ITEM 1 - BUSINESS
General Development and Description of Business
Headquartered in Van Nuys, California, the principal business of Superior Industries International, Inc. (referred to herein as the “company” or in the first person notation “we,” “us” and “our”) is the design and manufacture of aluminum road wheels for sale to original equipment manufacturers ("OEMs"). We are one of the largest suppliers of cast aluminum wheels to the world's leading automobile and light truck manufacturers, with wheel manufacturing operations in the United States and Mexico. Products made in our North American facilities are delivered primarily to automotive assembly operations in North America, both for domestic and internationally branded customers. Our OEM aluminum road wheels primarily are sold for factory installation, as either optional or standard equipment, on many vehicle models manufactured by Ford, General Motors ("GM"), Chrysler Group LLC ("Chrysler"), BMW, Mitsubishi, Nissan, Subaru, Toyota and Volkswagen.
Production levels of the U.S. automotive industry for 2012 were 15.4 million vehicles, an 18 percent, or 2.3 million unit, increase over 2011. We track annual production rates based on information from Ward's Automotive Group. The North American annual production levels of automobiles and light-duty trucks (including SUV's and crossover vehicles) have recovered substantially following the steep decline in production in 2009 caused by severe economic conditions and other factors. Current economic conditions and low consumer interest rates have been generally supportive of market growth and, in addition, the relatively high average age of vehicles on the road appears to be contributing to higher rates of vehicle replacement. It was reported in 2012 that the average age of an automobile in the U.S. reached 11 years, a new record according to Polk Automotive Research.
In 2011, production of automobiles and light-duty trucks in North America reached 13.1 million units, an increase of 10 percent over 2010. Production in 2010 reached 11.9 million units, an increase of 3.3 million, or 39 percent, from 8.6 million vehicles in 2009. An improved U.S. economy, low consumer interest rates and pent-up demand for vehicles following the recession all contributed to market demand recovery.
The 2012 rate of vehicle production increase was strong in both automobiles and light-duty trucks. The international brands gained market share in 2012, as their market share in 2011 was negatively impacted by lost production at Toyota and Honda due largely to effects of the March 2011 earthquake and tsunami that occurred in Japan. In contrast to the overall market, the company's unit sales to domestic brands grew more rapidly than to international brands.
Raw Materials
The raw materials used in producing our products are readily available and are obtained through numerous suppliers with whom we have established trade relations. We purchase aluminum for the manufacture of our aluminum road wheels, which accounted for the vast majority of our total raw material requirements during 2012. The majority of our aluminum requirements are met through purchase orders with certain major domestic and foreign producers. Generally, the orders are fixed as to minimum and maximum quantities of aluminum, which the producers must supply during the term of the orders. During 2012, we were able to successfully secure aluminum commitments from our primary suppliers to meet production requirements and we anticipate being able to source aluminum requirements to meet our expected level of production in 2013. We procure other raw materials through numerous suppliers with whom we have established trade relationships.
When market conditions warrant, we may also enter into purchase commitments to secure the supply of certain commodities used in the manufacture of our products, such as aluminum, natural gas and other raw materials. We currently have several purchase commitments, placed in January 2013, for the delivery of natural gas through 2013. These natural gas contracts are considered to be derivatives under U.S. GAAP, and when entering into these contracts, it was expected that we would take full delivery of the contracted quantities of natural gas over the normal course of business. Accordingly, at inception, these contracts qualified for the normal purchase, normal sale ("NPNS") exemption provided for under U.S. GAAP. As such, we do not account for these purchase commitments as derivatives unless there is a change in facts or circumstances in regard to the company's intent or ability to use the contracted quantities of natural gas over the normal course of business. See Note 11 - Commitments and Contingent Liabilities in Notes to Consolidated Financial Statements in Item 8 - Financial Statements and Supplementary Data of this Annual Report for further discussion of natural gas contracts.
Customer Dependence
We have proven our ability to be a consistent producer of quality aluminum wheels with the capability to meet our customers' price, quality, delivery and service requirements. We strive to continually enhance our relationships with our customers through continuous improvement programs, not only through our manufacturing operations but in the engineering, wheel development and quality areas as well. These key business relationships have resulted in multiple vehicle supply contract awards with our key customers over the past year.
Ford, GM and Chrysler were our only customers accounting for more than 10 percent of our consolidated net sales in 2012. Net sales to these customers in 2012, 2011 and 2010 were as follows (dollars in millions):
The loss of all or a substantial portion of our sales to Ford, GM or Chrysler would have a significant adverse effect on our financial results. See also Item 1A
ITEM 1A - RISK FACTORS
The following discussion of risk factors contains “forward-looking” statements, which may be important to understanding any statement in this Annual Report or elsewhere. The following information should be read in conjunction with Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") and Item 8 - Financial Statements and Supplementary Data of this Annual Report.
Our business routinely encounters and addresses risks and uncertainties. Our business, results of operations and financial condition could be materially adversely affected by the factors described below. Discussion about the important operational risks that our business encounters can also be found in the MD&A section and in the business description in Item 1 - Business of this Annual Report. Below, we have described our present view of the most significant risks and uncertainties we face. Additional risks and uncertainties not presently known to us, or that we currently do not consider significant, could also potentially impair our business, results of operations and financial condition. Our reactions to these risks and uncertainties as well as our competitors' reactions will affect our future operating results.
Risks Relating To Our Company
Automotive Industry Trends - The majority of our sales are made in domestic U.S. markets and almost exclusively within North America. Therefore, our financial performance depends largely on conditions in the U.S. automotive industry, which in turn can be affected significantly by broad economic and financial market conditions. Consumer demand for automobiles is subject to considerable volatility as a result of consumer confidence in general economic conditions, levels of employment, prevailing wages, fuel prices and the availability and cost of consumer credit. Despite the improvement in the U.S. automotive industry since the global recession that began in 2008, vehicle production levels still remain below historical highs. There can be no guarantee that the improvements in recent years will be sustained or that reductions from current production levels will not occur in future periods. Demand for aluminum wheels can be further affected by other factors, including pricing and performance comparisons to competitive materials such as steel. Finally, the demand for our products is influenced by shifts of market share between vehicle manufacturers and the specific market penetration of individual vehicle platforms being sold by our customers. Although we have witnessed significant recovery in demand for vehicles and our products since 2010, the events related to the global recession beginning in 2008, such as the significant number of restructuring actions announced by our customers, including bankruptcy reorganizations and planned assembly plant closures, demonstrate the degree to which industry volatility can occur and be beyond the control of industry participants. There can be no assurances that industry recovery occurring since 2010 will be sustained.
Customer Concentration - Ford, GM and Chrysler, together represented approximately 77 percent of our total wheel sales in 2012. Our OEM customers are not required to purchase any minimum amount of products from us. Increasingly global procurement practices, the pace of new vehicle introduction and demand for price reductions may make it more difficult to maintain long-term supply arrangements with our customers, and there are no guarantees that we will be able to negotiate supply arrangements on terms acceptable to us in the future. The contracts we have entered into with most of our customers provide that we will provide wheels for a particular vehicle model, rather than for manufacturing a specific quantity of products. Such contracts range from one year to the life of the model (usually three to five years), typically are non-exclusive, and do not require the purchase by the customer of any minimum number of wheels from us. Therefore, a significant decrease in demand for certain key models or group of related models sold by any of our major customers, or a decision by a manufacturer not to purchase from us, or to discontinue purchasing from us, for a particular model or group of models, could adversely affect our results of operations and financial condition.
Difficulties Associated with Fixed Capacity Levels - As a result of increased consumer demand for automobiles, as well as actions previously taken by us to rationalize the costs associated with our business, we operated our business at near full capacity levels for most of 2012. Our ability to increase manufacturing capacity may require significant investments in facilities, equipment and personnel. To the extent that we make investments to increase manufacturing capacity and demand for our products is not sustained, our results of operations and financial condition may be adversely affected. Conversely, if we choose not to make investments to increase manufacturing capacity, our ability to meet customer demand for our products and increase revenues may be adversely affected and any favorable impact may be delayed due to the length of time required before additional manufacturing capacity becomes available. Additionally, operating our facilities at near full capacity levels may cause us to incur labor cost at premium rates in order to meet customer requirements, experience increased maintenance expenses or require us to replace our machinery and equipment on an accelerated basis, each of which could cause our results of operations and financial condition to be adversely affected.
Future Expansion - In order to meet anticipated growth in demand for aluminum wheels in the North American market, we recently announced plans to invest between $125 million and $135 million to build a new manufacturing facility in Mexico. The construction of a new manufacturing facility entails a number of risks, including the ability to begin production within the cost and timeframe estimated and to attract a sufficient number of skilled workers to meet the needs of the new facility. Additionally, our assessment of the projected benefits associated with the construction of a new manufacturing facility is subject to a number of estimates and assumptions, which in turn are subject to significant economic, competitive and other uncertainties that are beyond our control. If we experience delays or increased costs, our estimates and assumptions are incorrect, or other unforeseen events occur, our business, financial condition and results of operations could be adversely impacted.
Although our existing liquidity is currently adequate to fund the project, dedication of our financial resources to this project will reduce our liquidity and working capital, which in turn may limit our flexibility to pursue other initiatives to grow our business or to return capital to our shareholders. After making such an investment, a significant change in our business, the economy or an unexpected decrease in our cash flow for any reason could result in the need for outside financing.
Customer Leverage Over Suppliers - Our OEM customers typically attempt to qualify more than one wheel supplier for the programs we participate on and for programs we may bid on in the future. To the extent that supplier capacity and other factors permit, our customers exerting leverage may result in decreased sales volumes and unit price reductions, resulting in lower revenues, gross profit, operating income and cash flows.
Additionally, the vehicle market is highly competitive at the OEM level, which drives continual cost-cutting initiatives by our customers. Our OEM customers historically have reacted by exerting significant leverage over their outside suppliers. Customer concentration, relative supplier fragmentation and product commoditization have translated into continual pressure from OEMs to reduce the price of our products. If we are unable to generate sufficient production cost savings in the future to offset price reductions, our gross margin, rate of profitability and cash flows would be adversely affected. In addition, changes in OEMs' purchasing policies or payment practices could have an adverse effect on our business.
Competition - The automotive component supply industry is highly competitive, both domestically and internationally. Competition is based primarily on price, technology, quality, delivery and overall customer service. Some of our competitors are companies, or divisions or subsidiaries of companies, which are larger and have greater financial and other resources than we do. We cannot ensure that our products will be able to compete successfully with the products of these competitors. Furthermore, the nature of the markets in which we compete has attracted new entrants, particularly from low cost countries. As a result, our sales levels and margins continue to be adversely affected by pricing pressures reflective of significant competition from producers located in low-cost foreign markets, such as China. Such competition with lower cost structures pose a significant threat to our ability to compete internationally and domestically. These factors have led to sourcing of future business by our customers to foreign competitors in the past and they may continue to do so in the future. In addition, any of our competitors may foresee the course of market development more accurately than we are able to, develop products that are superior to our products, have the ability to produce similar products at a lower cost than we do, or adapt more quickly than we do to new technologies or evolving customer requirements. Consequently, our products may not be able to compete successfully with their products.
Dependence on Third-Party Suppliers and Manufacturers - Generally, we obtain our raw materials, supplies and energy requirements from various sources. Although we currently maintain alternative sources, our business is subject to the risk of price increases and periodic delays in delivery. Fluctuations in the prices of raw materials may be driven by the supply/demand relationship for that commodity or governmental regulation. In addition, if any of our suppliers seek bankruptcy relief or otherwise cannot continue their business as anticipated, the availability or price of raw materials could be adversely affected.
Although we are able to periodically pass aluminum cost increases onto our customers, we may not be able to pass along all changes in aluminum costs and our customers are not obligated to accept energy or other supply cost increases that we may attempt
to pass along to them. In addition, fixed price natural gas contracts that expire in the future may expose us to higher costs that cannot be immediately recouped in selling prices. This inability to pass on these cost increases to our customers could adversely affect our operating margins and cash flow, possibly resulting in lower operating income and profitability.
Unexpected Production Interruptions - An interruption in production capabilities at any of our facilities as a result of equipment failure, interruption of raw material or other supplies, labor disputes or other reasons could result in our inability to produce our products, which would reduce our sales and operating results for the affected period and harm our customer relationships. We have, from time to time, undertaken significant re-tooling and modernization initiatives at our facilities which in the past have caused, and in the future may cause, unexpected delays and plant underutilization, and such adverse consequences may continue to occur as we continue to modernize our production facilities. In addition, we generally deliver our products only after receiving the order from the customer and thus typically do not hold large inventories. In the event of a stoppage in production at any of our manufacturing facilities, even if only temporary, or if we experience delays as a result of events that are beyond our control, delivery times could be severely affected. Any significant delay in deliveries to our customers could lead to premium freight costs and other performance penalties, as well as contract cancellations, and cause us to lose future sales and expose us to other claims for damages. Our manufacturing facilities are also subject to the risk of catastrophic loss due to unanticipated events such as fires, earthquakes, explosions or violent weather conditions. We have in the past and may in the future experience plant shutdowns or periods of reduced production which could have a material adverse effect on our results of operations or financial condition.
It also is possible that our customers may experience production delays for a variety of reasons, which in-part could include supply-chain disruption for parts other than wheels that negatively affect assembly rates of vehicles using our parts, equipment breakdowns or other events affecting assembly rates that impact us, work stoppages or slow-downs at factories where our products are consumed, or even catastrophic events such as fires, disruptive weather conditions or natural disasters.
Impact of Aluminum Pricing - The cost of aluminum is a significant component in the overall cost of a wheel and a portion of our selling prices to OEM customers is attributable to the cost of aluminum. The price for aluminum we purchase is adjusted monthly based primarily on changes in certain published market indices. Our selling prices are adjusted periodically based upon aluminum market price changes, but the timing of such adjustments are based on specific customer agreements and can vary from monthly to quarterly to semi-annually. In addition, the timing of aluminum price adjustments flowing through sales rarely will match the timing of such changes in cost. This is especially true during periods of frequent increases or decreases in the market price of aluminum and when a portion of our aluminum purchases is via long-term fixed purchase agreements. Accordingly, our gross profit is subject to fluctuations, since the change in the product selling prices related to the cost of aluminum does not necessarily match the change in the aluminum raw material purchase prices during the period being reported, which may have an adverse effect on our operating results for the period being reported.
Legal Proceedings - The nature of our business subjects us to litigation in the ordinary course of our business. We are exposed to potential product liability and warranty risks that are inherent in the design, manufacture and sale of automotive products, the failure of which could result in property damage, personal injury or death. Accordingly, individual or class action suits alleging product liability or warranty claims could result. Although we currently maintain what we believe to be suitable and adequate product liability insurance in excess of our self-insured amounts, we cannot assure you that we will be able to maintain such insurance on acceptable terms or that such insurance will provide adequate protection against potential liabilities. In addition, if any of our products prove to be defective, we may be required to participate in a recall involving such products. A successful claim brought against us in excess of available insurance coverage, if any, or a requirement to participate in any product recall, could have a material adverse effect on our results of operations or financial condition. We cannot give assurance that any current or future claims will not adversely affect our cash flows, financial condition or results of operations.
Implementation of Operational Improvements - As part of our ongoing focus on being a low-cost provider of high quality products, we continually analyze our business to further improve our operations and identify cost-cutting measures. Our continued analysis may include identifying and implementing opportunities for: (i) further rationalization of manufacturing capacity; (ii) streamlining of marketing and general and administrative overhead; (iii) implementation of lean manufacturing and Six Sigma initiatives; or (iv) efficient investment in new equipment and technologies and the upgrading of existing equipment. We may be unable to successfully identify or implement plans targeting these initiatives, or fail to realize the benefits of the plans we have already implemented, as a result of operational difficulties, a weakening of the economy or other factors.
Cost reductions may not fully offset decreases in the prices of our products due to the time required to develop and implement cost reduction initiatives. Additional factors such as inconsistent customer ordering patterns, increasing product complexity and heightened quality standards also are making it increasingly more difficult to reduce our costs. It is also possible that as we incur costs to implement improvement strategies, the initial impact on our financial position, results of operations and cash flow may be negative. The impact of these factors on our future financial position and results of operations may be negative, to an extent that cannot be predicted, and we may not be able to implement sufficient cost saving strategies to mitigate any future impact.
