automotive Aftermarket, Inc, Proliance International, Inc, Siemens VDO Automotive and Visteon Corporation |
| In addition, automobile manufacturers supply virtually every replacement part we sell |
| Some of our competitors may have larger customer bases and significantly greater financial, technical and marketing resources than we do |
| These factors may allow our competitors to: o respond more quickly than we can to new or emerging technologies and changes in customer requirements by devoting greater resources than we can to the development, promotion and sale of automotive aftermarket products and services; o engage in more extensive research and development; o sell products at a lower price than we do; o undertake more extensive marketing campaigns; and o make more attractive offers to existing and potential customers and strategic partners |
| We cannot assure you that our competitors will not develop products or services that are equal or superior to our products or that achieve greater market acceptance than our products or that in the future other companies involved in the automotive aftermarket industry will not expand their operations into product lines produced and sold by us |
| We also cannot assure you that additional entrants will not enter the automotive aftermarket industry or that companies in the aftermarket industry will not consolidate |
| Any of such competitive pressures could cause us to lose market share or could result in significant price decreases and could have a material adverse effect upon our business, financial condition and results of operations |
| 13 THERE IS SUBSTANTIAL PRICE COMPETITION IN OUR INDUSTRY, AND OUR SUCCESS AND PROFITABILITY WILL DEPEND ON OUR ABILITY TO MAINTAIN A COMPETITIVE COST AND PRICE STRUCTURE There is substantial price competition in our industry, and our success and profitability will depend on our ability to maintain a competitive cost and price structure |
| We may have to reduce prices in the future to remain competitive |
| Also, our future profitability will depend in part upon our ability to respond to changes in the product and distribution channel mix, to continue to improve our manufacturing efficiencies, to generate cost reductions, including reductions in the cost of components purchased from outside suppliers, and to maintain a cost structure that will enable us to offer competitive prices |
| Our inability to maintain a competitive cost structure could have a material adverse effect on our business, financial condition and results of operations |
| WE DEPEND ON A LIMITED NUMBER OF KEY CUSTOMERS, AND THE LOSS OF ANY SUCH CUSTOMER COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS Our five largest individual customers, including members of a marketing group, accounted for 52prca, 50prca and 43prca of our consolidated net sales for 2005, 2004 and 2003, respectively |
| Two individual customers accounted for 18prca and 15prca, respectively, of our 2005 consolidated net sales, 17prca and 14prca, respectively, of our 2004 consolidated net sales, and 12prca and 12prca, respectively, of our 2003 consolidated net sales |
| The loss of one or more of these customers or, if any of them ceases to acquire a significant product line, could have a materially adverse impact on our business, financial condition and results of operations |
| Also, we do not typically enter into long-term agreements with any of our customers |
| Instead, we enter into a number of purchase order commitments with our customers, based on their current or projected needs |
| We have in the past and may in the future lose customers or lose a particular product line of a customer due to the highly competitive conditions in the automotive aftermarket industry, including pricing pressures |
| A decision by any significant customer, whether motivated by competitive conditions, financial difficulties or otherwise, to materially decrease the amount of products purchased from us, to change their manner of doing business with us, or to stop doing business with us, could have a material adverse effect on our business, financial condition and results of operations |
| OUR BUSINESS IS SEASONAL AND IS SUBJECT TO SUBSTANTIAL QUARTERLY FLUCTUATIONS, WHICH IMPACT OUR QUARTERLY PERFORMANCE AND WORKING CAPITAL REQUIREMENTS Historically, our operating results have fluctuated by quarter, with the greatest sales occurring in the second and third quarters of the year and with revenues generally being recognized at the time of shipment |
| It is in these quarters that demand for our products is typically the highest, specifically in the Temperature Control Segment of our business |
| In addition to this seasonality, the demand for our Temperature Control products during the second and third quarters of the year may vary significantly with the summer weather and customer inventories |
| For example, a cool summer may lessen the demand for our Temperature Control products, while a hot summer may increase such demand |
| As a result of this seasonality and variability in demand of our Temperature Control products, our working capital requirements peak near the end of the second quarter, as the inventory build-up of air conditioning products is converted to sales and payments on the receivables associated with such sales have yet to be received |
