Item 1
Business
General
Technitrol, Inc. is a global producer of precision-engineered electronic components and electrical contact products and materials. We sometimes refer to Technitrol, Inc. as “Technitrol”, “we” or “our”. We believe we are a leading global producer of these products and materials in the primary markets we serve, based on our estimates of the size of our primary markets in annual revenues and our share of those markets relative to our competitors. Our electronic components are used in virtually all types of electronic products to manage and regulate electronic signals and power. Our electrical contact products and materials are used in any device in which the continuation or interruption of electrical currents is necessary. In each case, our products are critical to the functioning of the end product.
Our world-class design and manufacturing capabilities, together with the breadth of our product offerings, provide us with a competitive advantage that enables us to anticipate and deliver highly-customized solutions for our customers’ product needs. In addition, our global presence enables us to participate in many relevant product and geographic markets and provides us with proximity to our global customer base. This allows us to better understand and more easily satisfy our customers’ unique design and product requirements.
We operate our business in two distinct segments: the electronic components segment, which operates under the name Electronics, and the electrical contact products segment, which operates under the name Electrical. Electronics and Electrical are known in their primary markets as Pulse and AMI Doduco, respectively.
We incorporated in Pennsylvania on April 10, 1947 and we are headquartered in Trevose, Pennsylvania. Our mailing address is 1210 Northbrook Drive, Suite 470, Trevose, PA 19053-8406, and our telephone number is 215-355-2900. Our website is www.technitrol.com.
Electronics
Electronics designs and manufactures a wide variety of highly-customized electronic components and modules. Many of these components and modules capture wireless communication signals, filter out radio frequency interference, adjust and ensure proper current and voltage and activate certain automotive functions. These products are often referred to as antennas, chokes, inductors, filters, transformers and coils. Electronics sells its products primarily to multinational original equipment manufacturers, contract manufacturers and distributors.
We sometimes refer to the Electronics business, excluding products made by factories which we acquired in the Full Rise Electronic Co., Ltd. (“FRE”) acquisition in 2004, the LK Products Oy (“LK”) acquisition in 2005, the ERA Group (“ERA”) and Larsen Group (“Larsen”) acquisitions in 2006, as the wirewound magnetics division. We refer to LK, together with certain assets that we acquired with Larsen and FRE, as the antenna division. We refer to the automotive coils of ERA as the automotive division.
•
routers;
•
televisions and DVD players;
•
laptop computers;
•
video game consoles;
•
voice over internet equipment; and
•
automotive drivetrains.
Electronics’ products are generally characterized by relatively short life cycles and rapid technological change, allowing us to utilize our design and engineering expertise to meet our customers’ constantly evolving needs. We believe that the industries served by Electronics have been, and will continue to be, characterized by ongoing product innovation that will drive growth in the electronic components industry.
Electronics generated $671.6 million, or 65.4% our revenues, for the year ended December 28, 2007, and $627.5 million, or 65.8% of our revenues, for the year ended December 29, 2006. Note 19 to the consolidated financial statements contains additional segment information.
Electrical
Electrical is the only global manufacturer which produces a full array of precious metal electrical contact products that range from materials used in the fabrication of electrical contacts to completed contact subassemblies. Contact products complete or interrupt electrical circuits in virtually every electrical device. Electrical provides its customers with a broad array of highly engineered products and tools designed to meet unique customer needs. Electrical sells products primarily to multinational original equipment manufacturers.
Electrical’s products are generally characterized by longer life cycles and slower technological change than those of Electronics. We believe that technological developments in some of the industries served by Electrical, particularly in the electric power, appliance and automotive industries, along with opportunities arising from customer outsourcing and consolidation of the electrical contact industry, present growth opportunities for Electrical.
Electrical generated $355.0 million, or 34.6% of our revenues, for the year ended December 28, 2007, and $326.6 million, or 34.2% of our revenues, for the year December 29, 2006. Note 19 to the consolidated financial statements contains additional segment information.
In 2005, we received approximately $6.7 million for the sale of Electrical’s bimetal and metal cladding operations. We have reflected the results of the bimetal and metal cladding operations as discontinued operations on the Consolidated Statements of Operations for all periods presented.