New Product Introduction - In order to effectively compete in the automotive supply industry, we must be able to launch new products to meet our customers' demand in a timely manner. However, we cannot ensure that we will be able to install and certify the equipment needed to produce products for new product programs in time for the start of production, or that the transitioning of our manufacturing facilities and resources to full production under new product programs will not impact production rates or other operational efficiency measures at our facilities. In addition, we cannot ensure that our customers will execute on schedule the launch of their new product programs, for which we might supply products. Our failure to successfully launch new products, or a failure by our customers to successfully launch new programs, could adversely affect our results.
Technological and Regulatory Changes - Changes in legislative, regulatory or industry requirements or in competitive technologies may render certain of our products obsolete or less attractive. Our ability to anticipate changes in technology and regulatory standards and to successfully develop and introduce new and enhanced products on a timely basis will be a significant factor in our ability to remain competitive. We cannot ensure that we will be able to achieve the technological advances that may be necessary for us to remain competitive or that certain of our products will not become obsolete. We are also subject to the risks generally associated with new product introductions and applications, including lack of market acceptance, delays in product development and failure of products to operate properly.
International Operations - We manufacture a substantial portion of our products in Mexico and have a minor investment in a wheel manufacturing company in India. Accordingly, we sell our products internationally. Unfavorable changes in foreign cost structures, trade protection laws, policies and other regulations affecting trade and investments, social, political, labor, or economic conditions in a specific country or region, including foreign exchange rates, difficulties in staffing and managing foreign operations and foreign tax consequences, among other factors, could have a negative effect on our business and results of operations.
Foreign Currency Fluctuations - Due to the growth of our operations outside of the United States, we have experienced increased exposure to foreign currency gains and losses in the ordinary course of our business. As a result, fluctuations in the exchange rate between the U.S. dollar, the Mexican peso and any currencies of other countries in which we conduct our business may have a material impact on our financial condition as cash flows generated in foreign currencies may be used, in part, to service our U.S. dollar-denominated liabilities, or vice versa.
In addition, fluctuations in foreign currency exchange rates may affect the value of our foreign assets as reported in U.S. dollars, and may adversely affect reported earnings and, accordingly, the comparability of period-to-period results of operations. Changes in currency exchange rates may affect the relative prices at which we and our foreign competitors sell products in the same market. In addition, changes in the value of the relevant currencies may affect the cost of certain items required in our operations. We cannot ensure that fluctuations in exchange rates will not otherwise have a material adverse effect on our financial condition or results of operations, or cause significant fluctuations in quarterly and annual results of operations.
Environmental Matters - We are subject to various foreign, federal, state and local environmental laws, ordinances, and regulations, including those governing discharges into the air and water, the storage, handling and disposal of solid and hazardous wastes, the remediation of soil and groundwater contaminated by hazardous substances or wastes, and the health and safety of our employees. Under certain of these laws, ordinances or regulations, a current or previous owner or operator of property may be liable for the costs of removal or remediation of certain hazardous substances on, under, or in its property, without regard to whether the owner or operator knew of, or caused, the presence of the contaminants, and regardless of whether the practices that resulted in the contamination were legal at the time they occurred. The presence of, or failure to remediate properly, such substances may adversely affect the ability to sell or rent such property or to borrow using such property as collateral. Persons who generate, arrange for the disposal or treatment of, or dispose of hazardous substances may be liable for the costs of investigation, remediation or removal of these hazardous substances at or from the disposal or treatment facility, regardless of whether the facility is owned or operated by that person. Additionally, the owner of a site may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from a site. Future developments could lead to material costs of environmental compliance for us. The nature of our current and former operations and the history of industrial uses at some of our facilities expose us to the risk of liabilities or claims with respect to environmental and worker health and safety matters which could have a material adverse effect on our financial health. We are also required to obtain permits from governmental authorities for certain operations. We cannot ensure that we have been or will be at all times in complete compliance with such permits. If we violate or fail to comply with these permits, we could be fined or otherwise sanctioned by regulators. In some instances, such a fine or sanction could be material. In addition, some of our properties are subject to indemnification and/or cleanup obligations of third parties with respect to environmental matters. However, in the event of the insolvency or bankruptcy of such third parties, we could be required to bear the liabilities that would otherwise be the responsibility of such third parties.
Climate change legislation or regulations restricting emission of “greenhouse gases” could result in increased operating costs and reduced demand for the vehicles that use our product. On December 15, 2009, the U.S. Environmental Protection Agency (EPA)
published its findings that emissions of carbon dioxide, methane and other “greenhouse gases” present an endangerment to public health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the earth's atmosphere and other climatic changes. These findings allow the EPA to adopt and implement regulations that would restrict emissions of greenhouse gases under existing provisions of the federal Clean Air Act. Accordingly, the EPA has proposed regulations that would require a reduction in emissions of greenhouse gases from motor vehicles and could trigger permit review for greenhouse gas emissions from certain stationary sources. In addition, on October 30, 2009, the EPA published a final rule requiring the reporting of greenhouse gas emissions from specified large greenhouse gas emission sources in the United States, including facilities that emit more than 25,000 tons of greenhouse gases on an annual basis, beginning in 2011 for emissions occurring in 2010. At the state level, more than one-third of the states, either individually or through multi-state regional initiatives, already have begun implementing legal measures to reduce emissions of greenhouse gases. The adoption and implementation of any regulations imposing reporting obligations on, or limiting emissions of greenhouse gases from, our equipment and operations or from the vehicles that use our product could adversely affect demand for those vehicles or require us to incur costs to reduce emissions of greenhouse gases associated with our operations.
We incur significant costs to comply with applicable environmental, health and safety laws and regulations in the ordinary course of our business. Given the nature of our operations and the extensive environmental, public health and safety regulatory framework, the clear course of action is to place more restrictions and limitations on activities that may be perceived to affect the environment. Management expects environmental laws and regulations to impose increasingly stringent requirements upon the company and the industry in the future. Such regulation changes may have a significant impact on our cash flows, financial condition and results of operations.
Dependence on Key Personnel - Our success depends in part on our ability to attract, hire, train, and retain qualified managerial, engineering, sales and marketing personnel. We face significant competition for these types of employees in our industry. We may be unsuccessful in attracting and retaining the personnel we require to conduct our operations successfully. In addition, key personnel may leave us and compete against us. Our success also depends to a significant extent on the continued service of our senior management team. We may be unsuccessful in replacing key managers who either resign or retire. The loss of any member of our senior management team or other experienced senior employees could impair our ability to execute our business plans and strategic initiatives, cause us to lose customers and experience reduced net sales, or lead to employee morale problems and/or the loss of other key employees. In any such event, our financial condition, results of operations, internal control over financial reporting, or cash flows could be adversely affected.
Effective Internal Control Over Financial Reporting - Management is responsible for establishing and maintaining adequate internal control over financial reporting. Many of our key controls rely on maintaining a sufficient complement of personnel with an appropriate level of accounting knowledge, experience and training in the application of accounting principles generally accepted in the United States of America in order to operate effectively. Material weaknesses or deficiencies may cause our financial statements to contain material misstatements, unintentional errors, or omissions and late filings with regulatory agencies may occur.
Implementation of New Systems - We implemented a new enterprise resource planning system as of the beginning of the second quarter of 2010. We encountered technical and operating difficulties during and following the implementation process, as our employees learned and operated the new system which is critical to the management of and reporting of results for our operations. Any similar disruption while implementing other new systems could have an adverse impact on our financial condition, cash flows or results of operations and could prevent us from effectively reporting our financial results in a timely manner. In addition, the costs incurred in correcting any errors or problems with the new system could be substantial.
Cybersecurity - A cyber-attack that bypasses our information technology ("IT") security systems causing an IT security breach, may lead to a material disruption of our IT business systems and/or the loss of business information resulting in adverse consequences to our business, including: an adverse impact on our operations due to the theft, destruction, loss, misappropriation or release of confidential data or intellectual property, operational or business delays resulting from the disruption of IT systems and subsequent clean-up and mitigation activities, inability to timely prepare and file our financial reports with the Securities Exchange Commission and negative publicity resulting in reputation or brand damage with our customers, partners or industry peers.
ITEM 1B
ITEM 1B - UNRESOLVED STAFF COMMENTS
None.
ITEM 2
ITEM 2 - PROPERTIES
Our worldwide headquarters is located in leased office space in Van Nuys, California. We currently maintain and operate a total of five facilities that produce aluminum wheels for the automotive industry, located in Arkansas and Chihuahua, Mexico. These five facilities encompass 2,466,000 square feet of manufacturing space and 30,000 square feet of office space. We own all of these facilities with the exception of one warehouse in Rogers, Arkansas, and our worldwide headquarters located in Van Nuys, California that are leased.
In general, these facilities, which have been constructed at various times over the past several years, are in good operating condition and are adequate to meet our current productive capacity requirements. There are active maintenance programs to keep these facilities in good condition, and we have an active capital spending program to replace equipment as needed to keep technologically competitive on a worldwide basis.
Additionally, reference is made to Note 1 - Summary of Significant Accounting Policies, Note 5 - Property, Plant and Equipment and Note 8 - Leases and Related Parties, in Notes to the Consolidated Financial Statements in Item 8 - Financial Statements and Supplementary Data of this Annual Report.
ITEM 3
ITEM 3 - LEGAL PROCEEDINGS
We are party to various legal and environmental proceedings incidental to our business. Certain claims, suits and complaints arising in the ordinary course of business have been filed or are pending against us. Based on facts now known, we believe all such matters are adequately provided for, covered by insurance, are without merit, and/or involve such amounts that would not materially adversely affect our consolidated results of operations, cash flows or financial position. See also under Item 1A - Risk Factors - Legal Proceedings of this Annual Report.
ITEM 4
ITEM 4 - MINE SAFETY DISCLOSURES
Not applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding executive officers who are also Directors is contained in our 2013 Annual Proxy Statement under the caption “Election of Directors.” Such information is incorporated into Part III, Item 10 - Directors, Executive Officers and Corporate Governance. With the exception of the Chief Executive Officer ("CEO"), all executive officers are appointed annually by the Board of Directors and serve at the will of the Board of Directors. For a description of the CEO’s employment agreement, see “Employment Agreements” in our 2013 Annual Proxy Statement, which is incorporated herein by reference.
Listed below are the name, age, position and business experience of each of our officers who are not directors:
PART II
ITEM 5
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is traded on the New York Stock Exchange (symbol: SUP). We had approximately 500 shareholders of record and 27.3 million shares issued and outstanding as of March 1, 2013.
Dividends
Cash dividends declared totaled $1.12 and $0.64 during 2012 and 2011, respectively. During 2012 and 2011, the company declared and paid a regular dividend each quarter of $0.16 per share. In addition, dividends declared and paid in 2012 included an accelerated
payment of the 2013 regular cash dividend of $0.64 that was paid in December 2012. The company's Board of Directors approved an accelerated payment of the 2013 regular cash dividends into 2012. The accelerated dividend payment is intended to be in lieu of regular quarterly dividends that the company would have paid in calendar year 2013. Continuation of dividends is contingent upon various factors, including economic and market conditions, none of which can be accurately predicted, and the approval of our Board of Directors.
Quarterly Common Stock Price Information
The following table sets forth the high and low sales price per share of our common stock during the periods indicated.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
On March 17, 2000, the Board of Directors authorized the repurchase of 4.0 million shares of our common stock as part of the 2000 Stock Repurchase Plan ("Repurchase Plan"). During the last two fiscal years, there were no repurchases of common stock. As of December 31, 2012, approximately 3.2 million shares remained available for repurchase under the Repurchase Plan.
Recent Sales of Unregistered Securities
During the fiscal year 2012, there were no sales of unregistered securities.
ITEM 6
ITEM 6 - SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction with Item 7
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and the Notes to the Consolidated Financial Statements included in Item 8 - Financial Statements and Supplementary Data in this Annual Report. This discussion contains forward-looking statements, which involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of certain factors, including but not limited to those discussed in Item 1A - Risk Factors and elsewhere in this Annual Report.
Executive Overview
Overall North American production of passenger cars and light trucks in 2012 was reported by industry publications as being up by approximately 18 percent versus 2011, with production of passenger cars increasing 23 percent and production of light trucks and SUVs increasing 13 percent. While current production levels of the U.S. automotive industry are better than 2011 levels, they are still below historical highs. Results for 2012, 2011 and 2010 reflect the substantial recovery in the market for our products following the steep decline in production in 2009 caused by severe economic conditions and other factors affecting the U.S. automobile industry. Current economic conditions and low consumer interest rates have been generally supportive of market growth and, in addition, the continuing increase in the average age of vehicles on the road appears to be contributing to higher rates of vehicle replacement.
Net sales in 2012 decreased $0.7 million to $821.5 million from $822.2 million in 2011. Wheel sales in 2012 decreased $0.6 million to $812.4 million from $813.0 million in 2011, while our wheel unit shipments increased 0.8 million to 12.5 million in 2012. Gross profit in 2012 was $60.6 million, or 7 percent of net sales, compared to $67.1 million, or 8 percent of net sales, in 2011. Net income for 2012 was $30.9 million, or $1.13 per diluted share, including income tax expense of $3.6 million, compared to net income in 2011 of $67.2 million, or $2.46 per diluted share, which included an income tax benefit of $25.2 million. The 2011 tax benefit primarily resulted from the release of deferred tax asset valuation allowances established in prior years.
The comparisons below of 2012 and 2011 operating results reflect lower margins due to higher costs incurred in 2012. Higher costs in 2012 resulted from equipment reliability problems and manufacturing process issues with certain wheel programs which continued to increase our costs during sustained periods of high manufacturing capacity utilization. The comparisons below of 2011 and 2010 operating results reflect competitive pricing pressures and difficulties commercializing new product programs, as well as operating issues occurring during sustained high-volume production which led to higher costs and lower margins overall in 2011.
We are continuing to identify and implement action plans to improve our operational performance and mitigate the impact of continuing negative pricing pressure on our operating results and financial condition. We continue to focus on programs to reduce costs overall through improved operational and procurement practices, and increased capital reinvestment and factory maintenance to improve equipment reliability. However, it is possible that global pricing pressures may continue at a rate faster than our ability to achieve cost reductions which reflect the inherently time-consuming nature of developing and implementing these cost reduction programs. Furthermore, our capital investment projects have increased significantly since the relatively low capital spending levels experienced during the last few years as a result of the downturn in the automotive industry. Our capital investment projects have typically consisted of equipment upgrades and other capital projects that are focused on improving equipment reliability and efficiencies on newer, more complex wheel programs, in order to control labor and other costs. It is possible that capital expenditure levels will continue at these higher levels as we continue to seek to improve operational efficiencies and manufacturing process capability. In addition, although we have a portion of our natural gas requirements covered by fixed-price contracts expiring through 2013, costs may increase to a level that cannot be immediately recouped in selling prices or offset by cost-saving strategies.
In order to meet anticipated growth in demand for aluminum wheels in the North American market, we recently announced plans to invest between $125 million and $135 million to build a new manufacturing facility in Mexico, which we currently project will open in late 2015.
Listed in the table below are several key indicators we use to monitor our financial condition and operating performance.
Results of Operations
Net Sales
2012 versus 2011
Net sales in 2012 decreased $0.7 million to $821.5 million from $822.2 million in 2011. Wheel sales in 2012 decreased $0.6 million to $812.4 million from $813.0 million in 2011. Wheel shipments increased by 7 percent compared to 2011 with the increased volume contributing approximately $53.6 million in additional revenue. However, the favorable volume impact was substantially offset by a decline in the value of the aluminum component of sales which we generally pass through to our customers. The decline in aluminum value resulted in $49.7 million lower revenues, and also was the primary cause of a 6 percent reduction in the average selling price of our wheels. Additional factors leading to the overall change in sales such as the mix of wheel sizes and finishes sold were not individually material. Increases in unit shipments to Ford, Toyota, Chrysler and BMW were partially offset by declines in unit shipments to GM, Nissan, Subaru and Mitsubishi. Wheel program development revenues totaled $9.1 million in 2012 and $9.2 million in 2011.
U.S. Operations
Net sales of our U.S. wheel plants in 2012 increased $14.3 million, or 5 percent, to $308.0 million from $293.7 million a year ago, reflecting an increase in unit shipments partially offset by decreases in the average selling prices of our wheels. Unit shipments increased 13 percent in 2012, with the higher volume contributing approximately $38.4 million to the sales increase. The volume impact was partially offset by a 7 percent decrease in the average selling price of our wheels, primarily due to the decrease in the pass-through price of aluminum. The decline in aluminum value reduced revenues by approximately $19.9 million in 2012 when compared to 2011. Additional factors leading to the overall change in U.S. operations sales such as the mix of wheel sizes and finishes sold were not individually material.
