| TECUMSEH PRODUCTS CO Item 1A Risk Factors |
| 12 ITEM 1A RISK FACTORS Set forth below and elsewhere in this Annual Report on Form 10-K are some of the principal risks and uncertainties that could cause our actual business results to differ materially from any forward-looking statements contained in this Report |
| These risk factors should be considered in addition to our cautionary comments concerning forward-looking statements in this Report, including statements related to markets for our products and trends in our business that involve a number of risks and uncertainties |
| Our separate section in Item 7 below, "e Disclosure Regarding Forward-Looking Statements, "e should be considered in addition to the following statements |
| DEMAND FOR OUR PRODUCTS WILL BE AFFECTED BY GENERAL GLOBAL ECONOMIC CONDITIONS Demand for our products is influenced by many global economic conditions, including but not limited to new construction activity and the level of repair and remodeling activity |
| The level of new construction and repair and remodeling activity is affected by a number of factors beyond our control, such as the overall strength of the economy (including confidence in the economy by our customers), the strength of the residential and commercial real estate markets, institutional building activity, the age of existing housing stock, unemployment rates, availability of consumer financing and interest rates |
| Any declines in new housing or commercial construction starts or demand for replacement building and home improvement products may adversely impact us, and there can be no assurance that any such adverse effects would not be material and would not continue for an indeterminate period of time |
| Further, while we attempt to minimize our exposure to economic or market fluctuations by serving a balanced mix of end markets and geographic regions, we cannot assure you that a significant or sustained downturn in a specific end market or geographic region would not have a material adverse effect on us |
| OUR BUSINESSES OPERATE IN HIGHLY COMPETITIVE MARKETS, SO WE MAY SUFFER PRICING INFLEXIBILITY OR INCUR ADDITIONAL COSTS Our businesses generally face substantial competition in each of their respective markets |
| Competition may prevent us from raising or force us to cut prices or to incur additional costs to remain competitive |
| We compete on the basis of product design, quality, availability, performance, customer service and price |
| Present or future competitors may have greater financial, technical or other resources which could put us at a disadvantage in the affected business or businesses |
| We cannot assure you that these and other factors will not have a material adverse effect on our results of operations |
| In particular, our three largest business segments operate in environments where worldwide productive capacities exceed global demand and customers and competitors are establishing new productive capacities in low cost countries, including China |
| These trends have resulted in the need for Tecumseh to restructure its operations by removing excess capacities, lowering its cost of purchased inputs and shifting productive capacities to low cost countries in order to improve its 12 overall cost structure, restore margins and improve its competitive position in its major markets |
| There is no guarantee that these initiatives, which have included plant closures, headcount reductions, expanded operations in low-cost countries (including China, India and Brazil) and global sourcing initiatives, will be successful in setting the stage for improvement in profitability in the future |
| In particular we are making significant changes to the Engine & Power Train Group with a strategy to consolidate our manufacturing footprint to reduce costs |
| In 2005, the Company engaged Alix Partners to assess the Companyapstas strategy and execute the operational improvements identified from their study |
| MATERIAL COST INFLATION COULD ADVERSELY AFFECT OUR RESULTS OF OPERATIONS We are experiencing material cost inflation in a number of our businesses |
| We are striving for greater productivity improvements and implementing selective increases in selling prices to help mitigate cost increases in base materials such as copper, aluminum, steel, resins, as well as other input costs including ocean freight, fuel, health care and insurance |
| We also are continuing to implement our excellence in operations initiatives in order to continuously reduce our costs |
| We cannot assure you, however, that these actions will be successful to manage our costs or increase our productivity |
| Continued cost inflation or failure of our initiatives to generate cost savings or improve productivity may negatively impact our results of operations |
| End-user demand for equipment, particularly air conditioners, lawn and garden products, portable power generators and snow throwers, follows weather trends, water patterns (such as heavy droughts or flooding) or can be related to natural catastrophes |
| The magnitude of the sales spike is partially mitigated by effective use of the distribution channel by employing advance sales programs (generally including extended payment terms and/or additional discounts) |
| We cannot assure you that seasonality and weather conditions will not have a material adverse effect on our results of operations |