Products
Electronics designs and manufactures a wide array of electronic components and modules. These products are highly-customized to address our customers’ needs. The following table contains a list of some of Electronics’ key products:
Primary Products
Function
Application
Internal handset antenna and handset antenna modules
Captures communications signals in mobile handsets, personal digital assistants and notebook computers
Cell phones, other mobile terminal and information devices
Mobile and portable antennas
Transmit non-cellular signals
Global positioning systems, automotive antennas and machine to machine communication
Discrete filter or choke
Separates high and low frequency signals
Network switches, routers, hubs and personal computers
Phone, fax and alarm systems used with digital subscriber lines, or DSL
Filtered connector, which combines a filter with a connector and stand alone connector products
Removes interference, or noise, from circuitry and connects electronic applications
Local area networks, or LANs, and wide area networks, or WANs, equipment for personal computers and video game consoles
Inductor/chip inductor
Regulates electrical current under conditions of varying load
AC/DC & DC/DC power supplies
Mobile phones and portable devices
Power transformer
Modifies circuit voltage
AC/DC & DC/DC power supplies
Signal transformer
Limits distortion of signal as it passes from one medium to another
Analog circuitry
Military/aerospace navigation and weapon guidance systems
Automotive ignition coils
Provides power for automotive ignition
Ignition systems for automotive gasoline engines
Other automotive coils
Provides power for a variety of automotive electronic functions
Automotive management systems such as safety, communication, navigation, fuel efficiency and emissions control
Electrical designs and manufactures a wide array of contact materials, parts and completed contact subassemblies. The following table contains a list of some of Electrical’s key products:
Primary Products
Function
Application
Contact prematerial such as wire and metal tapes
Raw materials
Made into our customers’ and competitors’ electrical contact parts
Electrical contact parts, either discrete or affixed to precision stamped parts
Complete or interrupt an electrical circuit
Electrical switches, relays, circuit breakers and motor controls
Component subassemblies
Integrate contact with precision stampings and plastic housings
Sensors and control devices
Sales, Marketing and Distribution
Electronics and Electrical sell products predominantly through separate worldwide direct sales forces. Given the highly technical nature of our customers’ needs, our direct salespeople typically team up with members of our engineering staff to discuss a sale with a customer’s purchasing and engineering personnel. During the sales process, there is close interaction between our engineers and those in our customers’ organizations. This interaction extends throughout a product’s life cycle, engendering strong customer relationships. As of December 28, 2007, Electronics had approximately 73 salespeople and 10 sales offices worldwide and Electrical had approximately 32 salespeople and 7 sales offices worldwide.
We provide technical and sales support for our direct and indirect sales force. We believe that our coordinated sales effort provides a high level of market penetration and efficient coverage of our customers on a cost-effective basis.
Customers and End Markets
We sell our products and services to original equipment manufacturers and original design manufacturers, which design, build and market end-user products. Electronics also sells its products to contract electronic manufacturers. We sometimes refer to original equipment manufacturers as “OEMs”, original design manufacturers as “ODMs” and contract equipment manufacturers as “CEMs.” ODMs contract with OEMs to design the OEMs products. CEMs contract with OEMs to manufacture the OEM’s products. Many OEMs use CEMs primarily or exclusively to build their products. Independent distributors sell components and materials to both OEMs and CEMs. Nonetheless, OEMs generally control the decision as to which component designs best meet their needs. Accordingly, we consider OEMs to be customers for our products even if they design products through ODMs or purchase our products through CEMs or independent distributors. In order to maximize our sales opportunities, Electronics’ engineering and sales teams maintain close relationships with OEMs, ODMs, CEMs and distributors.
For the year ended December 28, 2007, one customer of Electronics accounted for more than 10% of our consolidated net sales. In the year ended December 29, 2006, no single customer accounted for more than 10% of our consolidated net sales. However, a group of affiliated customers, when aggregated, were greater than 10%. These customers are a major cell phone manufacturer and a CEM for the cell phone manufacturer. Sales to our ten largest customers accounted for 47.5% of net sales for the year ended December 28, 2007 and 38.0% of net sales for the year ended December 29, 2006.
An increasing percentage of our sales in recent years has been outside of the United States. For the year ended December 28, 2007, 88.1% of our net sales were outside of the United States. During the years ended December 29, 2006 and December 30, 2005, 86.9% and 83.7%, respectively, of our net sales were to customers outside of the United States. Sales made by Electronics to its customers outside the United States accounted for 89.4% of its net sales for the year ended December 28, 2007, 89.6% of its net sales for the year ended December 29, 2006 and 85.2% for the year ended December 30, 2005. Sales made by Electrical to its customers outside the United States accounted for 85.8% of its net sales for the year ended December 28, 2007, 81.8% of its net sales for the year ended December 29, 2006 and 81.6% of its net sales for the year ended December 30, 2005.