Mexico Operations
Net sales of our Mexico wheel plants in 2012 decreased $15.0 million, or 3 percent, to $504.3 million from $519.3 million in 2011, reflecting a decrease in average selling prices of our wheels somewhat offset by an increase in unit shipments. Unit shipments increased 3 percent in 2012, with the higher volume contributing approximately $15.2 million in revenues. However, impact of the volume increase was offset by a 5 percent decrease in the average selling price of our wheels in 2012 primarily resulting from a lower pass-through price of aluminum. The decline in aluminum value reduced revenues approximately $29.8 million when compared to 2011. Additional factors leading to the overall change in Mexico operations sales such as the mix of wheel sizes and finishes sold were not individually material.
2011 versus 2010
Net sales in 2011 increased $102.7 million, or 14 percent, to $822.2 million from $719.5 million in 2010. Wheel sales in 2011 increased $103.5 million, or 15 percent, to $813.0 million from $709.5 million in 2010. Wheel shipments increased by 6 percent compared to 2010, with the increased volume contributing approximately $47.2 million to the sales increase. Changes in aluminum price, which we generally pass through to our customers, contributed approximately $55.4 million to the sales increase and was the primary driver of the 7 percent increase in the average selling price of our wheels. Additional factors leading to the overall change in sales such as the mix of wheel sizes and finishes sold were not individually material. Increases in unit shipments to Ford, BMW and Nissan were partially offset by declines in unit shipments to Chrysler. Wheel program development revenues totaled $9.2 million in 2011 and $10.0 million in 2010.
U.S. Operations
Net sales of our U.S. wheel plants in 2011 increased $50.5 million, or 21 percent, to $293.7 million from $243.2 million a year ago, reflecting both an increase in unit shipments and average selling prices of our wheels. Unit shipments increased 9 percent in 2011, with the higher volume contributing approximately $21.8 million to the sales increase. The increase in sales also reflects a 12 percent increase in the average selling price of our wheels, primarily due to the increase in the pass-through price of aluminum. The increase in aluminum value accounted for approximately $18.9 million of the sales increase in 2011 when compared to 2010. Additional factors leading to the overall change in U.S. operations sales such as the mix of wheel sizes and finishes sold were not individually material.
Mexico Operations
Net sales of our Mexico wheel plants in 2011 increased $54.4 million, or 12 percent, to $519.3 million from $464.9 million in 2010, reflecting both an increase in unit shipments and average selling prices of our wheels. Unit shipments increased 5 percent in 2011, with the higher volume contributing approximately $25.3 million to the sales increase. The increase in sales also reflects a 6 percent increase in the average selling price primarily resulting from higher pass-through price of aluminum. The increase in aluminum value accounted for approximately $36.5 million of the sales increase in 2011 as compared to 2010. Additional factors leading to the overall change in Mexico operations sales such as the mix of wheel sizes and finishes sold were not individually material.
When looking at our major customer mix, OEM unit shipment percentages were as follows:
According to Ward's Auto Info Bank, overall North American production of passenger cars and light trucks in 2012 increased approximately 18 percent, while production of the specific passenger car and light truck programs using our wheels increased 11 percent. In contrast to the market, our total shipments increased 7 percent as lack of available manufacturing capacity was a key factor constraining our ability to participate fully in the market growth. As a result, our share of the North American aluminum wheel market decreased by 4 percentage points on a year-over-year basis, with the share decline lower when measured against wheel programs where we currently are qualified to participate. The decline in market share was only 1 percentage point in light trucks and SUV's, with the majority of the overall decline related to our participation in passenger car programs.
According to Ward's Automotive Group, aluminum wheel installation rates on passenger cars and light trucks in the U.S. have increased in the 2012 model year after remaining flat for the model years 2011 and 2010 -- 70 percent for the 2012 model year compared to 65 percent for the 2011 and 2010 model years. Aluminum wheel installation rates have increased to the current level since the mid-1980s, when this rate was only 10 percent. We expect the more recent trend of slow growth or no growth in the aluminum penetration rate to continue. In addition, our ability to increase net sales and sales volume in the future may be negatively impacted by continued customer pricing pressures, limits in our production capacity and overall economic conditions that impact the sales of passenger cars and light trucks.
At the customer level, shipments in 2012 to Ford increased 18 percent compared to last year, as light truck and SUV wheel shipments increased 27 percent and shipments of passenger car wheels decreased 5 percent. At the program level, the major unit shipment increases were for the Escape, the F-Series trucks, Taurus, Flex and Explorer with shipment decreases for the Fusion and the out-of-production Lincoln Town Car.
Shipments to GM in 2012 decreased 6 percent compared to 2011, as unit volume of passenger car wheels decreased 27 percent and light truck and SUV wheel shipments increased slightly. The major unit shipment decreases to GM were for Chevrolet’s Malibu and Traverse, which were partially offset by major unit shipment increases for GMT 900 platform vehicles and the Chevrolet Impala.
Shipments to Chrysler in 2012 increased 17 percent compared to last year, as unit volume of passenger car wheels increased 22 percent and light truck and SUV wheel shipments increased 17 percent. The major unit shipment increases to Chrysler were for
the Jeep Compass and Grand Cherokee, Chrysler's Town & Country and the Dodge Journey, which were partially offset by major unit shipment decreases for the discontinued Dodge Nitro.
Shipments to international customers in 2012 increased 2 percent compared to 2011, as shipments of light truck and SUV wheels increased 12 percent and shipments of passenger car wheels decreased 4 percent. This increase was led by higher unit shipments to Toyota and BMW, with 2012 shipments to each of these customers up 26 percent over the prior year, while 2012 shipments to Nissan decreased 11 percent, when compared to last year. The 2012 increase in our shipments to Toyota partially reflects their recovery from the effects of the March 2011 natural disasters in Japan. At the program level, major unit shipment increases to international customers were for Nissan's Maxima, Toyota's Highlander and Camry and BMW's X3, offset by major unit shipment decreases for the Nissan Sentra and Altima and Subaru's Outback.
Cost of Sales
2012 versus 2011
Aluminum, natural gas and other direct material costs are a significant component of our costs to manufacture wheels. These costs are substantially the same for all of our plants since many common suppliers service both our U.S. and Mexico operations. Consolidated cost of sales includes costs for both our U.S. and international operations, which are principally our wheel manufacturing operations in Mexico, and certain costs that are not allocated to a specific operation. These unallocated expenses include corporate services that are primarily incurred in the U.S. but are not charged directly to our world-wide operations, such as engineering services for wheel program development and manufacturing support, environmental and other governmental compliance services.
Consolidated cost of goods sold increased $5.7 million to $760.8 million in 2012, or 93 percent of net sales, compared to $755.1 million, or 92% of net sales, in 2011. Cost of sales in 2012 primarily reflects an increase in costs due to a 7 percent increase in unit shipments and increases in labor and other costs, when compared to a year ago, somewhat offset by a decrease in aluminum prices, which we generally pass through to our customers. Direct material costs decreased approximately $15.8 million to $399.3 million from $415.1 million in 2011. The decrease in direct material costs includes approximately $51.1 million of aluminum price decreases which we generally pass through to our customers. Plant labor and benefit costs increased $13.4 million to $132.8 million in 2012, from $119.4 million in 2011, repair and maintenance costs increased $5.6 million to $32.2 million in 2012, compared to $26.6 million in 2011, and supply costs increased $7.4 million to $29.2 million in 2012, from $21.8 million in 2011. Cost of goods sold for our U.S. operations increased $34.6 million while cost of goods sold for our Mexico operations decreased $25.8 million, when comparing 2012 to 2011. The cost of goods sold for our Mexico operations includes a reduction of $3.5 million from the release of a reserve, established in a prior year, for an uncertainty related to a foreign consumption tax that was resolved in 2012. Cost of sales associated with corporate services such as engineering support for wheel program development and manufacturing support decreased $3.1 million in 2012 when compared to 2011.
The higher levels of manufacturing costs reflect a variety of factors which primarily include higher unit volumes, labor costs, supplies and increased maintenance spending. Despite inefficiencies incurred as a result of equipment reliability problems and other manufacturing process issues while in the midst of continuing high volume demands, productivity measured in terms of wheels produced per labor hour was unchanged in 2012 when compared with 2011. A 2 percent increase in manufacturing labor cost per wheel was lower than the average rate of hourly wage increase in manufacturing operations. Included below are the major items that impacted cost of sales for our U.S. and Mexico operations during 2012.
U.S. Operations
Cost of sales for our U.S. operations increased by $34.6 million, or 12 percent, in 2012, as compared to 2011. Cost of sales for our U.S. wheel plants in 2012 primarily reflects an increase in costs due to a 13 percent increase in unit shipments and increases in labor and other costs, when compared to a year ago, somewhat offset by an approximate $18.3 million decrease in aluminum prices, which we generally pass through to our customers. During 2012, plant labor and benefit costs including overtime premiums increased approximately $12.1 million, or 17 percent, primarily as a result of higher headcount and increases in contract labor, when compared to last year. During 2012, labor cost per wheel increased 5 percent while the wheels produced per labor hour incurred decreased 12 percent, as compared to 2011 due primarily to equipment reliability and other manufacturing process issues. Other increases in 2012 included a $7.1 million increase in supply and small tool costs and a $4.1 million increase in plant repair and maintenance costs. These cost increases largely were the result of operating inefficiencies and cost incurred directly in response to equipment reliability issues. Higher costs also reflect an increasingly difficult mix of products being produced.
Mexico Operations
Cost of sales for our Mexico operations decreased by $25.8 million, or 6 percent, in 2012, when compared to 2011. The decline in cost of sales for our Mexico operations in 2012 primarily reflects a decrease in aluminum prices, which we generally pass
through to our customers, of approximately $32.8 million. The aluminum cost decline was offset partially by an increase in costs due primarily to a 3 percent increase in unit shipments. During 2012, plant labor and benefit costs increased approximately $1.3 million, or 3 percent, when compared to last year. However, operating efficiencies in 2012 improved as reflected in a 5 percent decrease in labor cost per wheel and a 10 percent improvement in the number of wheels produced per labor hour as compared to 2011. Additionally, cost of sales in 2012 included approximately $1.5 million higher plant repair and maintenance expenses and $0.3 million higher supply and small tool costs, as well as the $3.5 million reduction from releasing the foreign consumption tax reserve described above.
2011 versus 2010
Consolidated cost of goods sold increased $124.8 million to $755.1 million in 2011, or 92 percent of net sales, compared to $630.3 million, or 88% of net sales, in 2010. Unit shipments in 2011 increased 6 percent compared to last year. Direct material costs increased approximately $83.9 million to $415.1 million from $331.2 million in 2010. The increase in direct material costs includes approximately $57.8 million of aluminum price increases that we generally pass through to our customers. Plant labor and benefit costs increased $15.1 million to $119.4 million in 2011, from $104.3 million in 2010, repair and maintenance costs increased $5.6 million to $26.6 million in 2011, compared to $21.0 million in 2010, and supply costs increased $3.4 million to $21.8 million in 2011, from $18.4 million in 2010. Cost of goods sold for our U.S. operations increased $66.1 million while cost of goods sold for our Mexico operations increased $60.2 million, when comparing 2011 to 2010. Cost of sales associated with corporate services such as engineering support for wheel program development and manufacturing support decreased $1.5 million in 2011 when compared to 2010.
While continuing to operate at full capacity to meet customer demand, we incurred inefficiencies while commercializing certain new product programs, equipment reliability problems and other manufacturing process issues while in the midst of continuing high volume demands, all of which contributed to increased manufacturing cost per wheel. For 2011, productivity measured in terms of wheels produced per labor hour declined 4 percent when compared with 2010 and manufacturing labor cost per wheel increased 12 percent. Plant labor costs overall have increased at a higher rate than sales. Included below are the major items that impacted cost of sales for our U.S. and Mexico operations during 2011.
U.S. Operations
Cost of sales for our U.S. operations increased by $66.1 million, or 30 percent, in 2011, as compared to 2010. Our U.S. operations during both periods consisted of two wheel plants located in Arkansas. Cost of sales for our U.S. wheel plants in 2011 reflects a 9 percent increase in unit shipments, an approximate $20.7 million increase in aluminum prices, which we generally pass through to our customers, and increases in labor and other costs in 2011 when compared to the previous year. During 2011, plant labor and benefit costs, including overtime premiums incurred, increased approximately $11.6 million, or 20 percent, when compared to last year due to a variety of reasons including new product launch inefficiencies, weather related disruptions in the first quarter, and equipment reliability issues during a time of consistently high capacity utilization. Other increases in 2011 included a $3.6 million increase in plant repair and maintenance costs, a $1.9 million increase in supply and small tool costs and a $2.1 million increase in self-insured medical costs when compared to the prior year. The company is self-insured for individual medical claim costs up to specified stop-loss limits in our insurance contracts.
Mexico Operations
Cost of sales for our Mexico operations increased by $60.2 million, or 16 percent, in 2011, when compared to 2010. Mexico operations during 2011 and 2010 consisted of three wheel plants. Cost of sales for our Mexico operations in 2011 reflects an increase in unit shipments of 5 percent, an approximate $37.1 million increase in aluminum prices, which we generally pass through to our customers, and increases labor and other costs in 2011 when compared to 2010. During 2011, plant labor and benefit costs increased approximately $4.1 million, or 9 percent, when compared to the prior year, due to training inefficiencies resulting from increasing headcount to better balance manpower with production levels, new product launch difficulties, as well as certain equipment and process reliability issues encountered in several facilities. Additionally, cost of sales in 2011 included approximately $2.1 million higher plant repair and maintenance expenses and $1.6 million higher supply and small tool costs.
Gross Profit
Consolidated gross profit decreased $6.5 million in 2012 to $60.6 million, or 7 percent of net sales, compared to $67.1 million, or 8 percent of net sales, in 2011. The 2012 gross profit includes a $3.5 million benefit from the release of a reserve, established in a prior year, for an uncertainty related to a foreign consumption tax. Excluding the benefit from releasing the reserve our 2012 gross profit was $57.1 million, or 7 percent of net sales. Unit shipments in 2012 increased 7 percent compared to last year. However, the gross profit and margin percentage decline were largely the result of operating inefficiencies and cost incurred directly in response to equipment reliability issues, as well as an increasingly difficult mix of products being produced, as described in the discussion of cost of sales above.
The cost of aluminum is a significant component in the overall cost of a wheel and a portion of our selling prices to OEM customers is attributable to the cost of aluminum. The price for aluminum we purchase is adjusted monthly based primarily on changes in certain published market indices. Our selling prices are adjusted periodically based upon aluminum market price changes, but the timing of such adjustments is based on specific customer agreements and can vary from monthly to quarterly to semi-annually. Even if aluminum selling price adjustments were to perfectly match changes in aluminum purchase prices, an increasing aluminum price will result in a declining gross margin percentage - i.e., same gross profit dollars divided by increased sales dollars equals lower gross profit percentage. The opposite would then be true in periods during which the price of aluminum decreases. In addition, the timing of aluminum price adjustments flowing through sales rarely will match exactly the timing of such changes in cost. As estimated by the company, the impact on gross profit in 2012 related to such differences in timing of aluminum adjustments was not material when compared to the same period in 2011.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $27.7 million, or 3 percent of net sales, in 2012 compared to $25.9 million, or 3 percent of net sales, in 2011 and $28.3 million, or 4 percent of net sales, in 2010. Compared to 2011, the $1.8 million increase in 2012 expenses primarily reflects $1.0 million higher legal fees in 2012 and a $1.5 million benefit in 2011 for a reduction in our deferred compensation liability. Compared to 2011, the $1.3 million of higher expense in 2010 reflects implementation costs related to our new enterprise resource planning system, $0.9 million higher legal fees, and the $1.5 million reduction in our deferred compensation liability in 2011, offset partially by $0.7 million higher 2011 medical self-insurance costs.
Impairment of Long-Lived Assets and Other Charges
Impairment of long-lived assets and other charges totaled $1.3 million in 2011 and $1.2 million in 2010. The $1.3 million charge in 2011 and the $1.2 million charge in 2010 primarily reflect adjustments to the carrying value of certain assets held for sale, for which the estimated fair value had declined during the year. For further discussion of impairments and other charges, see Note 14 - Impairment of Long-Lived Assets and Other Charges in Notes to Consolidated Financial Statements in Item 8 - Financial Statements and Supplementary Data of this Annual Report.
