| SYPRIS SOLUTIONS INC Item 1A Risk Factors Risks Related to Our Business and Forward-Looking Statements This annual report, and our other oral or written communications, may contain “forward-looking” statements |
| These statements may include our expectations or projections about the future of our industries, business strategies, potential acquisitions or financial results and our views about developments beyond our control including domestic or global economic conditions, trends and market forces |
| These statements are based on management’s views and assumptions at the time originally made and we undertake no obligation to update these statements, even if, for example, they remain available on our website after our outlook has changed |
| There can be no assurance that our expectations, projections or views will come to pass, and you should not place undue reliance on these forward-looking statements |
| A number of significant risk factors could materially affect our specific business operations, and cause our performance to differ materially from any future results projected or implied by our prior statements, including those described below |
| Many of these risk factors are also identified in connection with the more specific descriptions contained throughout this report |
| Customers Customer contracts could be less profitable than expected |
| We generally bear the risk that our contracts could be unprofitable or less profitable than planned, despite our estimates of revenues and future costs to complete such contracts |
| For contracts to which we apply the “percentage of completion” accounting method, revisions to our cost estimates could reduce our operating results in later periods |
| A material portion of our business is conducted under multi-year contracts, which generally include fixed prices or periodic price reductions without minimum purchase requirements |
| Our financial results are at greater risk when we must accept contractual responsibility for raw material or component prices, when we cannot offset price reductions and cost increases with operating efficiencies or other savings, when we must submit contract bid prices before all key design elements are finalized or when we are subjected to other competitive pressures which erode our margins |
| The profitability of our contracts also can be adversely affected by unexpected start-up costs on new 9 ______________________________________________________________________ [34]Table of Contents programs, operating inefficiencies, ineffective capital investments, inflationary pressures or inaccurate forecasts of future unit costs |
| In the past few years we have signed long-term supply agreements with Dana and ArvinMeritor and acquired their facilities in Morganton, North Carolina, Kenton, Ohio and Toluca, Mexico, among other manufacturing assets |
| Although these acquired facilities have well-established product markets, these customers or their products may not continue to be successful, product enhancements may not be made in a timely fashion, our long-term pricing agreements could generate lower margins than anticipated and there can be no assurance that we will successfully integrate these operations |
| In addition, our failure to identify potential liabilities with respect to certain indemnified environmental and other conditions, or our assertion of related claims, could adversely affect our operating results or our customer relationships |
| Dana (or any of our other significant customers who similarly seek bankruptcy protection) could seek to terminate business with us, originate new business with our competitors, terminate or assign our long-term supply agreements |
| Any loss of revenue from our major customers, including the non-payment or late payment of our invoices could adversely affect our balance sheet, revenues, profitability and cash flows, debt covenants or access to capital needed for operations |
| Changing demands could reduce revenues or increase costs and harm operating results |
| Unexpected changes in our customers’ demand levels have harmed our operating results in the past and could do so in the future |
| Disagreements over pricing, quality, delivery, capacity, exclusivity, or trade credit terms could disrupt order schedules |
| Orders also fluctuate due to changing global capacity and demand, new products, changes in market share, reorganizations or bankruptcies, material shortages, labor disputes or other factors that discourage outsourcing |
| These forces could increase, decrease, accelerate, delay or cancel our delivery schedules |
| Inaccurate forecasting of our customers’ requirements can disrupt the efficient utilization of our manufacturing capacity, inventories or workforce |
| If we lose anticipated revenues, we might not succeed in redeploying our substantial capital investment and other fixed costs |
| If we receive unanticipated orders, these incremental volumes could be unprofitable due to the higher costs of operating above our optimal capacity |
| We depend on a few key customers in challenging industries for most of our revenues |
| Our five largest customers in 2005 were ArvinMeritor, Dana, Raytheon, Traxel and Visteon, collectively accounting for 67prca of 2005 net revenue |
| Our five largest customers in 2004 and 2003 were ArvinMeritor, Dana, Honeywell, Raytheon and Visteon, collectively accounting for 67prca and 51prca of net revenue in 2004 and 2003, respectively |
| The truck components & assemblies industry has experienced credit risk, labor unrest, rising steel costs, bankruptcy and other obstacles, while the aerospace & defense electronics industry has seen consolidation and uncertain funding |
| We depend on the continued growth and financial stability of these customers, our core markets in these industries and general economic conditions |