| During this period, our working capital requirements are typically funded by borrowing from our revolving credit facility |
| WE MAY INCUR MATERIAL LOSSES AND SIGNIFICANT COSTS AS A RESULT OF WARRANTY-RELATED RETURNS BY OUR CUSTOMERS IN EXCESS OF ANTICIPATED AMOUNTS Our products are required to meet rigorous standards imposed by our customers and our industry |
| Many of our products carry a warranty ranging from a 90-day limited warranty to a lifetime limited warranty, which generally covers defects in materials or workmanship and failure to meet industry published specifications |
| In the event that there are material deficiencies or defects in the design and manufacture of our products and/or installer error, the affected products may be subject to warranty returns and/or product recalls |
| Although we maintain a comprehensive quality control program, we cannot give any assurance that our products will not suffer from defects or other deficiencies or that we will not experience material warranty returns or product recalls in the future |
| 14 We accrue for warranty returns as a percentage of sales, after giving consideration to recent historical returns |
| While we believe that we make reasonable estimates for warranty returns in accordance with our revenue recognition policies, actual returns may differ from our estimates |
| We have in the past incurred, and may in the future incur, material losses and significant costs as a result of our customers returning products to us as a result of warranty-related issues in excess of anticipated amounts |
| Deficiencies or defects in our products in the future may result in warranty returns and product recalls in excess of anticipated amounts and may have a material adverse effect on our business, financial condition and results of operations |
| OUR PROFITABILITY MAY BE MATERIALLY ADVERSELY AFFECTED AS A RESULT OF OVERSTOCK INVENTORY-RELATED RETURNS BY OUR CUSTOMERS IN EXCESS OF ANTICIPATED AMOUNTS We permit overstock returns of inventory that we allow customers to return to us and that may be either new or non-defective or non-obsolete but that we believe we can re-sell |
| Customers are generally limited to returning overstocked inventory according to a specified percentage of their annual purchases from us |
| In addition, a customerapstas annual allowance cannot be carried forward to the upcoming year |
| We accrue for overstock returns as a percentage of sales, after giving consideration to recent historical returns |
| While we believe that we make reasonable estimates for overstock returns in accordance with our revenue recognition policies, actual returns may differ from our estimates |
| To the extent that overstocked returns are materially in excess of our projections, our business, financial condition and results of operations may be materially adversely affected |
| OVER THE LONG TERM, OUR BUSINESS IS DEPENDENT ON THE AUTOMOTIVE INDUSTRY, AND OUR FUTURE PERFORMANCE MAY BE MATERIALLY ADVERSELY AFFECTED BY PERSISTENT DECLINES IN THE AUTOMOTIVE INDUSTRY OR CHANGES IN TECHNOLOGIES AND IMPROVEMENTS IN THE QUALITY OF NEW VEHICLE PARTS Over the long term, our business is dependent upon the sales of automobiles within the automotive industry, which creates the total number of vehicles available for repair following the expiration of vehicle warranties |
| A persistent decline in automotive sales and production over the long term would likely affect sales to our aftermarket customers |
| Changes in automotive technologies, such as vehicles powered by fuel cells or electricity, could also negatively affect sales to our aftermarket customers |
| These factors could result in less demand for our products thereby resulting in a decline in our results of operations or a deterioration in our business and financial condition and may have a material adverse effect on our long-term performance |
| In addition, the size of the automobile replacement parts market depends, in part, upon the growth in number of vehicles on the road, increase in average vehicle age, increase in total miles driven per year, new and modified environmental regulations, increase in pricing of new cars and new car quality and related warranties |
| The automobile replacement parts market has been negatively impacted by the fact that the quality of more recent automotive vehicles and their component parts has improved, thereby lengthening the repair cycle |
| Generally, if parts last longer, there will be less demand for our products, and the average useful life of automobile parts has been steadily increasing in recent years due to innovations in products and technology |
| These factors could have a material adverse effect on our business, financial condition and results of operations |
| WE MAY BE MATERIALLY ADVERSELY AFFECTED BY ASBESTOS CLAIMS ARISING FROM PRODUCTS SOLD BY OUR FORMER BRAKE BUSINESS, AS WELL AS BY OTHER PRODUCT LIABILITY CLAIMS In 1986, we acquired a brake business, which we subsequently sold in March 1998 |
| When we originally acquired this brake business, we assumed future liabilities relating to any alleged exposure to asbestos-containing products manufactured by the seller of the acquired brake business |