Income from Operations
2012 versus 2011
As described in the discussion of cost of sales above, aluminum, natural gas and other direct material costs are substantially the same for all our plants since many common suppliers service both our U.S. and Mexico operations. In addition, our operations in the U.S. and Mexico sell to the same customers, utilize the same marketing and engineering resources, have interchangeable manufacturing processes and provide the same basic end product. However, profitability between our U.S. and Mexico operations can vary as a result of differing labor and benefit costs, the specific mix of wheels manufactured and sold by each plant, as well as differing plant utilization levels resulting from our internal allocation of wheel programs to our plants.
Consolidated income from operations includes results for both our U.S. and international operations, which are principally our wheel manufacturing operations in Mexico, and certain costs that are not allocated to a specific operation. These unallocated expenses include corporate services that are primarily incurred in the U.S. but are not charged directly to our world-wide operations, such as selling, general and administrative expenses, engineering services for wheel program development and manufacturing support, environmental and other governmental compliance services.
Consolidated income from operations decreased $6.9 million in 2012 to $32.9 million, or 4 percent of net sales, from $39.8 million, or 5 percent of net sales, in 2011. Income from our U.S. operations decreased $20.4 million, while income from our Mexico operations increased $11.1 million when comparing 2012 to 2011. Corporate costs were $2.4 million lower during 2012 when compared to 2011. Included below are the major items that impacted income from operations for our U.S. and Mexico operations during 2012.
U.S. Operations
Operating income from our U.S. operations for 2012 decreased by $20.4 million compared to the previous year. Although income from our U.S. operations in 2012 reflects a 13 percent increase in unit shipments, this improvement was more than offset by higher operating costs which caused gross profit to decrease by $20.3 million, and as a percentage of net sales our margin declined 7 percentage points when comparing 2012 with 2011. The decline reflects increases in labor, repair, maintenance, and supply and small tool costs as more fully explained in the cost of sales discussion above. The lower gross profit was largely the result of
operating inefficiencies and cost incurred directly in response to equipment reliability issues, as well as an increasingly difficult mix of products being produced.
Mexico Operations
Operating income from our Mexico operations increased by $11.1 million in 2012 compared to 2011. Income from our Mexico operations in 2012 included an increase in unit shipments of 3 percent and, excluding the benefit from release of the consumption tax reserve discussed above, gross profit increased $7.5 million, and as a percentage of net sales our margins increased 2 percentage points in 2012, as compared to 2011.
U.S. versus Mexico Production
During 2012 and 2011, wheels produced by our Mexico and U.S. operations accounted for 63 percent and 37 percent, respectively, of our total production. We anticipate that, absent any significant change in the market or overall demand, the percentage of production in Mexico will remain between 60 percent and 65 percent of our total production for 2013.
2011 versus 2010
Consolidated income from operations decreased $20.0 million in 2011 to $39.8 million, or 5 percent of net sales, from $59.8 million, or 8 percent of net sales, in 2010. Income from our U.S. operations decreased $15.1 million, while income from our Mexico operations decreased $5.6 million when comparing 2011 to 2010. Corporate costs were $0.7 million lower during 2011 when compared to 2010. Included below are the major items that impacted income from operations for our U.S. and Mexico operations during 2011.
U.S. Operations
Operating income from our U.S. operations for 2011 decreased by $15.1 million compared to the previous year. Although income from our U.S. operations in 2011 reflects a 9 percent increase in unit shipments, this improvement was more than offset by higher operating costs which caused gross profit to decrease $15.3 million and as a percentage of net sales our margins declined 7 percentage points in 2011 when compared to 2010. The decline reflects increases in labor, repair, maintenance, and supply and small tool costs (see cost of sales discussion above), as well as the impact of changes in product mix which impacted negatively on production efficiencies and gross margins.
Mexico Operations
Operating income from our Mexico operations decreased by $5.6 million in 2011 compared to 2010. Income from our Mexico operations in 2011 included an increase in unit shipments of 5 percent. However, the benefit of higher unit shipments was offset by operating cost increases and negative product mix changes in 2011 when compared to a year ago. Higher operating expense included labor, repair, maintenance, supply and small tool costs (see cost of sales discussion above). Changes in product mix, impacting both pricing and manufacturing efficiencies, and higher operating expense caused our gross profit to decrease $6.3 million and as a percentage of net sales our margins declined 3 percentage points in 2011 when compared to 2010.
U.S. versus Mexico Production
During 2011, wheels produced by our Mexico and U.S. operations accounted for 63 percent and 37 percent, respectively, of our total production. This compares to 62 percent in Mexico and 38 percent in the U.S. in 2010.
Interest Income, net and Other Income (Expense), net
Net interest income for 2012 increased 14 percent to $1.3 million from $1.1 million in 2011, due principally to an increase in the average rate of return on the average balance of cash invested. Net interest income for 2011 decreased 31 percent to $1.1 million from $1.6 million in 2010, due primarily to a decrease in the average rate of return on the average balance of cash invested.
Net other income (expense) was income of $0.4 million, $1.0 million and $0.2 million in 2012, 2011 and 2010, respectively. Foreign exchange gains and (losses) included in other income (expense) net was a $0.1 million gain in 2012, and losses of ($0.9) million and ($1.2) million in 2011 and 2010, respectively. Other income and expense items included were income of $0.3 million, $1.9 million and $1.4 million in 2012, 2011 and 2010, respectively.
Effective Income Tax Rate
Our income before income taxes and equity earnings was $34.5 million in 2012, $41.9 million in 2011 and $57.5 million in 2010. The effective tax rate on the 2012 pretax income was 10.4 percent compared to a benefit of 60.2 percent in 2011 and expense of 5.2 percent in 2010. The following is a reconciliation of the U. S. federal tax rate to our effective income tax rate along with a discussion of the key drivers that impacted our effective income tax rates for the periods presented:
1)
During the three years ended December 31, 2012, actual state tax provisions, net of federal income taxes, were $0.2 million, $0.2 million and $3.2 million in 2012, 2011 and 2010, respectively. The primary drivers for the decrease in the state tax expense in 2011, compared to 2010, relate to the favorable changes in the Michigan state income tax law, and to lower apportionment of income to the state of California.
2)
Actual permanent differences impacting the income tax provisions during the three years ended December 31, 2012 were benefits of $1.8 million, $0.7 million and $0.2 million in 2012, 2011 and 2010, respectively. The permanent differences increased in 2012 primarily due to income from the reversal of a reserve for a non-deductible cost related to the resolution of a certain VAT tax exposure of $3.5 million during 2012, there were no other material changes overall in the permanent differences in the periods presented. Changes in the effective income tax rate related to permanent differences are also affected by the fluctuating levels of income before income taxes and equity earnings.
3)
The impact of foreign income taxed at rates other than the statutory rate on our reported tax provisions during the three years ended December 31, 2012 were benefits of $0.2 million and $0.4 million in 2012 and 2011, respectively, and expense of $6.3 million in 2010. In 2011, the decline in foreign taxes resulted from being subject to Mexico's income tax regime, rather than to a flat tax regime which was applied in 2010.
4)
During 2012, increases in our valuation allowances resulted in additional tax expense of $3.4 million primarily due to state deferred tax assets for net operating loss and tax credit carryforwards that are no longer expected to be realized. During 2011, we released valuation allowances carried against our deferred tax assets based on an evaluation of current evidence and in accordance with our accounting policy. This adjustment resulted in a benefit of $42.3 million to the provision. In determining when to release the valuation allowance established against our net deferred income tax assets, we consider all available evidence, both positive and negative. During 2011, we generated pre-tax income of $41.9 million, and in the fourth quarter of 2011 we achieved three years of cumulative pre-tax income. We also reached sustained profitability, which our accounting policy defines as two consecutive one year periods of pre-tax income. With further consideration given to, among other things, historical operating results, estimates of future earnings in different taxing jurisdictions and the expected timing of reversals of temporary differences, we concluded that it was more likely than not that our deferred tax assets would be realized. During 2010, we released a portion of our valuation allowance which resulted in a benefit of $22.9 million. The primary driver for the release in the valuation allowance in 2010 was the use of federal, state, and foreign net operating losses and credits which were offset against taxable income, thus reducing our need for a valuation allowance.
5)
During 2012, the Mexican taxing authorities finalized their audit of the 2004 tax year, and the statute of limitations expired for the 2006 tax year, of one of our wholly-owned subsidiaries in Mexico. As a result, we recorded a net benefit of $8.1 million primarily due to a release of liabilities related to uncertain tax positions resulting from the Mexican taxing authorities finalizing their audit of the 2004 tax year. As a result of the audit settlement, the company paid $0.9 million and reversed approximately $21.7 million of liabilities for uncertain tax positions, which was partially offset by the $12.7 million reversal of related deferred tax assets established for the indirect benefit in the U.S. for the potential non-deductibility of expenses in Mexico. In 2012 we also had a net benefit of approximately $2.1 million from the expiration of the statute of limitations for the 2006 tax year. Partially offsetting these benefits was $2.0 million of interest and penalties we continue to accrue on the liability for uncertain tax positions established at the beginning of 2007 upon adoption of the U.S. GAAP method of accounting. The impact of changes in our tax liabilities for uncertain tax positions resulted in a net expense of $2.4 million in 2011, primarily due to $3.1 million of interest and penalties on the beginning
tax liabilities which resulted in increases to our tax provision. During 2010 we had a net benefit of $3.7 million from changes in our tax liabilities for uncertain tax positions as a result of the completion of certain tax examinations, which reduced our tax liabilities and provision, offset in part by $3.2 million of interest and penalties on the beginning tax liabilities which resulted in increases to our tax provision.
We are a multinational company subject to taxation in many jurisdictions. We record liabilities dealing with uncertainty in the application of complex tax laws and regulations in the various taxing jurisdictions in which we operate. If we determine that payment of these liabilities will be unnecessary, we reverse the liability and recognize the tax benefit during the period in which we determine the liability no longer applies. Conversely, we record additional tax liabilities or valuation allowances in a period in which we determine that a recorded liability is less than we expect the ultimate assessment to be or that a tax asset is impaired. The effects of recording liability increases and decreases are included in the effective income tax rate.
Unconsolidated Subsidiaries
Joint Venture in Hungary
In 1995, we entered into a joint venture with Otto Fuchs Kg ("Otto Fuchs"), based in Meinerzhagen, Germany, to form Suoftec Light Metal Products Production & Distribution Ltd ("Suoftec") to manufacture cast and forged aluminum wheels in Hungary principally for the European automobile industry. On June 18, 2010, we sold our 50-percent ownership to our joint venture partner, Otto Fuchs. Total sales proceeds of 7.0 million euros ($8.6 million) for our investment consisted of 4.0 million euros ($4.9 million) received in the second quarter of 2010, and 3.0 million euros ($3.7 million) subsequently received in machinery, equipment and cash. As of the date of sale, our net investment in Suoftec, including amounts included in other comprehensive income, was approximately $12.8 million, resulting in a loss on the sale of our investment of $4.1 million.
Being 50-percent owned and non-controlled, Suoftec was not consolidated but was accounted for using the equity method of accounting. Equity losses through the date of sale in June 2010 were $2.8 million. Our share of the joint venture's net loss was included in “Equity in Losses of Unconsolidated Affiliates" in the Consolidated Statements of Operations in Item 8 - Financial Statements and Supplementary Data.
Investment in India
On June 28, 2010, we executed a share subscription agreement (the "Agreement") with Synergies Casting Limited ("Synergies"), a private aluminum wheel manufacturer based in Visakhapatnam, India, providing for our acquisition of a minority interest in Synergies by the company. As of December 31, 2012, the total cash investment in the equity of Synergies amounted to $4.5 million, representing 12.6 percent of the outstanding equity shares of Synergies. Our share of the equity income associated with our investment in Synergies since our initial investment has been immaterial to the consolidated results of the company. Our investment in Synergies was initially accounted for under the equity method of accounting; however, during the third quarter of 2011, an amendment of the Synergies shareholder agreement eliminated our ability to exercise significant influence over the financial policies and operations of Synergies. As a result, effective with the amendment, we began accounting for the investment using the cost method of accounting on a prospective basis. As of December 31, 2012 we have a note receivable from Synergies totaling $0.3 million.
Net Income
Net income in 2012 was $30.9 million, or 4 percent of net sales, and included an income tax provision of $3.6 million, compared to $67.2 million, or 8 percent of net sales in 2011, including an income tax benefit of $25.2 million, and to $51.6 million, or 7 percent of net sales in 2010, including an income tax provision of $3.0 million. Earnings per share was $1.13, $2.46 and $1.93 per diluted share in 2012, 2011 and 2010, respectively.
Liquidity and Capital Resources
Our sources of liquidity include cash and cash equivalents, short-term investments, net cash provided by operating activities, and other external sources of funds. During the three years ended December 31, 2012, we had no bank or other interest-bearing debt. At December 31, 2012, our cash, cash equivalents and short-term investments totaled $207.3 million compared to $192.9 million at year-end 2011 and $151.6 million at the end of 2010.
Our working capital requirements, investing activities and cash dividend payments have historically been funded from internally generated funds, proceeds from the exercise of stock options or existing cash, cash equivalents and short-term investments, and we believe these sources will continue to meet our capital requirements in the foreseeable future.
We recently announced plans to invest between $125 million and $135 million to build a new manufacturing facility in Mexico. Although our existing liquidity is currently adequate to fund the project, we are evaluating various financing options available to the company, including new borrowings.
The following table summarizes the cash flows from operating, investing and financing activities as reflected in the consolidated statements of cash flows.
2012 versus 2011
Our liquidity remained strong in 2012. Working capital (current assets minus current liabilities) and our current ratio (current assets divided by current liabilities) were $338.3 million and 6.1:1, respectively, at December 31, 2012, versus $335.7 million and 5.9:1 at December 31, 2011. We generate our principal working capital resources primarily through operations. Working capital increased slightly in 2012 and primarily reflects increases in cash, cash equivalents and inventory, partially offset by lower accounts receivable. Accordingly, we believe we are well positioned to take advantage of new and complementary business opportunities, with the ability to further expand into emerging international markets and to fund our working capital and capital expenditure requirements for the foreseeable future.
Net cash provided by operating activities decreased $1.9 million to $65.8 million for 2012, compared to net cash provided by operating activities of $67.7 million for 2011. The primary operating activities during 2012 included net income of $30.9 million, changes in operating assets and liabilities totaling $19.3 million, and adjustments for non-cash items of $15.5 million, primarily due to depreciation of $26.3 million, deferred income tax changes of $13.6 million substantially related to the reversal of deferred tax assets established for the indirect benefit from uncertain tax positions that were resolved during the year, and stock-based compensation expense of $2.1 million, partially offset by ($26.3) million of non-cash reductions in tax liabilities primarily related to uncertain tax positions resolved during the year. Changes in operating assets included a $21.4 million decrease in our trade accounts receivable, an ($8.3) million change in inventory and an ($8.1) million change in other assets primarily due to customer owned tooling. The changes in operating liabilities in 2012 included an $8.8 million increase substantially related to deferred tooling revenues.
Our principal investing activities during 2012 were the funding of $23.1 million of capital expenditures and the purchase of $4.0 million of certificates of deposit, partially offset by the receipt of $5.1 million cash proceeds from maturing certificates of deposit. Investing activities during 2011 included the receipt of $21.7 million cash proceeds from maturing certificates of deposits, partially offset by the funding of $17.0 million of capital expenditures and the purchase of $4.9 million of certificates of deposit.
Financing activities during 2012 consisted of the payment of cash dividends on our common stock totaling $34.9 million, partially offset by the receipt of cash proceeds from the exercise of stock options totaling $1.5 million. Financing activities during 2011 consisted of the payment of cash dividends on our common stock totaling $17.4 million, partially offset by the receipt of cash proceeds from the exercise of stock options totaling $4.5 million.
2011 versus 2010
Working capital (current assets minus current liabilities) and our current ratio (current assets divided by current liabilities) were $335.7 million and 5.9:1, respectively, at December 31, 2011, versus $311.1 million and 5.4:1 at December 31, 2010. We generate our principal working capital resources primarily through operations. Working capital increased in 2011 and primarily reflects increases in cash, cash equivalents and short-term investments, partially offset by lower prepaid aluminum.