| OUR RESULTS OF OPERATIONS MAY BE NEGATIVELY IMPACTED BY LITIGATION Our business exposes us to potential litigation, especially product liability suits that are inherent in the design, manufacture, and sale of our products |
| These claims can be expensive to defend and can divert the attention of management and other personnel for significant periods of time, regardless of the ultimate outcome |
| As we self-insure a portion of product liability claims, an unsuccessful defense of a product liability claim or series of successful claims could materially and adversely affect our product reputation and our financial condition, results of operations, and cash flows |
| Even if we are successful in defending against a claim relating to our products, claims of this nature could cause our customers to lose confidence in our products and our Company |
| WE ARE SUBJECT TO CURRENCY EXCHANGE RATE AND OTHER RELATED RISKS We conduct operations in many areas of the world involving transactions denominated in a variety of currencies |
| We are subject to currency exchange rate risk to the extent that our costs are denominated in currencies other than those in which we earn revenues |
| In particular, this situation exists for the Company with respect to our Brazilian operations which has sales denominated in the 13 US dollar and the Euro |
| In 2005, total sales generated by Tecumseh do Brasil amounted to 40prca of total Compressor Products segment sales |
| In addition, since our financial statements are denominated in US dollars, changes in currency exchange rates between the US dollar and other currencies have had, and will continue to have, an impact on our earnings |
| While we customarily enter into financial transactions to mitigate these risks, we cannot assure that currency exchange rate fluctuations will not adversely affect our results of operations and financial condition |
| In addition, while the use of currency hedging instruments may provide us with protection from adverse fluctuations in currency exchange rates, by utilizing these instruments we potentially forego the benefits that might result from favorable fluctuations in currency exchange rates |
| We also face risks arising from the imposition of exchange controls and currency devaluations |
| Exchange controls may limit our ability to convert foreign currencies into US dollars or to remit dividends and other payments by our foreign subsidiaries or businesses located in or conducted within a country imposing controls |
| Currency devaluations result in a diminished value of funds denominated in the currency of the country instituting the devaluation |
| Actions of this nature, if they occur or continue for significant periods of time, could have an adverse effect on our results of operations and financial condition in any given period |
| WE ARE EXPOSED TO POLITICAL, ECONOMIC AND OTHER RISKS THAT ARISE FROM OPERATING A MULTINATIONAL BUSINESS Sales outside of North America, including export sales from North American businesses, accounted for approximately 47prca of our net sales in 2005 |
| Further, certain of our businesses obtain raw materials and finished goods from foreign suppliers |
| Accordingly, our business is subject to the political, economic and other risks that are inherent in operating in numerous countries |
| These risks include: - the difficulty of enforcing agreements and collecting receivables through foreign legal systems; - trade protection measures and import or export licensing requirements; - tax rates in certain foreign countries that exceed those in the US and the imposition of withholding requirements on foreign earnings; - the imposition of tariffs, exchange controls or other restrictions; - difficulty in staffing and managing widespread operations and the application of foreign labor regulations; - the protection of intellectual property in foreign countries may be more difficult; - required compliance with a variety of foreign laws and regulations; and - changes in general economic and political conditions in countries where we operate, particularly in emerging markets |
| Our business success depends in part on our ability to anticipate and effectively manage these and other risks |
| We cannot assure you that these and other factors will not have a material adverse effect on our international operations or on our business as a whole |
| 14 OUR OPERATIONS ARE SUBJECT TO EXTENSIVE ENVIRONMENTAL LAWS AND REGULATIONS Our plants and operations are subject to increasingly stringent environmental laws and regulations in all of the countries in which we operate, including laws and regulations governing emissions to air, discharges to water and the generation, handling, storage, transportation, treatment and disposal of waste materials |
| While we believe that we are in compliance in all material respects with these environmental laws and regulations, we cannot assure that we will not be adversely impacted by costs, liabilities or claims with respect to existing or subsequently acquired operations, under either present laws and regulations or those that may be adopted or imposed in the future |
| We are also subject to laws requiring the cleanup of contaminated property |
| If a release of hazardous substances occurs at or from any of our current or former properties or at a landfill or another location where we have disposed of hazardous materials, we may be held liable for the contamination, and the amount of such liability could be material |