| In accordance with the related purchase agreement, we agreed to assume the liabilities for all new claims filed after September 1, 2001 |
| Our ultimate exposure will depend upon the number of claims filed against us on or after September 1, 2001 and the amounts paid for indemnity and defense thereof |
| We currently do not have insurance coverage for the defense and indemnity costs associated with the claims we face |
| 15 Actuarial consultants with experience in assessing asbestos-related liabilities conducted a study to estimate our potential claim liability as of August 31, 2005 |
| The actuarial study estimated an undiscounted liability for settlement payments, excluding legal costs, ranging from dlra25 to dlra51 million for the period through 2049 |
| Accordingly, based on the information contained in the actuarial study and all other available information that we considered, we maintain a reserve of dlra27dtta6 million for this liability |
| Legal costs, which are expensed as incurred, are estimated to range from dlra16 to dlra20 million during the same period |
| At December 31, 2005, approximately 4cmam500 cases were outstanding for which we were responsible for any related liabilities |
| Since inception in September 2001 through February 28, 2006, the amounts paid for settled claims are approximately dlra3dtta9 million |
| Although we settled a significant number of cases in early 2006, a substantial increase in the number of new claims or increased settlement payments or awards of damages could have a material adverse effect on our business, financial condition and results of operations |
| Given the uncertainties associated with projecting asbestos-related matters into the future and other factors outside our control, we cannot give any assurance that significant increases in the number of claims filed against us will not occur, that asbestos-related damages or settlement awards will not exceed the amount we have in reserve, or that additional provisions will not be required |
| Management will continue to monitor the circumstances surrounding these potential liabilities in determining whether additional reserves and provisions may be necessary |
| We plan on performing a similar annual actuarial analysis during the third quarter of each year for the foreseeable future |
| In addition to asbestos-related claims, our product sales entail the risk of involvement in other product liability actions |
| We maintain product liability insurance coverage, but we cannot give any assurance that current or future policy limits will be sufficient to cover all possible liabilities |
| Further, we can give no assurance that adequate product liability insurance will continue to be available to us in the future or that such insurance may be maintained at a reasonable cost to us |
| In the event of a successful product liability claim against us, a lack or insufficiency of insurance coverage could have a material adverse effect on our business, financial condition and results of operations |
| OUR SUBSTANTIAL INDEBTEDNESS COULD NEGATIVELY AFFECT OUR FINANCIAL HEALTH We have a significant amount of indebtedness |
| As of December 31, 2005, our total outstanding indebtedness was dlra248 million |
| We incurred dlra90 million of indebtedness in July 1999 from the sale of our convertible debentures |
| We have an existing revolving bank credit facility of dlra305 million with General Electric Capital Corporation, as agent, and a syndicate of lenders, which we refer to throughout this Report as our revolving credit facility |
| As of December 31, 2005, we had dlra142 million of outstanding indebtedness and approximately dlra52 million of availability under this revolving credit facility |
| Our substantial indebtedness could: o increase our vulnerability to general adverse economic and industry conditions; o limit our ability to fund future working capital, capital expenditures, research and development costs and other general corporate requirements; o limit our ability to pay future dividends; o limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; o increase the amount of interest expense that we have to pay because some of our borrowings are at variable rates of interest, which, if interest rates increase, could result in a higher interest expense; and o limit, along with the financial and other restrictive covenants of our indebtedness, among other things, our ability to borrow additional funds |
| 16 In addition, we have granted the lenders under our revolving credit facility a first priority security interest in substantially all of our currently owned and future acquired personal property, real property (other than our Long Island City facility) and other assets |
| We have also pledged shares of stock in our subsidiaries to those lenders |
| In addition, our credit facility requires us to meet specified financial ratios and limits our ability to enter into various transactions |
| If we default on any of our indebtedness, or if we are unable to obtain necessary liquidity, our business could be adversely affected |
| WE MAY NOT BE ABLE TO GENERATE THE SIGNIFICANT AMOUNT OF CASH NEEDED TO SERVICE OUR INDEBTEDNESS AND FUND OUR FUTURE OPERATIONS Our ability either to make payments on or to refinance our indebtedness, or to fund planned capital expenditures and research and development efforts, will depend on our ability to generate cash in the future |