Net cash provided by operating activities increased $37.1 million to $67.7 million for 2011, compared to net cash provided by operating activities of $30.6 million for 2010. The primary operating activities during 2011 included net income of $67.2 million, changes in operating assets and liabilities totaling $7.5 million, and adjustments for non-cash items resulting in a net reduction of ($7.0) million, primarily due to deferred income tax changes of ($38.7) million related to the release of the valuation allowance,
depreciation of $27.5 million, stock-based compensation expense of $2.3 million and asset impairment charges totaling $1.3 million. Changes in operating assets included an $11.0 million increase in our trade accounts receivable, an $8.0 million decrease in other assets primarily due to lower prepaid aluminum, and a $4.6 million decrease in inventory. The changes in operating liabilities in 2011 included a $6.7 million increase in other liabilities, principally deferred tooling revenue.
Our principal investing activities during 2011 were the receipt of $21.7 million cash proceeds from maturing certificates of deposit, offset by the funding of $17.0 million of capital expenditures and the purchase of $4.9 million of certificates of deposit. Investing activities during 2010 included the receipt of $36.1 million cash proceeds from maturing certificates of deposit, partially offset by the purchase of $22.1 million of certificates of deposit and the funding of $9.3 million of capital expenditures.
Financing activities during 2011 consisted of the payment of cash dividends on our common stock totaling $17.4 million, partially offset by the receipt of cash proceeds from the exercise of stock options totaling $4.5 million. Financing activities during 2010 consisted of the payment of cash dividends on our common stock totaling $17.1 million, partially offset by the receipt of cash proceeds from the exercise of stock options totaling $2.4 million.
Risk Management
We are subject to various risks and uncertainties in the ordinary course of business due, in part, to the competitive global nature of the industry in which we operate, to changing commodity prices for the materials used in the manufacture of our products, and to development of new products.
We have operations in Mexico with sale and purchase transactions denominated in both pesos and dollars. The peso is the functional currency of certain of our operations in Mexico. The settlement of accounts receivable and accounts payable transactions denominated in a non-functional currency results in foreign currency transaction gains and losses. In 2012, the value of the Mexican peso increased by 6 percent in relation to the U.S. dollar. For the year ended December 31, 2012, we had foreign currency transaction gains of $0.1 million, and for the years ended December 31, 2011 and 2010, we had foreign currency transaction losses of ($0.9) million, and ($1.2) million, respectively, which are included in other income (expense) in the Consolidated Statements of Operations in Item 8 - Financial Statements and Supplementary Data of this Annual Report.
Since 1990, the Mexican peso has experienced periods of relative stability followed by periods of major declines in value. The impact of this change in value relative to our Mexico operations has resulted in a cumulative unrealized translation loss at December 31, 2012 of $56.5 million. Translation gains and losses are included in other comprehensive income (loss) in the Consolidated Statements of Shareholders' Equity in Item 8 - Financial Statements and Supplementary Data of this Annual Report.
When market conditions warrant, we may enter into purchase commitments to secure the supply of certain commodities used in the manufacture of our products, such as aluminum, natural gas and other raw materials. We currently have several purchase commitments, placed in January 2013, for the delivery of natural gas through 2013. These natural gas contracts are considered to be derivatives under U.S. GAAP, and when entering into these contracts, it was expected that we would take full delivery of the contracted quantities of natural gas over the normal course of business. Accordingly, at inception, these contracts qualified for the normal purchase, normal sale ("NPNS") exemption provided for under U.S. GAAP. As such, we do not account for these purchase commitments as derivatives unless there is a change in facts or circumstances in regard to the company's intent or ability to use the contracted quantities of natural gas over the normal course of business. As of December 31, 2012 there were no fixed price natural gas purchase agreements outstanding.
During 2010, certain of these natural gas contracts no longer qualified for the NPNS exemption because we could not take full delivery of the contracted quantities of natural gas under these contracts due to plant shutdowns and low levels of production caused by the sharp decline in our customers' requirements. In accordance with U.S. GAAP, the purchase commitments that no longer qualified for the NPNS exemption were accounted for as derivatives, with the changes in estimated fair value of these contracts being recorded in cost of sales in our income statement. The fair value measurements of our natural gas purchase commitments that were accounted for as derivatives were based on quoted market prices using the market approach and the fair values were determined using Level 1 inputs within the fair value hierarchy provided by U.S. GAAP. During 2010, the gains recorded in cost of sales totaled $1.9 million. The natural gas purchase commitments accounted for as derivatives were settled or full delivery was taken by December 31, 2010. In the first quarter of 2010, settlement payments for natural gas purchase commitments related to closed facilities totaled $1.1 million.
Contractual Obligations
Contractual obligations as of December 31, 2012 are as follows (amounts in millions):
The table above does not reflect unrecognized tax benefits of $11.3 million. Approximately $0.3 million of this amount will be paid during the first quarter of 2013. The timing of the settlement of the remaining amount is uncertain.
Off-Balance Sheet Arrangements
As of December 31, 2012, we had no significant off-balance sheet arrangements.
Inflation
Inflation has not had a material impact on our results of operations or financial condition for the three years ended December 31, 2012. Cost increases in our principal raw material, aluminum, fundamentally are passed through to our customers, with timing of the pass-through dependent on the specific commercial agreements. Wage increases have averaged 4 to 5 percent during this period. Cost increases for labor, other raw materials and for energy may not be recovered in our selling prices. Additionally, competitive global pricing pressures are expected to continue, which may lessen the possibility of recovering these types of cost increases in selling prices.
Critical Accounting Policies
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to apply significant judgment in making estimates and assumptions that affect amounts reported therein, as well as financial information included in this Management's Discussion and Analysis of Financial Condition and Results of Operations. These estimates and assumptions, which are based upon historical experience, industry trends, terms of various past and present agreements and contracts, and information available from other sources that are believed to be reasonable under the circumstances, form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent through other sources. There can be no assurance that actual results reported in the future will not differ from these estimates, or that future changes in these estimates will not adversely impact our results of operations or financial condition. As described below, the most significant accounting estimates inherent in the preparation of our financial statements include estimates and assumptions as to revenue recognition, allowance for doubtful accounts, inventory valuation, amortization of preproduction costs, impairment of and the estimated useful lives of our long-lived assets and the fair value of stock-based compensation, as well as those used in the determination of liabilities related to self-insured portions of employee benefits, workers' compensation and general liability programs and deferred income taxes.
Wheel Revenue Recognition - Our products are manufactured to customer specifications under standard purchase orders. We ship our products to OEM customers based on release schedules provided weekly by our customers. Our sales and production levels are highly dependent upon the weekly forecasted production levels of our customers. Sales of these products, net of estimated pricing adjustments, and their related costs are recognized when title and risk of loss transfers to the customer, generally upon shipment. A portion of our selling prices to OEM customers is attributable to the aluminum content of our wheels. Our selling prices are adjusted periodically for changes in the current aluminum market based upon specified aluminum price indices during specific pricing periods, as agreed with our customers. See Preproduction Costs and Revenue Recognition Related to Long-Term Supply Arrangements below for a discussion of tooling reimbursement revenues.
Allowance for Doubtful Accounts - We maintain an allowance for doubtful accounts receivable based upon the expected collectability of all trade receivables. The allowance is reviewed continually and adjusted for amounts deemed uncollectible by management.
Inventories - Inventories are stated at the lower of cost or market value and categorized as raw material, work-in-process or finished goods. When necessary, management uses estimates of net realizable value to record inventory reserves for obsolete and/or slow-
moving inventory. Our inventory values, which are based upon standard costs for raw materials and labor and overhead established at the beginning of the year, are adjusted to actual costs on a first-in, first-out ("FIFO") basis. Current raw material prices and labor and overhead costs are utilized in developing these adjustments.
Preproduction Costs and Revenue Recognition Related to Long-Term Supply Arrangements - We incur preproduction engineering and tooling costs related to the products produced for our customers under long-term supply agreements. We expense all preproduction engineering costs for which reimbursement is not contractually guaranteed by the customer or that are in excess of the contractually guaranteed reimbursement amount. We amortize the cost of the customer-owned tooling over the expected life of the wheel program on a straight line basis. Also, we defer any reimbursements made to us by our customer and recognize the tooling reimbursement revenue over the same period in which the tooling is in use. Changes in the facts and circumstances of individual wheel programs may accelerate the amortization of both the cost of the customer-owned tooling and the deferred tooling reimbursement revenues. Recognized tooling reimbursement revenues totaled approximately $8.0 million, $8.3 million and $10.0 million, in 2012, 2011 and 2010, respectively, and are included in net sales in the Consolidated Statements of Operations in Item 8 - Financial Statements and Supplementary Data of this Annual Report. The following tables summarize the unamortized customer-owned tooling costs included in our long-term other assets, and the deferred tooling revenues included in accrued expenses and other non-current liabilities:
Impairment of Long-Lived Assets and Investments - In accordance with U.S. GAAP, management evaluates the recoverability and estimated remaining lives of long-lived assets whenever facts and circumstances suggest that the carrying value of the assets may not be recoverable or the useful life has changed. See Note 14 - Impairment of Long-Lived Assets and Other Charges in Notes to Consolidated Financial Statements in Item 8 for further discussion of asset impairments.
When facts and circumstances indicate that there may have been a loss in value, management will also evaluate its cost and equity method investments to determine whether there was an other-than-temporary impairment. If a loss in the value of the investment is determined to be other than temporary, then the decline in value is recognized in earnings. See Note 6 - Investment in Unconsolidated Subsidiaries in Notes to Consolidated Financial Statements in Item 8 for further discussion of investment impairments.
Retirement Plans - Subject to certain vesting requirements, our unfunded retirement plan generally provides for a benefit based on final average compensation, which becomes payable on the employee's death or upon attaining age 65, if retired. The net periodic pension cost and related benefit obligations are based on, among other things, assumptions of the discount rate, future salary increases and the mortality of the participants. The net periodic pension costs and related obligations are measured using actuarial techniques and assumptions. See Note 9 - Retirement Plans in Notes to Consolidated Financial Statements in Item 8 for a description of these assumptions.
The following information illustrates the sensitivity to a change in certain assumptions of our unfunded retirement plans as of December 31, 2012. Note that these sensitivities may be asymmetrical, and are specific to 2012. They also may not be additive, so the impact of changing multiple factors simultaneously cannot be calculated by combining the individual sensitivities shown.
The effect of the indicated increase (decrease) in selected factors is shown below (in thousands):
Stock-Based Compensation - We account for stock-based compensation using the fair value recognition in accordance with U.S. GAAP. We use the Black-Scholes option-pricing model to determine the fair value of any stock options granted, which requires us to make estimates regarding dividend yields on our common stock, expected volatility in the price of our common stock, risk free interest rates, forfeiture rates and the expected life of the option. To the extent these estimates change, our stock-based compensation expense would change as well. The fair value of any restricted shares awarded is calculated using the closing market price of our common stock on the date of issuance. We recognize these compensation costs net of the applicable forfeiture rates and recognize the compensation costs for only those shares expected to vest on a straight-line basis over the requisite service period of the award, which is generally the option vesting term of three or four years. We estimated the forfeiture rate based on our historical experience.
Workers' Compensation and Loss Reserves - We self-insure any losses arising out of workers' compensation claims. Workers' compensation accruals are based upon reported claims in process and actuarial estimates for losses incurred but not reported. Loss reserves, including incurred but not reported reserves, are estimated using actuarial methods and ultimate settlements may vary significantly from such estimates due to increased claim frequency or the severity of claims.
Accounting for Income Taxes - We account for income taxes using the asset and liability method. The asset and liability method requires the recognition of deferred tax assets and liabilities for expected future tax consequences of temporary differences that currently exist between the tax basis and financial reporting basis of our assets and liabilities. We calculate current and deferred tax provisions based on estimates and assumptions that could differ from actual results reflected on the income tax returns filed during the following years. Adjustments based on filed returns are recorded when identified in the subsequent years.
The effect on deferred taxes for a change in tax rates is recognized in income in the period that the tax rate change is enacted. In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion of the deferred tax assets will not be realized. A valuation allowance is provided for deferred income tax assets when, in our judgment, based upon currently available information and other factors, it is more likely than not that all or a portion of such deferred income tax assets will not be realized. The determination of the need for a valuation allowance is based on an on-going evaluation of current information including, among other things, historical operating results, estimates of future earnings in different taxing jurisdictions and the expected timing of the reversals of temporary differences. We believe that the determination to record a valuation allowance to reduce a deferred income tax asset is a significant accounting estimate because it is based, among other things, on an estimate of future taxable income in the United States and certain other jurisdictions, which is susceptible to change and may or may not occur, and because the impact of adjusting a valuation allowance may be material.
In determining when to release the valuation allowance established against our net deferred income tax assets, we consider all available evidence, both positive and negative. Consistent with our policy, the valuation allowance against our net deferred income tax assets will not reversed until such time as we have generated three years of cumulative pre-tax income and have reached sustained profitability, which we define as two consecutive one year periods of pre-tax income.
We account for our uncertain tax positions in accordance with U.S. GAAP. The purpose of this method is to clarify accounting for uncertain tax positions recognized. The U.S. GAAP method of accounting for uncertain tax positions utilizes a two-step approach to evaluate tax positions. Step one, recognition, requires evaluation of the tax position to determine if based solely on technical merits it is more likely than not to be sustained upon examination. Step two, measurement, is addressed only if a position is more likely than not to be sustained. In step two, the tax benefit is measured as the largest amount of benefit, determined on a cumulative probability basis, which is more likely than not to be realized upon ultimate settlement with tax authorities. If a position does not meet the more likely than not threshold for recognition in step one, no benefit is recorded until the first subsequent period in which the more likely than not standard is met, the issue is resolved with the taxing authority, or the statute of limitations expires. Positions previously recognized are derecognized when we subsequently determine the position no longer is more likely than not to be sustained. Evaluation of tax positions, their technical merits, and measurements using cumulative probability are highly subjective management estimates. Actual results could differ materially from these estimates.
Presently, we have not recorded a deferred tax liability for temporary differences related to investments in foreign subsidiaries that are essentially permanent in duration. These temporary differences may become taxable upon a repatriation of earnings from the subsidiaries or a sale or liquidation of the subsidiaries. During 2011, the company provided a provision for taxes for its European subsidiary, as a result of the repatriation of 2011 earnings and profits of approximately $0.1 million. At this time the company does not have any plans to repatriate additional income from its foreign subsidiaries.
New Accounting Standards
In June 2011, the FASB modified the presentation of comprehensive income in the financial statements. The revised standard requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements and must be applied retrospectively. This standard eliminates the former option to report other comprehensive income and its components in the statement of changes in equity. The revised standard does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The modification of the standard did not have an effect on our consolidated results of operations and financial position, when adopted, on December 26, 2011.
ITEM 7A
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency. A significant portion of our business operations are conducted in Mexico. As a result, we have a certain degree of market risk with respect to our cash flows due to changes in foreign currency exchange rates when transactions are denominated in currencies other than our functional currency, including inter-company transactions. Historically, we have not actively engaged in substantial exchange rate hedging activities and, at December 31, 2012, we had not entered into any significant foreign exchange contracts.
During 2012, the Mexican peso to U.S. dollar exchange rate averaged 13.19 pesos to $1.00. Based on the balance sheet at December 31, 2012, the value of net assets for our operations in Mexico was 1,518 million pesos. Accordingly, a 10 percent change in the relationship between the peso and the U.S. dollar may result in a translation impact of between $10.5 million and $12.8 million, which would be recognized in other comprehensive income (loss).
Our business requires us to settle transactions between currencies in both directions - i.e., peso to U.S. dollar and vice versa. To the greatest extent possible, we attempt to match the timing of transaction settlements between currencies to create a “natural hedge.” For the full year 2012, we had a $0.1 million net foreign exchange transaction gain related to the peso. Based on the current business model and levels of production and sales activity, the net imbalance between currencies depends on specific circumstances and there can be no assurances that the net transaction balance will not change significantly in the future.
Natural Gas Purchase Commitments. When market conditions warrant, we enter into purchase commitments to secure the supply of certain commodities used in the manufacture of our products, such as natural gas. However, under no circumstances do we enter into derivatives or other financial instrument transactions for speculative purposes. At December 31, 2012, we had no fixed price natural gas purchase agreements outstanding. Subsequent to December 31, 2012, we entered into natural gas purchase agreements for deliveries in 2013 of 590 MMbtu of natural gas for a total cost of $2.3 million. These fixed price natural gas contracts may expose us to higher costs that cannot be recouped in selling prices in the event that the market price of natural gas declines below the contract price.