Manufacturing
We have developed our manufacturing processes in ways intended to maximize our profitability. Accordingly, the manufacturing of Electronics’ wirewound magnetics products tends to be labor intensive and highly variable. This model enables us to increase and decrease production rapidly to contain costs during slower periods, reflecting the relatively greater degree of cyclicality in these product lines. Conversely, the Electronics antenna and automotive divisions’ manufacturing plants are highly mechanized or, in some cases, automated and therefore very sensitive to the volume of production. These product lines tend to be less cyclical than those of wirewound magnetics. Electrical’s products tend to have longer life cycles and longer time to market. As a result, we have automated or mechanized many functions at Electrical’s facilities and vertically integrated our products in an attempt to utilize all of our manufacturing capabilities to create products that are higher value added and at a lower cost.
Generally, our engineers design products to meet our customers’ product needs and then we mass-produce the products once a contract is awarded by, or orders are received from, our customer. To a much lesser extent, we also service customers that design their own components and outsource production of these components to us. We then build the components to the customer’s design.
The absolute productive capacity of our facilities is difficult to quantify due to the continually changing extent of utilization. In any facility, maximum capacity and utilization vary periodically depending on the segment’s manufacturing strategies, the product being manufactured, current market conditions and customer demand. Therefore, we cannot accurately estimate our utilization of overall production capacity at a given time.
Research, Development and Engineering
Our research, development and engineering efforts are focused on the design and development of innovative products in collaboration with our customers. We work closely with OEMs and ODMs to identify their design and engineering requirements. We maintain strategically located design centers throughout the world where proximity to customers enables us to better understand and more readily satisfy their design and engineering needs. Our design process is a disciplined and orderly process that uses a product data management system to track the level of design activity enabling us to manage and improve how our engineers design products. We typically own the customized designs used to make products.
Electronics’ research, development and engineering expenditures were $35.1 million for the year ended December 28, 2007, $35.0 million for the year ended December 29, 2006 and $21.4 million for the year ended December 30, 2005. The increase at Electronics over the past three years is primarily due to the inclusion of development and engineering expenditures of acquired companies since the date of acquisition. Electrical’s research, development and engineering expenditures were $5.3 million for the year ended December 28, 2007, $4.6 million for the year ended December 29, 2006 and $4.1 million for the year ended December 30, 2005. Over the past three years, Electrical has invested in research, development and engineering in order to improve our technological expertise and focus on product development. We intend to continue investing in personnel and new technologies so that our consolidated net sales will be positively impacted by factors such as improved product performance and a broader product portfolio.
Competition
We believe we are a market leader in the primary markets we serve based on our estimates of the size of those markets in annual revenues and our share of those markets relative to our competitors. We do not believe that any one company competes with all of the product lines of either Electronics or Electrical on a global basis. However, both Electronics and Electrical frequently encounter strong competition within individual product lines, both domestically and internationally. In addition, several OEMs internally, or through CEMs, manufacture some of the products offered by Electronics and Electrical. We believe that this represents an opportunity to capture additional market share as OEMs decide to outsource component manufacturing. Therefore, we constantly work to identify these opportunities and to convince these OEMs that our economies of scale, purchasing power and manufacturing core competencies enable us to produce these products more efficiently. Increasingly, Electronics’ competitors are located in Asia and enjoy very low cost structures and very low cost of capital. Many of these competitors aggressively seek market share at the detriment of profits.
We believe we are competitive in each of these factors. Product quality and reliability, as well as design and manufacturing capabilities, are enhanced through our commitment to continually invest in and improve our manufacturing and designing resources and our close relationships with our customers’ engineers. The breadth of our product offering provides customers with the ability to satisfy their entire electronic component or electrical contact needs through one supplier. Our global presence enables us to deepen our relationship with our customers and to better understand and more easily satisfy the needs of local markets. In addition, our ability to purchase raw materials in large quantities and our focus on continually reducing our production expenses reduces our manufacturing costs and enables us to price our products competitively.
Employees
As of December 28, 2007, we had approximately 26,100 full-time employees as compared to 28,100 as of December 29, 2006. The number of employees at year-end includes employees of certain subcontractors that are integral to our operations in the People’s Republic of China (“PRC” or “China”). Such employees numbered approximately 14,100 and 17,000 as of December 28, 2007 and December 29, 2006, respectively. The decrease in employees from 2006 to 2007 was primarily the result of higher voluntary terminations of hourly employees in the PRC during December 2007 as compared to December 2006. We believe this increase in voluntary terminations was also experienced by other companies with manufacturing operations in the PRC. Of the 26,100 full-time employees, approximately 700 were located in the United States. There are no employees in the United States covered by collective-bargaining agreements. We have not experienced any major work stoppages and consider our relations with our employees to be good.