| Adverse changes affecting these customers, markets or general conditions could harm our operating results |
| The truck components market is highly cyclical, due in part to regulatory deadlines |
| Rising costs of steel or component parts have increased our inventory and working capital levels and caused delays in payment from, or other difficulties for, our automotive customers |
| Many of these customers’ labor disputes, financial difficulties and restructuring needs have created rising uncertainty and risk, which could increase our costs or impair our business model |
| The aerospace & defense industry is pressured by cyclicality, technological change, shortening product life cycles, decreasing margins, unpredictable funding levels and government procurement processes |
| Any of these factors, particularly in our secured electronic communications or missile programs, could impair our business model |
| If any of our significant customers were restructured, the resulting entity could seek to terminate business with us or originate new business with our competitors |
| Any loss of revenue from our major customers, including the non-payment or late payment of our invoices could adversely affect our balance sheet, revenues, profitability and cash flows |
| As of February 24, 2006, we had provided approximately dlra54dtta8 million in combined trade credit outstanding to ArvinMeritor, Dana and Visteon, each of which currently carries at least one “non-investment grade” 10 ______________________________________________________________________ [35]Table of Contents credit rating on its unsecured debt, indicating a high potential risk of default |
| There can be no assurance that any of our customers will not default on, delay or dispute payment of, or seek to reject our outstanding invoices in bankruptcy or otherwise |
| On March 3, 2006 (the Filing Date), our largest customer, Dana, and 40 of its US subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the US Bankruptcy Code in the US Bankruptcy Court for the Southern District of New York |
| Dana’s European, South American, Asia- Pacific, Canadian and Mexican subsidiaries (Dana Mexico) were excluded from the Chapter 11 filing |
| As of the Filing Date, we had been paid for substantially all outstanding Dana accounts receivable recorded in the balance sheet at December 31, 2005 |
| Accounts receivable from domestic Dana subsidiaries at the Filing Date could be subject to compromise, right of offset or set aside as a protected payment under Dana’s Chapter 11 filing |
| For example, recently amended bankruptcy law generally permits accounts payable to be offset against accounts receivable and offers protection for the last 20 calendar days of shipments as an administrative priority expense in the bankruptcy |
| As of the Filing Date and excluding certain gain contingencies, we estimated amounts due from Dana to approximate dlra28dtta6 million including up to an estimated dlra13dtta0 million due from Dana Mexico, in addition to potential offsets from accounts payable and other protected claims of dlra12dtta0 million, although right of offset and protected claims have not been approved by the Bankruptcy Court |
| We continue to pursue additional offsets to further reduce our net receivable position |
| Dana may be unable to reorganize, reach acceptable terms with its creditor’s or emerge from Chapter 11 |
| We may: • be unable to obtain right of offset with regard to our outstanding domestic payables and receivables; • be unable to secure 100prca payment for shipments 20 calendar days prior to the Filing Date; • be required to refund payments made by Dana to us in the 90 days proceeding the Filing Date; • have our supply agreements rejected or assigned by Dana; • be required to settle all amounts due from Dana at discounted rates; or • be unable to negotiate acceptable terms with the reorganized Dana |
| Dana (or any of our other significant customers who similarly seek bankruptcy protection) could seek to terminate business with us or originate new business with our competitors |
| Any loss of revenue from our major customers, including the non-payment or late payment of our invoices could adversely affect our balance sheet, revenues, profitability and cash flows, debt covenants or access to capital needed for operations |
| Congressional budgetary constraints or reallocations can reduce our government sales |
| We sell manufacturing services and products to a number of government agencies, which in the aggregate represented approximately 9prca of our net revenue in 2005 and 2004 |
| We also serve as a contractor for large aerospace & defense companies such as Boeing, Honeywell, Lockheed Martin, Northrop Grumman and Raytheon, typically under federally funded programs |
| Sales to larger aerospace & defense customers, in the aggregate, represented approximately 9prca and 16prca of net revenue during 2005 and 2004, respectively |
| Our government contracts have many inherent risks that could adversely impact our financial results |
| These contracts depend upon the continuing availability of Congressional appropriations |
| Future levels of governmental spending, including delays, declines or reallocations in the funding of certain programs could adversely affect our financial results, if we are unable to offset these changes with new business or cost reductions |
| Suppliers Interruptions in the supply of key components could disrupt production |
| Some of our manufacturing services or products require one or more components that are available from a limited number of providers or from sole-source providers |
| In the past, some of the materials we use, including steel, certain forgings or castings, capacitors and memory and logic devices, have been subject to industry-wide shortages |