See the section captioned "Risk Management" in Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations for a further discussion about the market risk we face.
ITEM 8
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to the Consolidated Financial Statements of Superior Industries International, Inc.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Superior Industries International, Inc.
Van Nuys, California
We have audited the accompanying consolidated balance sheets of Superior Industries International, Inc. and subsidiaries (the "Company") as of December 30, 2012 and December 25, 2011, and the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for each of the three years ended December 30, 2012, December 25, 2011, and December 26, 2010. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Superior Industries International, Inc. and subsidiaries as of December 30, 2012 and December 25, 2011, and the results of their operations and their cash flows for each of the three years ended December 30, 2012, December 25, 2012, and December 26, 2010, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
As discussed in Note 1 to the consolidated financial statements, during 2012 the Company adopted Accounting Standards Update 2011-5 which revises the presentation of comprehensive income.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 30, 2012, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 12, 2013 expressed an unqualified opinion on the Company's internal control over financial reporting.
DELOITTE & TOUCHE LLP
Los Angeles, California
March 12, 2013
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Superior Industries International, Inc.
Van Nuys, CA
We have audited the internal control over financial reporting of Superior Industries International, Inc. and subsidiaries (the "Company") as of December 30, 2012, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Annual Report of Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 30, 2012, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended December 30, 2012 of the Company and our report dated March 12, 2013 expressed an unqualified opinion on those financial statements and financial statement schedule.
DELOITTE & TOUCHE LLP
Los Angeles, California
March 12, 2013
SUPERIOR INDUSTRIES INTERNATIONAL, INC.
CONSOLIDATED INCOME STATEMENTS
(Dollars in thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
SUPERIOR INDUSTRIES INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
SUPERIOR INDUSTRIES INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
SUPERIOR INDUSTRIES INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Dollars in thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
SUPERIOR INDUSTRIES INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
SUPERIOR INDUSTRIES INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2012
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
Headquartered in Van Nuys, California, the principal business of Superior Industries International, Inc. (referred to herein as the “company” or in the first person notation “we,” “us” and “our”) is the design and manufacture of aluminum road wheels for sale to original equipment manufacturers ("OEM"). We are one of the largest suppliers of cast aluminum wheels to the world’s leading automobile and light truck manufacturers, with wheel manufacturing operations in the United States and Mexico. Customers in North America represent the principal market for our products. As described in Note 2 - Business Segments, the company operates as a single integrated business and, as such, has only one operating segment - automotive wheels.
Presentation of Consolidated Financial Statements
The consolidated financial statements include the accounts of the company and its wholly owned subsidiaries. All intercompany transactions are eliminated in consolidation. The equity method of accounting is used for investments in non-controlled affiliates in which the company's ownership ranges from 20 to 50 percent, or in instances in which the company is able to exercise significant influence but not control (such as representation on the investee's Board of Directors.) The carrying value of these equity investments is reported in long-term investments and the company's equity in net earnings of these investments is reported separately in the consolidated income statements.
We have made a number of estimates and assumptions related to the reporting of assets, liabilities, revenues and expenses to prepare these financial statements in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP") as delineated by the Financial Accounting Standards Board ("FASB") in its Accounting Standards Codification ("ASC"). Generally, assets and liabilities that are subject to estimation and judgment include the allowance for doubtful accounts, inventory valuation, amortization of preproduction costs, impairment of and the estimated useful lives of our long-lived assets, self-insurance portions of employee benefits, workers' compensation and general liability programs, fair value of stock-based compensation, income tax liabilities and deferred income taxes. While actual results could differ, we believe such estimates to be reasonable.
Our fiscal year is the 52- or 53-week period ending generally on the last Sunday of the calendar year. The 2012 fiscal year comprised the 53-week period ended December 30, 2012. The fiscal years 2011 and 2010 comprised the 52-week periods ended on December 25, 2011, and December 26, 2010, respectively. For convenience of presentation, all fiscal years are referred to as beginning as of January 1, and ending as of December 31, but actually reflect our financial position and results of operations for the periods described above.
Cash and Cash Equivalents
Cash and cash equivalents generally consist of cash, certificates of deposit and fixed deposits and money market funds with original maturities of three months or less. Our cash and cash equivalents are not subject to significant interest rate risk due to the short maturities of these investments. Included in cash and cash equivalents are money market funds of $28.5 million and $13.4 million as of December 31, 2012 and 2011, respectively. Our money market funds are categorized as Level 1 in the fair value hierarchy with fair value measurements based on quoted prices in active markets for identical assets. Certificates of deposit and fixed deposits whose original maturity is greater than three months and is one year or less are classified as short-term investments and certificates of deposit and fixed deposits whose maturity is greater than one year at the balance sheet date are classified as non-current assets in our consolidated balance sheets. The purchase of any certificates of deposit or fixed deposits that are classified as short-term investments or non-current assets appear in the investing section of our consolidated statements of cash flows. At times throughout the year and at year-end, cash balances held at financial institutions were in excess of federally insured limits.
Restricted Deposits
We purchase certificates of deposit that mature within twelve months and are used to secure our workers’ compensation obligations and collateralize letters of credit securing our forward natural gas contracts. At December 31, 2012 and 2011, certificates of deposit totaling $4.0 million and $5.1 million, respectively, were restricted in use and were classified as short-term investments on our consolidated balance sheet.
Non-Cash Investing Activities
During the years ended December 31, 2012, 2011 and 2010, an additional $0.9 million, $0.4 million and $0.3 million, respectively, of equipment had been purchased but not yet paid for and are included in accounts payable in our consolidated balance sheets.
On June 18, 2010, we sold our 50-percent ownership interest in an unconsolidated affiliate, as described in Note 6 - Investments in Unconsolidated Affiliates. The total sales proceeds for our investment included cash of 4.0 million euros, or $4.9 million, which was received in the second quarter of 2010, and the balance of 3.0 million euros, or $3.8 million, which was subsequently received in machinery and equipment and cash. As of December 31, 2010, we had received equipment valued at 0.8 million euros and had a receivable in the amount of 2.2 million euros, or $2.9 million, which was collected in cash in 2011.
At December 31, 2012 and 2011, we had proceeds receivable from company executive life insurance policies totaling $0.3 million and $1.7 million, respectively.
Fair Values of Financial Instruments and Commitments
The company applies fair value accounting for all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:
Level 1 - Quoted prices in active markets for identical assets or liabilities.
Level 2 - Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 - Inputs that are generally unobservable and typically reflect management’s estimate of assumptions that market participants would use in pricing the asset or liability.
The carrying amounts for cash and cash equivalents, investments in certificates of deposit, accounts receivable, accounts payable and accrued expenses approximate their fair values due to the short period of time until maturity. Fair values of our natural gas contracts that we accounted for as derivatives are discussed further in Note 11 - Commitments and Contingent Liabilities, and were based upon quoted market prices using the market approach on a recurring basis and were considered Level 1 inputs within the fair value hierarchy provided in accordance with U.S. GAAP.
Accounts Receivable
We maintain an allowance for doubtful accounts receivable based upon the expected collectability of all trade receivables. The allowance is reviewed continually and adjusted for amounts deemed uncollectible by management.
Inventories
Inventories, which are categorized as raw materials, work-in-process or finished goods, are stated at the lower of cost or market using the first-in, first-out method. When necessary, management uses estimates of net realizable value to record inventory reserves for obsolete and/or slow-moving inventory. Aluminum is the primary material component in our inventories. Our aluminum requirements are supplied from two primary vendors, each accounting for more than 10 percent of our aluminum purchases during 2012.
Property, Plant and Equipment
Property, plant and equipment are carried at cost, less accumulated depreciation. The cost of additions, improvements and interest during construction, if any, are capitalized. Our maintenance and repair costs are charged to expense when incurred. Depreciation is calculated generally on the straight-line method based on the estimated useful lives of the assets.
When property, plant and equipment is replaced, retired or disposed of, the cost and related accumulated depreciation are removed from the accounts. Property, plant and equipment no longer used in operations, which are generally insignificant in amount, are stated at the lower of cost or estimated net realizable value. Gains and losses, if any, are recorded as a component of operating income if the disposition relates to an operating asset. If a non-operating asset is disposed of, any gains and losses are recorded in other income or expense in the period of disposition or write down.
Preproduction Costs and Revenue Recognition Related to Long-Term Supply Arrangements
We incur preproduction engineering and tooling costs related to the products produced for our customers under long-term supply agreements. We expense all preproduction engineering costs for which reimbursement is not contractually guaranteed by the customer or which are in excess of the contractually guaranteed reimbursement amount. We amortize the cost of the customer-owned tooling over the expected life of the wheel program on a straight line basis. Also, we defer any reimbursements made to us by our customer and recognize the tooling reimbursement revenue over the same period in which the tooling is in use. Changes in the facts and circumstances of individual wheel programs may accelerate the amortization of both the cost of customer-owned tooling and the deferred tooling reimbursement revenues. Recognized tooling reimbursement revenues, which totaled $8.0 million, $8.3 million and $10.0 million in 2012, 2011 and 2010, respectively, are included in net sales in the consolidated income statements. The following tables summarize the unamortized customer-owned tooling costs included in our non-current other assets, and the deferred tooling revenues included in accrued expenses and other non-current liabilities:
Impairment of Long-Lived Assets and Investments
In accordance with the Property, Plant and Equipment Topic of the ASC, management evaluates the recoverability and estimated remaining lives of long-lived assets. The company reviews long-lived assets for impairment whenever facts and circumstances suggest that the carrying value of the assets may not be recoverable or the useful life has changed. See Note 14 - Impairment of Long-Lived Assets and Other Charges for further discussion of asset impairments.
When facts and circumstances indicate that there may have been a loss in value, management will also evaluate its cost and equity method investments to determine whether there was an other-than-temporary impairment. If a loss in the value of the investment is determined to be other than temporary, then the decline in value is recognized as a loss. See Note 6 - Investment in Unconsolidated Affiliates for further discussion of investment impairments.
Derivative Instruments and Hedging Activities
In order to hedge exposure related to fluctuations in foreign currency rates and the cost of certain commodities used in the manufacture of our products, we periodically may purchase derivative financial instruments such as forward contracts, options or collars to offset or mitigate the impact of such fluctuations. Programs to hedge currency rate exposure may address ongoing
transactions including, foreign-currency-denominated receivables and payables, as well as specific transactions related to purchase obligations. Programs to hedge exposure to commodity cost fluctuations would be based on underlying physical consumption of such commodity. At December 31, 2012 and 2011, we held no derivative financial instruments other than the natural gas contracts discussed below.
We enter into contracts to purchase certain commodities used in the manufacture of our products, such as aluminum, natural gas, and other raw materials. Our natural gas contracts are considered to be derivatives instruments under US GAAP. However, upon entering into these contracts, we expect to fulfill our purchase commitments and take full delivery of the contracted quantities of natural gas during the normal course of business. Accordingly, under U.S. GAAP, these purchase contracts are not accounted for as derivatives because we typically qualify for the normal purchase normal sale exception under US GAAP, unless there is a change in the facts or circumstances that causes management to believe that these commitments would not be used in the normal course of business. See Note 11 - Commitments and Contingent Liabilities for additional information pertaining to these purchase commitments.
Foreign Currency Transactions and Translation
We have a wholly-owned foreign subsidiary with operations in Mexico whose functional currency is the peso. In addition, we have operations with U.S. dollar functional currencies with transactions denominated in pesos and other currencies. These operations had monetary assets and liabilities that were denominated in currencies that were different than their functional currency and were translated into the functional currency of the entity using the exchange rate in effect at the end of each accounting period. Any gains and losses recorded as a result of the remeasurement of monetary assets and liabilities into the functional currency are reflected as transaction gains and losses and included in other income (expense) in the consolidated income statements. For the year ended December 31, 2012, we had foreign currency transaction gains of $0.1 million, and for the years ended December 31, 2011 and 2010, we had transaction losses of $(0.9) million and $(1.2) million, respectively, which are included in other income (expense) in the consolidated income statements. In addition, we have a minority investment in India and, until June 2010, an investment in Hungary previously accounted for under the equity method. The functional currency of our Indian investee is the Indian rupee and the functional currency of our Hungarian investee was the euro.
When our foreign subsidiaries and equity method investees translate their financial statements from the functional currency to the reporting currency, the balance sheet accounts are translated using the exchange rates in effect at the end of the accounting period and retained earnings is translated using historical rates. The income statement accounts are generally translated at the weighted average of exchange rates during the period and the cumulative effect of translation is recorded as a separate component of accumulated other comprehensive income (loss) in shareholders' equity, as reflected in the consolidated statements of shareholders' equity. For our equity method investees, we record our proportionate share of the equity method investees cumulative effect of translation as a separate component of accumulated other comprehensive loss in shareholders' equity. The value of the Mexican peso increased by 6% in relation to the U.S. dollar in 2012.
Revenue Recognition
Sales of products and any related costs are recognized when title and risk of loss transfers to the purchaser, generally upon shipment. Tooling reimbursement revenues related to initial tooling reimbursed by our customers are deferred and recognized over the expected life of the wheel program on a straight line basis, as discussed above.
Research and Development
Research and development costs (primarily engineering and related costs) are expensed as incurred and are included in cost of sales in the consolidated statements of operations. Amounts expensed during each of the three years in the period ended December 31, 2012, 2011 and 2010 were $5.8 million, $5.3 million, and $4.9 million, respectively.
Value-Added Taxes
Value-added taxes that are collected from customers and remitted to taxing authorities are excluded from sales and cost of sales.
Stock-Based Compensation
We account for stock-based compensation using the fair value recognition method in accordance with U.S. GAAP. We recognize these compensation costs net of the applicable forfeiture rate and recognize the compensation costs for only those shares expected to vest on a straight-line basis over the requisite service period of the award, which is generally the option vesting term of three
to four years. We estimate the forfeiture rate based on our historical experience. See Note - 12 Stock-Based Compensation for additional information concerning our share-based compensation awards.
Income Taxes
We account for income taxes using the asset and liability method. The asset and liability method requires the recognition of deferred tax assets and liabilities for expected future tax consequences of temporary differences that currently exist between the tax basis and financial reporting basis of our assets and liabilities. We calculate current and deferred tax provisions based on estimates and assumptions that could differ from actual results reflected on the income tax returns filed during the following years. Adjustments based on filed returns are recorded when identified in the subsequent years.
The effect on deferred taxes for a change in tax rates is recognized in income in the period that the tax rate change is enacted. In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion of the deferred tax assets will not be realized. A valuation allowance is provided for deferred income tax assets when, in our judgment, based upon currently available information and other factors, it is more likely than not that all or a portion of such deferred income tax assets will not be realized. The determination of the need for a valuation allowance is based on an on-going evaluation of current information including, among other things, historical operating results, estimates of future earnings in different taxing jurisdictions and the expected timing of the reversals of temporary differences. We believe that the determination to record a valuation allowance to reduce a deferred income tax asset is a significant accounting estimate because it is based, among other things, on an estimate of future taxable income in the United States and certain other jurisdictions, which is susceptible to change and may or may not occur, and because the impact of adjusting a valuation allowance may be material.
In determining when to release the valuation allowance established against our net deferred income tax assets, we consider all available evidence, both positive and negative. Consistent with our policy, the valuation allowance against our net deferred income tax assets will not reversed until such time as we have generated three years of cumulative pre-tax income and have reached sustained profitability, which we define as two consecutive one year periods of pre-tax income.
The company adopted the U.S. GAAP method of accounting for uncertain tax positions during 2007. The purpose of this method is to clarify accounting for uncertain tax positions recognized. The U.S. GAAP method of accounting for uncertain tax positions utilizes a two-step approach to evaluate tax positions. Step one, recognition, requires evaluation of the tax position to determine if based solely on technical merits it is more likely than not to be sustained upon examination. Step two, measurement, is addressed only if a position is more likely than not to be sustained. In step two, the tax benefit is measured as the largest amount of benefit, determined on a cumulative probability basis, which is more likely than not to be realized upon ultimate settlement with tax authorities. If a position does not meet the more likely than not threshold for recognition in step one, no benefit is recorded until the first subsequent period in which the more likely than not standard is met, the issue is resolved with the taxing authority, or the statute of limitations expires. Positions previously recognized are derecognized when we subsequently determine the position no longer is more likely than not to be sustained. Evaluation of tax positions, their technical merits, and measurements using cumulative probability are highly subjective management estimates. Actual results could differ materially from these estimates.