Raw Materials
Currently, we do not have significant difficulty obtaining any of our raw materials and do not anticipate that we will face any significant difficulties in the near future. However, many of the raw materials we use are considered commodities, such as copper, tungsten, nickel, silver and gold, and the market prices of a number of these commodities have been volatile in the last several years. Although we are not dependent on any one particular source of supply, several of our raw materials are sold by a limited number of suppliers, which could affect the price of these materials. Should prices rise or a shortage occur in any necessary raw material, our manufacturing costs will likely increase, which may result in lower margins if we are unable to pass along the price increases to our customers.
Electrical uses precious metals, primarily silver, in manufacturing many of its electrical contacts, contact materials and contact subassemblies. Historically, we have leased or held these precious metals through consignment arrangements with our suppliers. Leasing and consignment costs have historically been substantially below the costs to borrow funds to purchase the metals and these arrangements eliminate the effect of fluctuations in the market price associated with owned precious metal. Electrical’s terms of sale generally allow us to charge customers for the fabricated market value of silver on the day after we ship the silver bearing product to the customer. See additional discussions of precious metals beginning on page 21.
Backlog
Our backlog of orders at December 28, 2007 was $94.8 million compared to $115.1 million at December 29, 2006. We expect to ship the majority of the backlog over the next six months. Customers can cancel orders at any time, sometimes requiring a payment of cancellation charges. We do not believe that our backlog is an accurate indicator of near-term business activity because short lead times, increased use of vendor managed inventory and other similar consignment type arrangements tend to distort the significance of backlog. Orders from these arrangements typically are not reflected in backlog.
Intellectual Property
We own many patents and have acquired the use of patents of others under license agreements, which impose restrictions on other’s ability to utilize the intellectual property. We seek to limit disclosure of our intellectual property by requiring employees and consultants with access to our proprietary information to enter into confidentiality agreements with us and by restricting access to our proprietary information.
Existing legal protections afford only limited protection for our products. For example, others may independently develop similar or competing products or attempt to copy or use aspects of our products that we regard as proprietary. Furthermore, intellectual property law may not fully protect products or technology that we consider to be our own, and claims of intellectual property infringement may be asserted against us or against our customers in connection with their use of our products.
While our intellectual property is important to us in the aggregate, we do not believe any individual patent, trademark, or license is material to our business or operations.
Environmental
Our manufacturing operations are subject to a variety of local, state, federal, and international environmental laws and regulations governing air emissions, wastewater discharges, the storage, use, handling, disposal and remediation of hazardous substances and wastes and employee health and safety. It is our policy to meet or exceed the environmental standards set by these laws. However, in the normal course of business, environmental issues may arise. We may incur increased costs associated with environmental compliance and cleanup projects necessitated by the identification of new environmental issues or new environmental laws and regulations.
Available Information
We make available free of charge on our website, www.technitrol.com, all materials that we file electronically with the Securities and Exchange Commission (“SEC”), including our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports and all Board and Committee charters, as soon as reasonably practicable after we electronically file or furnish such materials to the SEC.
Item 1a
Item 1a
Risk Factors
Factors That May Affect Our Future Results (Cautionary Statements for Purposes of the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995)
Our disclosures and analysis in this report contain forward-looking statements. Forward-looking statements reflect our current expectations of future events or future financial performance. You can identify these statements by the fact that they do not relate strictly to historical or current facts. They often use words such as “anticipate”, “estimate”, “expect”, “project”, “intend”, “plan”, “believe”, and similar terms. These forward-looking statements are based on our current plans and expectations.
Any or all of our forward-looking statements in this report may prove to be incorrect. They may be affected by inaccurate assumptions we might make or by risks and uncertainties which are either unknown or not fully known or understood. Accordingly, actual outcomes and results may differ materially from what is expressed or forecasted in this report.
We sometimes provide forecasts of future financial performance. The risks and uncertainties described under “Risk Factors” as well as other risks identified from time to time in other Securities and Exchange Commission reports, registration statements and public announcements, among others, should be considered in evaluating our prospects for the future. We undertake no obligation to release updates or revisions to any forward-looking statement, whether as a result of new information, future events or otherwise.
The following factors represent what we believe are the major risks and uncertainties in our business. They are listed in no particular order.
Cyclical changes in the markets we serve could result in a significant decrease in demand for our products and reduce our profitability.
Our components are used in various products for the electronic and electrical markets. These markets are cyclical. Generally, the demand for our components reflects the demand for products in the electronic and electrical equipment markets. A contraction in demand would result in a decrease in sales of our products, as our customers:
•
may cancel many existing orders;
•
may introduce fewer new products;
•
may discontinue current products; and
•
may decrease their inventory levels.