| Our inability to reliably obtain these or any other materials when and as 11 ______________________________________________________________________ [36]Table of Contents needed could slow production or assembly, delay shipments to our customers, impair the recovery of our fixed costs and increase the costs of recovering to customers’ schedules, including overtime, expedited freight, equipment maintenance, operating inefficiencies, higher working capital and the obsolescence risks associated with larger buffer inventories |
| Shortages or increased costs of utilities could harm our business and our customers |
| We and our customers depend on a constant supply of electricity and natural gas from utility providers for the operation of our respective businesses and facilities |
| If we or our customers experience future interruptions in service from these providers, our production and/or delivery of products could be negatively affected |
| Additionally, due to the heavy consumption of energy in our production process and the businesses of our customers, if the cost of energy significantly increases, our results of operations, and those of our customers, could be negatively impacted |
| Execution We must operate more efficiently, or our results could decline |
| If we are unable to improve the cost, efficiency and yield of our operations, our costs could increase and our financial results could decline |
| A number of major obstacles could include: • inflationary pressures; • changes in anticipated product mix and the associated variances in our profit margins; • efforts to increase our manufacturing capacity and launch new programs; • the need to identify and eliminate our root causes of scrap; • our ability to achieve expected annual savings or other synergies from past and future business combinations; • inventory risks due to shifts in market demand; • obsolescence; • price erosion of raw material or component parts; • shrinkage, or other factors affecting our inventory valuations; or • inability to successfully manage growth, contraction or competitive pressures in our primary markets |
| Our management or systems could be inadequate to support our existing or future operations |
| Growth in our business could require us to invest in additional equipment to improve our efficiency |
| We may have limited experience or expertise in installing or operating such equipment, which could negatively impact our ability to deliver products on time or with acceptable costs |
| In addition, a material portion of our manufacturing equipment requires significant maintenance to operate effectively and we may experience maintenance and repair issues |
| We may also be required to relocate equipment between facilities, which could negatively impact our production processes |
| Our growth strategies could be ineffective due to the risks of further acquisitions |
| Our growth strategy includes acquiring complementary businesses |
| We could fail to identify, finance or complete suitable acquisitions on acceptable terms and prices |
| Acquisition efforts could increase a number of risks, including: • diversion of management’s attention; • difficulties in integrating systems, operations and cultures; • potential loss of key employees and customers of the acquired companies; • lack of experience operating in the geographic market of the acquired business; • an increase in our expenses and working capital requirements; • risks of entering into markets or producing products where we have limited or no experience, including difficulties in integrating purchased technologies and products with our technologies and products; • our ability to improve productivity and implement cost reductions; • our ability to secure collective bargaining agreements with employees; and • exposure to unanticipated liabilities |
| 12 ______________________________________________________________________ [37]Table of Contents Our discovery of, or failure to discover, material issues during due diligence investigations of acquisition targets, either before closing with regard to potential risks of the acquired operations, or, after closing with regard to the timely discovery of breaches of representations or warranties, or of certain indemnified environmental conditions could seriously harm our business |
| Competition Increasing competition could limit or reduce our market share |
| We operate in highly competitive environments that include our customers’ internal capabilities |
| We believe that the principal competitive factors in our markets include the availability of manufacturing capacity, technological strength, speed and flexibility in responding to design or schedule changes, price, quality, delivery, cost management and financial strength |
| Our earnings could decline if our competitors or customers can provide comparable speed and quality at a lower cost, or if we fail to adequately invest in the range and quality of manufacturing services and products our customers require |
| Some of our competitors have greater financial and organizational resources, customer bases and brand recognition than we do |
| As a result, our competitors may respond more quickly to technological changes or customer needs, consume lower fixed and variable unit costs, negotiate reduced component prices, and obtain better terms for financing growth |
| If we fail to compete in any of these areas, we may lose market share and our business could be seriously harmed |
| There can be no assurance that we will not experience increased competition or that we will be able to maintain our profitability if our competitive environment changes |
| Our technologies could become obsolete, reducing our revenues and profitability |