Presently, we have not recorded a deferred tax liability for temporary differences related to investments in foreign subsidiaries that are essentially permanent in duration. These temporary differences may become taxable upon a repatriation of earnings from the subsidiaries or a sale or liquidation of the subsidiaries. During 2011, the company provided a provision for taxes for its European subsidiary, as a result of the repatriation of 2011 earnings and profits of approximately $0.1 million. At this time the company does not have any plans to repatriate income from its foreign subsidiaries.
Earnings Per Share
As summarized below, basic earnings per share is computed by dividing net income for the period by the weighted average number of common shares outstanding for the period. For purposes of calculating diluted earnings per share, net income is divided by the total of the weighted average shares outstanding plus the dilutive effect of our outstanding stock options under the treasury stock method, which includes consideration of stock-based compensation required by U.S. GAAP.
The following potential shares of common stock were excluded from the diluted earnings per share calculations because they would have been anti-dilutive due to their exercise prices exceeding the average market prices for the respective periods: for the year ended December 31, 2012, options to purchase 1,828,727 shares at prices ranging from $18.37 to $43.22; for the year ended December 31, 2011, options to purchase 1,456,440 shares at prices ranging from $21.72 to $43.22; and for the year ended December 31, 2010, options to purchase 2,956,100 shares at prices ranging from $16.32 to $43.22 per share.
New Accounting Pronouncement
In June 2011, the FASB modified the presentation of comprehensive income in the financial statements. The revised standard requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements and must be applied retrospectively. This standard eliminates the former option to report other comprehensive income and its components in the statement of changes in equity. The revised standard does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The modification of the standard did not have an effect on our consolidated results of operations and financial position, when adopted, on December 26, 2011.
NOTE 2 - BUSINESS SEGMENTS
The company's Chairman and Chief Executive Officer is the chief operating decision maker ("CODM") because he has final authority over performance assessment and resource allocation decisions. The CODM evaluates both consolidated and disaggregated financial information for each of the company's business units in deciding how to allocate resources and assess performance. Each manufacturing facility manufactures the same products, ships product to the same group of customers, utilizes the same cast manufacturing process and as a result, production can generally be transferred amongst our facilities. Accordingly, we operate as a single integrated business and, as such, have only one operating segment - automotive wheels.
NOTE 3 - ACCOUNTS RECEIVABLE
The following percentages of our consolidated net sales were made to Ford, GM and Chrysler: 2012 - 38 percent, 27 percent and 12 percent; 2011 - 35 percent, 30 percent and 11 percent; and 2010 - 33 percent, 33 percent and 14 percent, respectively. These three customers represented 82 percent and 75 percent of trade receivables at December 31, 2012 and 2011, respectively.
NOTE 4 - INVENTORIES
Service wheel and supplies inventory included in other non-current assets in the consolidated balance sheets totaled $6.5 million and $2.8 million at December 31, 2012 and 2011, respectively. Included in raw materials were operating supplies and spare parts totaling $10.2 million and $14.4 million at December 31, 2012 and 2011, respectively.
NOTE 5 - PROPERTY, PLANT AND EQUIPMENT
The net book values of all assets available for sale, totaling $1.5 million at December 31, 2011, were removed from the respective fixed asset categories above and were included in assets held for sale on the consolidated balance sheet. As of December 31, 2012 all assets held for sale have been sold. Depreciation expense was $26.4 million, $27.5 million and $29.1 million for the years ended December 31, 2012, 2011 and 2010, respectively.
NOTE 6 - INVESTMENTS IN UNCONSOLIDATED AFFILIATES
Investment in Hungary
In 1995, we entered into a joint venture with Otto Fuchs Kg, based in Meinerzhagen, Germany ("Otto Fuchs"), to form Suoftec Light Metal Products Production & Distribution Ltd ("Suoftec") to manufacture cast and forged aluminum wheels in Hungary principally for the European automobile industry. During the second quarter of 2010, we made a strategic decision to liquidate our investment in Suoftec and, on June 18, 2010, we sold our 50 percent ownership interest to our joint venture partner, Otto Fuchs. Total sales proceeds for our investment included cash of 4.0 million euros, or $4.9 million, which was received in the second quarter of 2010, and an unconditional right to receive machinery and equipment from Suoftec valued up to 3.0 million euros, or $3.8 million. As of December 31, 2010, we had received equipment valued at 0.8 million euros and had recorded a receivable in the amount of 2.2 million euros, or $2.9 million which was collected in cash in 2011. As of the date of sale, the net investment in Suoftec was $12.8 million, resulting in a loss on the sale of our investment of $4.1 million.
Being 50-percent owned and non-controlled, Suoftec was not consolidated, but was accounted for using the equity method of accounting. Included below are Suoftec's summary statements of operations through the date of sale in June 2010.
Investment in India
On June 28, 2010, we executed a share subscription agreement (the "Agreement") with Synergies Castings Limited ("Synergies"), a private aluminum wheel manufacturer based in Visakhapatnam, India, providing for our acquisition of a minority interest in Synergies. As of December 31, 2012, the total cash investment in Synergies amounted to $4.5 million, representing 12.6 percent of the outstanding equity shares of Synergies. Through September 22, 2011, the Agreement provided the company with rights to appoint a member to the Synergies board of directors and veto powers over significant financial policy and operating decisions, and as a result of these provisions, we were able to exert significant influence over Synergies and accounted for this investment under the equity method.
Effective September 23, 2011, the Agreement was amended for certain events and to remove the company's rights to appoint a director and the veto powers over significant financial policy and operating decisions. As a result of the amendment, it was determined that the company no longer had the ability to exercise significant influence over Synergies' financial policies and operations, and that the equity method of accounting for our investment was no longer appropriate. Accordingly, effective with the amendment, the company began accounting for Synergies under the cost method of accounting on a prospective basis. Our proportionate share of Synergies operating results was immaterial from our original investment through September 23, 2011. During 2011, a group of existing equity holders, including the company, made a loan of $1.5 million to Synergies for working capital needs. The company's share of this unsecured advance was $450,000, to be repaid over twenty-four months beginning in October 2011 and bearing interest at 7 percent per annum, payable quarterly. The terms and conditions of the loan were substantially the same for all equity holders involved in the transaction. Based upon our review of Synergies operating results, recent share issuances, and our review of the projected results, we do not believe there is an other-than-temporary impairment as of December 31, 2012. The principal balance as of December 31, 2012 was $346,000.
NOTE 7 - INCOME TAXES
The (provision) benefit for income taxes is comprised of the following:
(1) Included in the current foreign tax provisions are $23.9 million and $15.9 million net reversals of liabilities for uncertain tax positions for the years ending December 31, 2012 and 2010, respectively.
The following is a reconciliation of the United States federal tax rate to our effective income tax rate:
Our effective income tax rate for 2012 was 10 percent. Our effective income tax rate differed from the U.S. federal tax rate of 35 percent during 2012 primarily due to changes in our tax liability for uncertain tax positions resulting from the Mexican taxing authorities finalizing their audit of the 2004 tax year of Superior Industries de Mexico S.A. de C.V. ("SIM"), our wholly-owned Mexican subsidiary. As a result of the settlement, the company paid $0.9 million and reversed approximately $21.7 million of liabilities for uncertain tax positions, which was partially offset by the $12.7 million reversal of related deferred tax assets established for the indirect benefit in the U.S. for the potential non-deductibility of expenses in Mexico. Additional factors favorably impacting the 2012 effective tax rate include the net release of foreign tax liabilities for the 2006 tax year of $2.1 million as a result of the expiration of the statute of limitations, permanent differences including income from the reversal of a $3.5 million reserve established for an uncertainty related to certain non-deductible VAT tax credits, and income tax credits. The 2012 effective tax rate was unfavorably impacted by valuation allowance increases of approximately $3.4 million related primarily to state deferred tax assets for net operating loss ("NOL") and tax credit carryforwards that are no longer expected to be realized due to changes in tax law and cessation of business in Kansas.
Our effective income tax rate for 2011 was negative 60 percent. Our effective income tax rate differed from the U.S. federal tax rate of 35 percent during 2011 primarily due to the reversal of valuation allowances that benefited the income tax provision by $42.3 million. During the fourth quarter of 2011, we determined that it was more likely than not that our deferred tax assets would be realized in future periods and reversed the valuation allowances accordingly. Absent the reversal of the valuation allowances during 2011, our overall effective tax rate would have been 41 percent. The effective tax rate excluding the reversal of the valuation allowances was higher than the U.S. federal tax rate primarily due to the accrual of $3.1 million of additional interest and penalties on existing uncertain tax positions and state income taxes. In addition, during 2011 our operations in Mexico were not subject to the IETU tax regime and were subjected to regular income tax, causing a more normalized rate, absent the reversal of valuation allowances. The 2010 rate was favorably impacted by a net $3.7 million reduction in our tax liability caused by the benefit from a favorable outcome of a tax examination in Mexico which was partially offset by the reversal of related deferred tax assets and the accrual of additional interest and penalties on existing tax positions. The rate in 2010 was also favorably impacted by the utilization of net operating losses in the U.S. of $16.0 million, for which a valuation allowance had previously been provided. During 2010, our effective tax rate in Mexico was 27 percent. The statutory tax rate in Mexico is 30 percent. Much like in the U.S. the effective rate was reduced by the net reversal of valuation allowance which had been provided against our net operating loss carryforward, but increased as a result of the company being subject to the IETU tax regime. Additionally, the overall effective rate was increased by the $4.1 million loss on the sale of our investment in Suoftec for which no tax benefit had been recorded.
We are a multinational company subject to taxation in many jurisdictions. We record liabilities dealing with uncertainty in the application of complex tax laws and regulations in the various taxing jurisdictions in which we operate. If we determine that payment of these liabilities will be unnecessary, we reverse the liability and recognize the tax benefit during the period in which we determine the liability no longer applies. Conversely, we record additional tax liabilities or valuation allowances in a period in which we determine that a recorded liability is less than we expect the ultimate assessment to be or that a tax asset is impaired.
Income taxes are accounted for pursuant to U.S. GAAP, which requires the use of the liability method and the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement carrying amounts and the tax basis of assets and liabilities. The effect on deferred taxes for a change in tax rates is recognized in the provision for income taxes in the period of enactment. U.S. income taxes on undistributed earnings of our international subsidiaries have not been provided as such earnings are considered permanently reinvested. Tax credits and special deductions are accounted for as a reduction of the provision for income taxes in the period in which the credits arise.
Tax effects of temporary differences that gave rise to significant portions of the deferred tax assets and deferred liabilities at December 31, 2012 and 2011:
As of December 31, 2012 we had approximately $6.1 million of net deferred tax assets in Mexico and the U.S. During 2012, the decrease in our deferred tax assets related primarily to the indirect benefit in the U.S. for potential non-deductibility of expenses in Mexico resulting from uncertain tax positions, which were reversed as a result of an audit settlement and the expiration of the statute of limitations for open tax years.
As of December 31, 2011 we had approximately $22.1 million of net deferred tax assets. During the fourth quarter of 2011, we released valuation allowances carried against our net deferred tax assets in the U.S. based on an evaluation of current evidence and in accordance with our accounting policy. This release of the valuation allowance during 2011 resulted in a benefit of $42.3 million. In determining when to release the valuation allowance established against our U.S. net deferred income tax assets, we consider all available evidence, both positive and negative. During 2011, we generated pre-tax income of $41.9 million, and in the fourth quarter of 2011 we achieved three years of cumulative pre-tax income. We also reached sustained profitability, which our accounting policy defines as two consecutive one year periods of pre-tax income. With further consideration given to, among other things, historical operating results, estimates of future earnings in different taxing jurisdictions and the expected timing of reversals of temporary differences, we concluded that it was more likely than not that our deferred tax assets would be realized.
Realization of any of our deferred tax assets at December 31, 2012 is dependent on the company generating sufficient taxable income in the future. The determination of whether or not to record a full or partial valuation allowance on our deferred tax assets is a critical accounting estimate requiring a significant amount of judgment on the part of management. We perform our analysis on a jurisdiction by jurisdiction basis at the end of each reporting period.
At the end of 2009, the company determined that it was more likely than not that 1) the federal U.S. and state deferred tax assets would not be realized within the carryforward period and 2) the foreign NOL carryforwards would not be realized within the carryforward period. Based on our cumulative losses at the end of 2009, we could not look to projected operating results as a source of income. We, therefore, continued to establish full valuation allowances against those deferred tax assets that would be realized through the reversal of taxable temporary differences until the fourth quarter of 2011.
During 2010, the valuation allowances against our deferred tax assets decreased by $22.9 million to $43.2 million from $66.1 million at the end of 2009. Due to our increased profitability in 2010 as the automotive industry experienced a significant recovery, we were able to generate enough domestic taxable income to use our NOL carryforward from 2009, as well as realize the benefit of the reversal of certain taxable temporary differences. Also in 2010, the carryback period for NOLs was extended from two years to five years, thereby allowing us to carryback our 2008 NOL in full to 2003. Therefore, the valuation allowance associated with these items was released during 2010.
Due to our continued profitability in 2011, along with the continued improvement in the automotive industry, we were able to generate enough domestic taxable income to use our state NOL carryforwards from 2010 as well as reverse certain temporary items. During 2011, we also generated foreign income which allowed us to use a portion of our foreign NOL carryforwards.
As of December 31, 2012, we have cumulative state NOL carryforwards of $39.4 million that begin to expire in 2016. Also, we have $1.0 million of state tax credit carryforwards for 2012 and 2011 which are available indefinitely.
We have not provided for deferred income taxes or foreign withholding tax on basis differences in our non-U.S. subsidiaries that result from undistributed earnings of $124.8 million which the company has the intent and the ability to reinvest in its foreign operations. Determination of the deferred income tax liability on these basis differences is not reasonably estimable because such liability, if any, is dependent on circumstances existing if and when remittance occurs. During 2011, the company established a provision for taxes for its European subsidiary, as a result of the repatriation of 2011 earnings and profits of approximately $0.1 million.
We account for our uncertain tax positions in accordance with U.S. GAAP. A reconciliation of the beginning and ending amounts of these tax benefits for the three years ended December 31, 2012 is as follows:
(1) Excludes $5.0 million, $20.4 million and $19.5 million of potential interest and penalties associated with uncertain tax positions in 2012, 2011 and 2010, respectively.
Our policy regarding interest and penalties related to unrecognized tax benefits is to record interest and penalties as an element of income tax expense. The cumulative amounts related to interest and penalties are added to the total unrecognized tax liabilities on the balance sheet. Accordingly, the balance sheet at December 31, 2012 includes the unrecognized tax benefits, cumulative interest and penalties accrued on the liabilities totaling $11.3 million. During 2012, we accrued potential interest and penalties of $1.6 million and $0.4 million, respectively, related to unrecognized tax benefits. As of December 31, 2012, we have cumulative recorded liabilities for potential interest and penalties of $3.1 million and $1.9 million, respectively. Included in the unrecognized tax benefits of $11.3 million at December 31, 2012, was $5.8 million of tax benefit that, if recognized, would affect our annual effective tax rate. Within the next twelve-month period ending December 31, 2012, we do not expect any of the unrecognized tax benefits to be recognized due to the expiration of certain statute of limitations or settlements with tax authorities, except as described below.
We conduct business internationally and, as a result, one or more of our subsidiaries files income tax returns in U.S. federal, U.S. state and certain foreign jurisdictions. Accordingly, in the normal course of business, we are subject to examination by taxing authorities throughout the world, including Hungary, Mexico, the Netherlands, India, and the United States. We are no longer under examination by taxing authorities regarding any U.S. federal income tax returns for years before 2009 while the years open for examination under various state and local jurisdictions varies. Within the next twelve month period ending December 31, 2013, we do not expect any income tax examinations to be completed, except as described below.
Mexico's Tax Administration Service (Servicio de Administracion Tributaria, or "SAT"), finalized their examination of the 2007 tax year of Superior Industries de Mexico S.A. de C.V., our wholly-owned Mexican subsidiary, during February 2013. In February 2013 we reached a settlement with SAT for the 2007 tax year and made a cash payment of $0.3 million. The closure of the 2007 tax year audit resulted in an immaterial decrease in the liability for uncertain tax positions.
Total income tax payments made were $11.0 million in 2012, $15.8 million in 2011 and $9.6 million in 2010.