| Our ability to generate cash is in part subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control |
| Based on our current level of operations, we believe our cash flow from operations, available cash and available borrowings under our revolving credit facility will be adequate to meet our future liquidity needs for at least the next few years |
| Significant assumptions underlie this belief, including, among other things, that there will be no material adverse developments in our business, liquidity or capital requirements |
| If we are unable to service our indebtedness, we will be forced to adopt an alternative strategy that may include actions such as: o reducing capital expenditures; o reducing research and development efforts; o selling assets; o restructuring or refinancing our indebtedness; and o seeking additional funding |
| We cannot assure you that our business will generate sufficient cash flow from operations, or that future borrowings will be available to us under our revolving credit facility in amounts sufficient to enable us to pay the principal and interest on our indebtedness or to fund our other liquidity needs |
| We may need to refinance all or a portion of our indebtedness on or before maturity |
| We cannot assure you that we will be able to refinance any of our indebtedness on commercially reasonable terms or at all |
| OUR BUSINESS IS DEPENDENT ON OUR MAINTAINING SATISFACTORY RELATIONSHIPS WITH SUPPLIERS, AND THE LOSS OF SEVERAL MAJOR SUPPLIERS OF RAW MATERIALS OR KEY COMPONENTS MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR OPERATIONS Our business depends on our relationships with suppliers of raw materials and components that we use on our product lines and on our ability to purchase these raw materials and key components at prices and on terms comparable to similarly-situated companies |
| We purchase most materials in the US open market |
| Although we do not expect that the loss of any one supplier would have a material adverse effect on us, the loss of several major suppliers would have a material adverse effect on our business, financial condition and results of operations |
| WE MAY INCUR LIABILITIES UNDER GOVERNMENT REGULATIONS AND POLICIES AND ENVIRONMENTAL LAWS, WHICH MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS Domestic and foreign political developments and government regulations and policies directly affect automotive consumer products in the United States and abroad |
| Regulations and policies relating to over-the-highway vehicles include standards established by the United States Department of Transportation for motor vehicle safety and emissions |
| The modification of existing laws, regulations or policies, or the adoption of new laws, regulations or policies, could have a material adverse effect on our business, financial condition and results of operations |
| Our failure to comply with these laws and regulations could subject us to civil and criminal penalties |
| 17 Our operations and properties are also subject to a wide variety of increasingly complex and stringent federal, state, local and international laws and regulations, including those governing the use, storage, handling, generation, treatment, emission, release, discharge and disposal of materials, substances and wastes, the remediation of contaminated soil and groundwater and the health and safety of employees |
| Such environmental laws, including but not limited to those under the Comprehensive Environmental Response Compensation & Liability Act, may impose joint and several liability and may apply to conditions at properties presently or formerly owned or operated by an entity or its predecessors, as well as to conditions at properties at which wastes or other contamination attributable to an entity or its predecessors have been sent or otherwise come to be located |
| The nature of our operations exposes us to the risk of claims with respect to such matters, and we can give no assurance that violations of such laws have not occurred or will not occur or that material costs or liabilities will not be incurred in connection with such claims |
| One of our facilities is currently undergoing minor environmental remediation |
| The environmental remediation costs at such facility are covered by an insurance policy of dlra3 million, which is subject to a dlra1dtta5 million deductible; we have purchased additional environmental insurance coverage in the amount of dlra2 million with a dlra0dtta1 million deductible relating to such facility |
| We also maintain two dlra10 million environmental policies to cover our existing US facilities |
| Based upon our experience to date, we believe that the future cost of compliance with existing environmental laws, and liability for known environmental claims pursuant to such environmental laws, will not give rise to additional significant expenditures or liabilities that would be material to us |
| However, future events, such as new information, changes in existing environmental laws or their interpretation, and more vigorous enforcement policies of regulatory agencies, may have a material adverse effect on our business, financial condition and results of operations |