| The markets for our products and services are characterized by changing technology and continuing process development |
| The future of our business will depend in large part upon the continuing relevance of our technological capabilities |
| We could fail to make required capital investments, develop or successfully market services and products that meet changing customer needs, and anticipate or respond to technological changes in a cost-effective and timely manner |
| We could encounter competition from new or revised technologies that render our technologies and equipment less profitable or obsolete in our chosen markets, and our operating results may suffer |
| Access to Capital An inability to obtain favorable financing could impair our growth |
| Our future liquidity and capital requirements are difficult to predict because they depend on numerous factors, including the pace at which we grow our business and acquire new facilities |
| One method we have used to obtain multi-year supply agreements is to buy a customer’s non-core manufacturing assets and produce products for them |
| We may need to raise substantial additional funds in order to grow this business |
| We cannot be certain that we will be able to obtain additional financing on favorable terms or at all |
| Additional equity financing could result in dilution to existing holders |
| If additional financing is obtained in the form of debt, the terms of the debt could place restrictions on our ability to operate or increase the financial risk of our capital structure |
| Our ability to borrow under our current credit facility is conditioned upon our compliance with various financial covenants |
| We could lose our access to such financing if we experience adverse changes in our operations, poor financial results, increased risk profiles of our businesses, declines in our credit ratings, any actual or alleged breach of our debt covenants, insurance conditions or similar agreements, or any adverse regulatory developments |
| Any inability to raise additional funds as needed could impair our ability to operate and grow our business |
| Such financing could be subject to a number of factors, including market conditions, our operating performance and investor sentiment |
| These factors may make the timing, amount, terms and conditions of additional financing unattractive for us |
| Contract Terminations Contract terminations or delays could harm our business |
| We often provide manufacturing services and products under contracts that contain detailed specifications, quality standards and other terms |
| If we are unable to perform in accordance with such terms, our customers might seek to terminate such contracts, or downgrade our past performance rating, an increasingly critical factor in federal procurement competitions |
| Moreover, many of our contracts are subject to termination for convenience or upon 13 ______________________________________________________________________ [38]Table of Contents default |
| These provisions could provide only limited recoveries of certain incurred costs or profits on completed work, and could impose liability for our customers’ costs in procuring undelivered items from another source |
| If any of our significant contracts were to be terminated or not renewed, we would lose substantial revenues and our operating results as well as prospects for future business opportunities would be adversely affected |
| We are subject to various audits, reviews and investigations, including private party “whistleblower” lawsuits, relating to our compliance with federal and state laws |
| Should our business be charged with wrongdoing, or determined not to be a “presently responsible contractor,” we could be temporarily suspended or debarred for up to three or more years from receiving new government contracts or government-approved subcontracts |
| Labor Relations We must attract and retain qualified employees |
| Our future success in a changing business environment, including during rapid changes in the size, complexity or skills required of our workforce, will depend to a large extent upon the efforts and abilities of our executive, managerial and technical employees |
| The loss of key employees could have a material adverse effect on our operations |
| Our future success will also require an ability to attract and retain qualified employees |
| Labor disputes or changes in the cost of providing pension and other employee benefits, including changes in health care costs, investment returns on plan assets, and discount rates used to calculate pension and related liabilities, could lead to increased costs or disruptions of operations in any of our business units |
| Disputes with labor unions could disrupt our business plans |
| We currently have collective bargaining agreements covering approximately 1cmam489 employees, or approximately 50prca of total employees |
| Although we believe that our overall relations with our labor unions are positive, we could experience a work stoppage or other disputes which could disrupt our operations and harm our operating results |
| Regulatory Environmental, health and safety risks could expose us to potential liability |
| We are subject to a variety of environmental regulations relating to the use, storage, discharge and disposal of hazardous chemicals and substances used in our operations |
| If we fail to comply with present or future regulations, we could be forced to alter, suspend or discontinue our manufacturing processes, and pay substantial fines or penalties |
| Groundwater and other contamination has occurred at certain of our current and former facilities during the operation of those facilities by their former owners, and this contamination may occur at future facilities we operate or acquire |