NOTE 8 - LEASES AND RELATED PARTIES
We lease certain land, facilities and equipment under long-term operating leases expiring at various dates through 2016. Total lease expense for all operating leases amounted to $1.5 million in 2012, $1.0 million in 2011 and $1.7 million in 2010.
Our corporate office and former manufacturing and warehouse facility in Van Nuys, California were leased from the Louis L. Borick Trust and the Nita A. Borick Management Trust (the Trusts). The Trusts are controlled by Mr. Steven J. Borick, Chairman and Chief Executive Officer of the company, as sole trustee, and Nita A. Borick, Mr. L. Borick's former spouse, respectively. Due to the closure of our manufacturing and warehouse operations at our Van Nuys, California facility in June 2009, we entered into an amended lease in May 2010 of the office space occupied by our corporate office.
The current operating lease expires at the end of March 2015. There are two additional lease extension options of approximately five years each. The current annual lease payment is approximately $425 thousand. The facilities portion of the lease agreement requires rental increases every five years based upon the change in a specific Consumer Price Index. The future minimum lease payments that are payable to the Trusts for the Van Nuys corporate office lease are $1.0 million. Total lease payments to these related entities were $0.4 million in 2012, $0.4 million in 2011 and $1.0 million for 2010.
The following are summarized future minimum payments under all leases. The table below contains the current annual lease payments of approximately $425 thousand for the corporate office facility through March 2015.
NOTE 9 - RETIREMENT PLANS
We have an unfunded salary continuation plan covering certain directors, officers and other key members of management. We purchase life insurance policies on certain participants to provide in-part for future liabilities. Cash surrender value of these policies, totaling $5.9 million and $5.6 million at December 31, 2012 and 2011, respectively, are included in other non-current assets in the company's consolidated balance sheets. Subject to certain vesting requirements, the plan provides for a benefit based on final average compensation, which becomes payable on the employee's death or upon attaining age 65, if retired. The plan was closed to new participants effective February 3, 2011. We have measured the plan assets and obligations of our salary continuation plan as of our fiscal year end for all periods presented.
The following table summarizes the changes in plan benefit obligations:
Components of net periodic pension cost are described in the following table:
The increase in the 2012 net periodic pension cost compared to the 2011 cost was primarily due to an increase in amortization of actuarial losses. The decrease in the 2011 net periodic pension cost compared to the 2010 cost was primarily due to a decrease in the discount rate.
Benefit payments during the next ten years, which reflect applicable future service, are as follows:
The following is an estimate of the components of net periodic pension cost in 2013:
Other Retirement Plans
We also have a contributory employee retirement savings plan (a 401k plan) covering substantially all of our employees. The employer contribution totaled $1.8 million, $1.8 million and $1.3 million for the three years ended December 31, 2012, 2011 and 2010, respectively.
Pursuant to the deferred compensation provision of his 1994 Employment Agreement ("1994 Agreement"), Mr. Louis L. Borick, Founding Chairman and a Director of the company until his passing in November 2011, was paid an annual amount of $1.0 million in 26 equal payments for five years through 2009. Beginning in 2010, the 1994 Agreement called for this annual amount to be reduced to $0.5 million.
NOTE 10 - ACCRUED EXPENSES
NOTE 11 - COMMITMENTS AND CONTINGENT LIABILITIES
The 2012 cost of sales includes a $3.5 million benefit from the release of a contingency reserve, established in a prior year, for an uncertainty related to a foreign consumption tax that was resolved during the third quarter of 2012. We are party to various legal and environmental proceedings incidental to our business. Certain claims, suits and complaints arising in the ordinary course of business have been filed or are pending against us. Based on facts now known, we believe all such matters are adequately provided
for, covered by insurance, are without merit, and/or involve such amounts that would not materially adversely affect our consolidated results of operations, cash flows or financial position.
In order to hedge exposure related to fluctuations in foreign currency rates and the cost of certain commodities used in the manufacture of our products, we periodically may purchase derivative financial instruments such as forward contracts, options or collars to offset or mitigate the impact of such fluctuations. Programs to hedge currency rate exposure may address ongoing transactions including, foreign-currency-denominated receivables and payables, as well as, specific transactions related to purchase obligations. Programs to hedge exposure to commodity cost fluctuations would be based on underlying physical consumption of such commodities. At December 31, 2012 we held no derivative financial instruments, and at December 31, 2011 we held no derivative financial instruments other than the natural gas contracts discussed below.
When market conditions warrant, we may also enter into purchase commitments to secure the supply of certain commodities used in the manufacture of our products, such as aluminum, natural gas and other raw materials. These natural gas contracts are considered to be derivatives under U.S. GAAP, and when entering into these contracts, it was expected that we would take full delivery of the contracted quantities of natural gas over the normal course of business. Accordingly, at inception, these contracts qualified for the normal purchase, normal sale ("NPNS") exemption provided for under U.S. GAAP. As such, we do not account for these purchase commitments as derivatives unless there is a change in facts or circumstances in regard to the company's intent or ability to use the contracted quantities of natural gas over the normal course of business. As of December 31, 2012, there were no fixed price natural gas purchase agreements outstanding.
During 2010, certain of these natural gas contracts no longer qualified for the NPNS exemption because we could not take full delivery of the contracted quantities of natural gas under these contracts due to plant shutdowns and low levels of production caused by the sharp decline in our customers' requirements in prior years. In accordance with U.S. GAAP, the purchase commitments that no longer qualified for the NPNS exemption were accounted for as derivatives, with the changes in estimated fair value of these contracts being recorded in cost of sales in our consolidated income statement. The fair value measurements of our natural gas purchase commitments that were accounted for as derivatives were based on quoted market prices using the market approach and the fair values were determined using Level 1 inputs within the fair value hierarchy provided by U.S. GAAP. During 2010, the gains recorded in cost of sales totaled $1.9 million. The natural gas purchase commitments accounted for as derivatives were settled or full delivery was taken by December 31, 2010. In the first quarter of 2010, settlement payments for natural gas purchase commitments related to closed facilities totaled $1.1 million.
NOTE 12 - STOCK BASED COMPENSATION
Our 2008 Equity Incentive Plan authorizes us to issue incentive and non-qualified stock options, as well as stock appreciation rights, restricted stock and performance units to our non-employee directors, officers, employees and consultants totaling up to 3.5 million shares of common stock. No more than 100,000 shares may be used under such plan as “full value” awards, which include restricted stock and performance units. Stock options are granted at not less than fair market value on the date of grant and expire no later than ten years after the date of grant. Options granted under this plan require no less than a three year ratable vesting period if vesting is based on continuous service. Vesting periods may be shorter than three years if performance based.
Restricted stock, or “full value” awards, vest ratably over no less than a three year period. Restricted shares are considered issued and outstanding at the date of grant, have the same dividend and voting rights as other outstanding common stock, are subject to forfeiture if employment terminates prior to vesting, and are expensed ratably over the vesting period. Dividends paid on the restricted shares are non-forfeitable. During 2012, we granted 33,550 shares of restricted stock, which vest ratably over a three year period. During 2011, we granted 29,250 shares of restricted stock, which vest ratably over a three year period.
We received cash proceeds of $1.5 million, $4.5 million and $2.4 million from stock options exercised in 2012, 2011 and 2010, respectively. The total intrinsic value of options exercised was $0.3 million and $1.9 million, during the years ended December 31, 2012 and 2011, respectively. It is our policy to issue shares from authorized but not issued shares upon the exercise of stock options and upon the issuance of restricted stock awards. At December 31, 2012, there were 2.0 million shares available for future grants under this plan.
We have elected to adopt the alternative transition method for calculating the initial pool of excess tax benefits and to determine the subsequent impact of the tax effects of employee stock-based compensation awards that are outstanding on shareholders' equity and the consolidated statements of cash flows.
Stock option activity in 2012:
Included in the total stock options outstanding at December 31, 2012 are 1.9 million options that were granted under prior stock option plans that have expired. The aggregate intrinsic value represents the total pretax difference between the closing stock price on the last trading day of the reporting period and the option exercise price, multiplied by the number of in-the-money options. This is the amount that would have been received by the option holders had they exercised and sold their options on that day. This amount varies based on changes in the fair market value of our common stock. The closing price of our common stock on the last trading day of our fiscal year was $19.55.
Stock options outstanding at December 31, 2012:
Restricted stock activity in 2012:
Stock-based compensation expense related to our equity incentive plans in accordance with U.S. GAAP was allocated as follows:
As discussed in Note 7 - Income Taxes, we had previously provided valuation allowances on our U.S. deferred tax assets. Consequently, the income tax benefit on our stock-based compensation expense in 2010 was entirely offset by changes in valuation allowances. There were no significant capitalized stock-based compensation costs at December 31, 2012 or 2011. As of December 31, 2012, there was $2.8 million of unrecognized stock-based compensation expense expected to be recognized related to unvested stock-based awards. That cost is expected to be recognized over a weighted-average period of 1.9 years.
The fair value of each option grant was estimated as of the date of grant using the Black-Scholes option-pricing model with the following assumptions:
(a)
This assumes that cash dividends of $0.16 per share are paid each quarter on our common stock.
(b)
Expected volatility is based on the historical volatility of our stock price, over the expected term of the option.
(c)
The risk-free rate is based upon the rate on a U.S. Treasury note for the period representing the expected term of the option.
(d)
The expected term of the option is based on historical employee exercise behavior, a contractual life of ten years and employees' post-vesting employment termination behavior.
NOTE 13 - COMMON STOCK PURCHASE PROGRAMS
Since 1995, our Board of Directors has authorized several common stock repurchase programs totaling 8.0 million shares, under which we have repurchased approximately 4.8 million shares for approximately $130.9 million, or $27.16 per share. Under the
latest authorization to repurchase up to 4.0 million shares, approved in March 2000, to date we have repurchased a total of 818,000 shares for a total cost of $26.9 million at an average cost per share of $32.82. All repurchased shares are immediately canceled and retired. There have been no stock repurchases since 2005. As of December 31, 2012, approximately 3.2 million additional shares can be repurchased under the current authorization.
NOTE 14 - IMPAIRMENT OF LONG-LIVED ASSETS AND OTHER CHARGES
Due to changing and deteriorating conditions in the automotive industry and reduced production requirements between 2006 and 2009, we ceased production at several of our facilities, including our Pittsburg, Kansas and Johnson City, Tennessee facilities. As a result of these plant shut-downs and the analyses of our long-lived assets, we recorded impairment charges related to the long-lived assets associated with facilities reducing the carrying value of certain assets at the facilities to their respective fair values.
The excess property, plant and equipment associated with the closed facilities that were being actively marketed for sale were included in assets held for sale. During 2011 and 2010, the estimated fair values of certain of these assets declined to an amount that was less than their respective book values, resulting in additional asset impairment charges of $1.3 million and $1.2 million, during 2011 and 2010, respectively. The fair value of these assets was determined based upon comparable sales information and with the assistance of independent third party appraisers and we had classified the inputs to the nonrecurring fair value measurement of these assets as being level 2 within the fair value hierarchy in accordance with U.S. GAAP. During 2011, impairment charges of $1.3 million related to our idle Pittsburg, Kansas and Johnson City, Tennessee facilities were recorded because the fair values were determined to be less than their remaining book values based on negotiations for the sales of the assets. During the third quarter of 2012, we completed the sale of the idle Pittsburg, Kansas facility for $2.0 million, and the purchase price less commission and fees was collected in cash, consistent with the carrying value. During 2011, the company completed the sale of the closed Johnson City, Tennessee facility for $1.7 million, and the purchase price less commission and fees was collected in cash, consistent with the carrying value.
Below is a summary of the long-lived asset impairment charges discussed above:
In 2010, the company completed a restructuring program, which included plant closures and workforce reductions, caused by the general decline in the automotive industry. Plant closure and related costs are included in the table below. All of the non-impairment costs were included in cost of sales. The following table summarizes the expenses, payments and resulting liabilities that were included in accrued expenses for one-time termination benefits and other plant closure related costs:
NOTE 15 - QUARTERLY FINANCIAL DATA (UNAUDITED)
(Thousands of dollars, except per share amounts)
(1) The third quarter of 2012 includes the income tax benefit of the settlement of an income tax audit and the reversal of the related liability for uncertain tax positions.
(1) The fourth quarter of 2011 includes the income tax benefit of the release of valuation allowances established in prior years against our deferred tax assets.
ITEM 9
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A
ITEM 9A - CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls
The company's management, with the participation of the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 30, 2012. Our disclosure controls and procedures are designed to ensure that information required to be disclosed in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures.
Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 30, 2012, our disclosure controls and procedures were effective.
Management's Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting. As defined in Rule 13a-15(f) under the Exchange Act, internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect all misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changing conditions, or that the degree of compliance with policies or procedures may deteriorate.
A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis.
Management performed an assessment of the effectiveness of the company's internal control over financial reporting as of December 30, 2012 based upon criteria established in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our assessment, management determined that our internal control over financial reporting was effective as of December 30, 2012 based on the criteria in the Internal Control -- Integrated Framework issued by COSO.
The effectiveness of the company's internal control over financial reporting as of December 30, 2012 has been audited by Deloitte and Touche LLP, an independent registered public accounting firm, as stated in their report, which is included in this Annual Report.
Changes in Internal Control Over Financial Reporting
There has been no change in our internal control over financial reporting during the most recent fiscal quarter ended December 30, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting, except as discussed above in the Management's Report on Internal Control Over Financial Reporting.
ITEM 9B
ITEM 9B - OTHER INFORMATION
None.
PART III
ITEM 10
ITEM 10 - DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Except as set forth herein, the information required by this Item is incorporated by reference to our 2013 Annual Proxy Statement.
Executive Officers - The names of corporate executive officers as of fiscal year end who are not also Directors are listed at the end of Part I of this Annual Report. Information regarding executive officers who are Directors is contained in our 2013 Annual Proxy Statement under the caption “Election of Directors.” Such information is incorporated herein by reference. With the exception of the Chief Executive Officer (CEO), all executive officers are appointed annually by the Board of Directors and serve at the will of the Board of Directors. For a description of the CEO’s employment agreement, see “Employment Agreements” in our 2013 Annual Proxy Statement, which is incorporated herein by reference.
Code of Ethics - Included on our website, www.supind.com, under “Investor,” is our Code of Conduct, which, among others, applies to our Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer. Copies of our Code of Conduct are available, without charge, from Superior Industries International, Inc., Shareholder Relations, 7800 Woodley Avenue, Van Nuys, CA 91406.
ITEM 11
ITEM 11 - EXECUTIVE COMPENSATION
Information relating to Executive Compensation is set forth under the captions “Compensation of Directors” and “Compensation Discussion and Analysis” in our 2013 Annual Proxy Statement, which is incorporated herein by reference.
ITEM 12
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information related to Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters is set forth under the caption “Voting Securities and Principal Holders” in our 2013 Annual Proxy Statement. Also see Note 12- Stock Based Compensation in Notes to the Consolidated Financial Statements in Item 8 - Financial Statements and Supplementary Data of this Annual Report.
ITEM 13
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information related to Certain Relationships and Related Transactions is set forth under the captions, “Election of Directors” and “Transactions with Related Persons,” in our 2013 Annual Proxy Statement, and in Note 8 - Leases and Related Parties in Notes to the Consolidated Financial Statements in Item 8 - Financial Statements and Supplementary Data of this Annual Report.
ITEM 14
ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information related to Principal Accountant Fees and Services is set forth under the caption “Audit Fees,” “Audit Related Fees” and “Tax Fees” in our 2013 Annual Proxy Statement and is incorporated herein by reference.
PART IV
ITEM 15
ITEM 15 - EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)
The following documents are filed as a part of this report:
1.
Financial Statements: See the “Index to the Consolidated Financial Statements and Financial Statement Schedule” in Item 8 of this Annual Report.
2.
Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts for the Years Ended December 31, 2012, 2011 and 2010
3.
Exhibits
* Indicates management contract or compensatory plan or arrangement.
SUPERIOR INDUSTRIES INTERNATIONAL, INC.
ANNUAL REPORT ON FORM 10-K
Schedule II
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010
(Thousands of dollars)
S-1
SUPERIOR INDUSTRIES INTERNATIONAL, INC.
ANNUAL REPORT ON FORM 10-K
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SUPERIOR INDUSTRIES INTERNATIONAL, INC.
(Registrant)
By
/s/ Steven J. Borick
March 12, 2013
Steven J. Borick
Chairman, Chief Executive Officer and President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacity and on the dates indicated.