| Approximately 1cmam000 of our US employees are represented by various unions under collective bargaining agreements with various unions |
| While we have no reason to believe that we will be impacted by work stoppages and other labor matters, we cannot assure that future issues with our labor unions will be resolved favorably or that we will not encounter future strikes, further unionization efforts or other types of conflicts with labor unions or our employees |
| Any of these factors may have an adverse effect on us or may limit our flexibility in dealing with our workforce |
| Work stoppages or slow-downs experienced by our customers could result in slow-downs or closures at vehicle assembly plants where our engines are installed |
| If one or more of our customers experience a material work stoppage, it could have a material adverse effect on our business, results of operations and financial condition |
| OUR LEVERAGE MAY IMPAIR OUR OPERATIONS AND FINANCIAL CONDITION As of December 31, 2005, our total consolidated debt was dlra365dtta5 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, acquisitions 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 industries in which we operate |
| 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 senior credit facility requires us to maintain specified financial ratios and satisfy certain financial condition tests |
| 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 to 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 |
| 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 |
| 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 |
| 15 OUR PRODUCTS ARE SUBJECT TO RECALL FOR PERFORMANCE RELATED ISSUES We incur product recall costs when we decide, either voluntarily or involuntarily, to recall a product through a formal campaign to solicit the return of specific products due to a known or suspected performance issue |
| Costs typically include the cost of the product, part or component being replaced, customer cost of the recall and labor to remove and replace the defective part or component |
| In making this estimate, judgment is required as to the quantity or volume to be recalled, the total cost of the recall campaign, the ultimate negotiated sharing of the cost between us and the customer and, in some cases, the extent to which the supplier of the part or component will share in the recall cost |
| Due to the nature of these actions, several recalls experienced simultaneously or one of particular significance could materially and adversely affect our financial condition, results of operation and cash flows |
| INCREASED OR UNEXPECTED PRODUCT WARRANTY CLAIMS COULD ADVERSELY AFFECT US We provide our customers a warranty on products we manufacture |
| Our warranty generally provides that products will be free from defects for periods ranging from 12 months to 36 months |
| 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 |
| In certain of our businesses, a significant number of our suppliers of our raw material or component purchases in 2005 were the sole source for a particular supply item, although the majority of these materials and components can be obtained from other suppliers |
| Any delay in our suppliers &apos abilities to provide us with necessary materials and components may affect our capabilities at a number of our manufacturing locations, or may require us to seek alternative supply sources |
| Delays in obtaining supplies may result from a number of factors affecting our suppliers including capacity constraints, labor disputes, the impaired financial condition of a particular supplier, suppliers &apos allocations to other purchasers, weather emergencies or acts of war or terrorism |
| Any delay in receiving supplies could impair our ability to deliver products to our customers and, accordingly, could have a material adverse effect on our business results |
| IF WE FAIL TO DEVELOP NEW AND INNOVATIVE PRODUCTS OR IF CUSTOMERS IN OUR MARKETS DO NOT ACCEPT THEM, OUR RESULTS WOULD BE NEGATIVELY AFFECTED Our products must be kept current to meet our customers &apos 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 significantly in the research and development of new products |
| 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 and lack of return on invested capital |
| Failure to develop successful new products 16 may also cause potential customers to choose to purchase other equipment or competitors &apos products rather than invest in products manufactured by us |
| SYSTEM IMPLEMENTATION During 2004, we selected a common information technology platform for the Company and began the process of converging our practices and methods to one version to be used by the Company and supported by the new system |
| The process of transforming our business practices to a common platform and risks associated with switching over data processing present the risk of interruption to our business |
| This would have a wide ranging impact including raising concerns regarding the accuracy of our reported financial results or damaging our relationships with our customers and vendors |
| STRATEGIC DIVESTITURES COULD NEGATIVELY AFFECT OUR RESULTS We regularly review our business units and evaluate them against our core business strategies |
| As part of that process, we regularly consider the divestiture of non-core and non-strategic operations or facilities |
| Depending upon the circumstances and terms, the divestiture of a profitable operation or facility could negatively affect our earnings |