| Although we typically receive environmental indemnification agreements from previous owners of these facilities, there is no assurance that the indemnifications of former owners will be adequate to protect us from liability |
| Our Marion, Ohio facility is subject to soil and groundwater contamination involving petroleum compounds, semi-volatile and volatile organic compounds, certain metals, PCBs and other contaminants, some of which exceed the state voluntary action program standards applicable to the site |
| We continue to test and assess this site to determine the extent of this contamination by the prior owners of the facility |
| Under our purchase agreement for this facility, Dana has agreed to indemnify us for, among other things, environmental conditions that existed on the site as of closing and as to which we notified Dana prior to December 31, 2002 |
| Such amounts due from Dana, if any, could be subject to compromise or rejection in conjunction with Dana’s Chapter 11 filing |
| A leased facility we formerly occupied in Tampa, Florida is subject to remediation activities related to groundwater contamination involving methyl chloride and other volatile organic compounds which occurred prior to our use of the facility, and such contamination extends beyond the boundaries of the facility |
| The prior operator of the facility has entered into a consent order with the State of Florida and agreed to remediate the contamination, the full scope of which has not yet been determined |
| We previously acquired certain business assets formerly located at a leased facility in Littleton, Colorado, where chlorinated solvents had been disposed of on site by a prior owner of the business at the site, contaminating the groundwater at and around the site |
| The seller of the assets to us is 14 ______________________________________________________________________ [39]Table of Contents operating a remediation system on the site approved by the State of Colorado and has entered into a consent order with the EPA providing for additional investigation at the site |
| Our Morganton, North Carolina facility is subject to soil and groundwater contamination involving petroleum compounds, certain metals, and other contaminants, some of which exceed the State of North Carolina standards applicable to the site |
| Under our purchase agreement for this facility, Dana has agreed to indemnify us for, among other things, environmental conditions that existed on the site as of closing and as to which we notified Dana prior to December 31, 2005 |
| Such amounts due from Dana, if any, could be subject to compromise or rejection in conjunction with Dana’s Chapter 11 filing |
| Our Toluca, Mexico facility is subject to soil and groundwater contamination involving petroleum compounds and volatile organic compounds, among other concerns |
| We continue to test and assess this site to determine the extent of any contamination by the prior owners of the facility |
| Under our purchase agreement for each facility, Dana and Dana Mexico (Dana’s Mexican subsidiary, not currently a party to the bankruptcy) have agreed to indemnify us for, among other things, environmental conditions that existed on the site as of closing and as to which we notify Dana prior to June 30, 2006 |
| Such amounts due from Dana, if any, could be subject to compromise or rejection in conjunction with Dana’s Chapter 11 filing |
| Our Kenton, Ohio facility is subject to soil and groundwater contamination involving petroleum compounds, volatile organic compounds, certain metals, PCBs and other contaminants |
| We continue to test and assess this site to determine the extent of any contamination by the prior owners of the facility |
| Under our purchase agreement for this facility, Meritor Heavy Vehicle Systems has agreed to indemnify us for, among other things, environmental conditions that existed on the site as of closing and as to which we notify ArvinMeritor prior to May 2, 2006 |
| Adverse regulatory developments or litigation could harm our business |
| Our businesses operate in heavily regulated environments |
| We must successfully manage the risk of changes in or adverse actions under applicable law or in our regulatory authorizations, licenses and permits, governmental security clearances or other legal rights to operate our businesses, to manage our work force or to import and export goods and services as needed |
| Our business activities expose us to the risks of litigation with respect to our customers, suppliers, creditors, stockholders or from product liability, environmental or asbestos-related matters |
| We also face the risk of other adverse regulatory actions, compliance costs or governmental sanctions, as well as the costs and risks related to our ongoing efforts to design and implement effective internal controls |
| Other Risks We face other factors which could seriously disrupt our operations |
| Many other risk factors beyond our control could seriously disrupt our operations, including: • risks relating to war, future terrorist activities or political uncertainties which could shut down our domestic or foreign facilities, disrupt transportation of products or supplies, or change the timing and availability of funding in our aerospace & defense electronics markets; • risks inherent in operating abroad, including foreign currency exchange rates, adverse regulatory developments, and miscommunications or errors due to inaccurate foreign language translations or currency exchange rates; • risks relating to natural disasters or other casualties; or • our failure to anticipate or to adequately insure against other risks and uncertainties present in our businesses including unknown or unidentified risks |