A decrease in demand for our products would have a significant adverse effect on our operating results and profitability. Accordingly, we may experience volatility in both our revenues and profits.
Reduced prices for our products may adversely affect our profit margins if we are unable to reduce our costs of production.
The average selling prices for our products tend to decrease over their life cycle. In addition, foreign currency movements and the desire to retain market share increase the pressure on our customers to seek lower prices from their suppliers. As a result, our customers are likely to continue to demand lower prices from us. To maintain our margins and remain profitable, we must continue to meet our customers’ design needs while reducing costs through efficient raw material procurement and process and product improvements. Our profit margins will suffer if we are unable to reduce our costs of production as sales prices decline.
An inability to adequately respond to changes in technology, applicable standards or customer needs may decrease our sales.
Electronics operates in an industry characterized by rapid change caused by the frequent emergence of new technologies and standards. Generally, we expect life cycles for our products in the electronic components industry to be relatively short. This requires us to anticipate and respond rapidly to changes in industry standards and customer needs and to develop and introduce new and enhanced products on a timely and cost effective basis. Our engineering and development teams place a priority on working closely with our customers to design innovative products and improve our manufacturing processes. Similarly, at Electrical, the performance and cost of electrical contacts are closely linked to alloys used in their production. Improving performance and reducing costs for our customers requires continuing
development of new alloys and products. Our inability to react to changes in technology, standards or customer needs quickly and efficiently may decrease our sales or margins.
If our inventories become obsolete, our future performance and operating results will be adversely affected.
The life cycles of our products depend heavily upon the life cycles of the end products into which our products are designed. Many of Electronics’ products have very short life cycles which are measured in quarters. Products with short life cycles require us to closely manage our production and inventory levels. Inventory may become obsolete because of adverse changes in end market demand. During market slowdowns, this may result in significant charges for inventory write-offs. Our future operating results may be adversely affected by material levels of obsolete or excess inventories.
An inability to capitalize on our recent or future acquisitions may adversely affect our business.
We have completed several acquisitions in recent years. We continually seek acquisitions to grow our business. We may fail to derive significant benefits from our acquisitions. In addition, if we fail to achieve sufficient financial performance from an acquisition, long-lived assets, such as property, plant and equipment, goodwill and other intangibles, could become impaired, resulting in our recognition of an impairment loss.
The success of any of our acquisitions depends on our ability to:
•
successfully execute the integration or consolidation of the acquired operations into our existing businesses;
•
develop or modify the financial reporting and information systems of the acquired entity to ensure overall financial integrity and adequacy of internal control procedures;
•
identify and take advantage of cost reduction opportunities; and
•
further penetrate the markets for the product capabilities acquired.
Integration of acquisitions may take longer than we expect and may never be achieved to the extent originally anticipated. This could result in lower than anticipated business growth or higher than anticipated costs. In addition, acquisitions may:
•
cause a disruption in our ongoing business;
•
distract our managers;
•
unduly burden our other resources; and
•
result in an inability to maintain our historical standards, procedures and controls, which may result in non-compliance with external laws and regulations.
Integration of acquisitions into the acquiring segment may limit the ability of investors to track the performance of individual acquisitions and to analyze trends in our operating results.
Our historical practice has been to rapidly integrate acquisitions into the existing business of the acquiring segment and to report financial performance on the segment level. As a result of this practice, we do not separately track the standalone performance of acquisitions after the date of the transaction. Consequently, investors cannot quantify the financial performance and success of any individual acquisition or the financial performance and success of a particular segment excluding the impact of acquisitions. In addition, our practice of rapidly integrating acquisitions into the financial performance of each segment may limit the ability of investors to analyze any trends in our operating results over time.
An inability to identify, consummate or integrate acquisitions may slow our future growth.
We plan to continue to identify and consummate additional acquisitions to further diversify our business and to penetrate important markets. We may not be able to identify suitable acquisition candidates at reasonable prices. Even if we identify promising acquisition candidates, the timing, price, structure and success of future acquisitions are uncertain. An inability to consummate or integrate attractive acquisitions may reduce our growth rate and our ability to penetrate new markets.
If our customers terminate their existing agreements, or do not enter into new agreements or submit additional purchase orders for our products, our business will suffer.
Most of our sales are made on a purchase order basis, as needed by our customers. In addition, to the extent we have agreements in place with our customers, most of these agreements are either short term in nature or provide our
customers with the ability to terminate the arrangement with little or no prior notice. Such agreements typically do not provide us with any material recourse in the event of non-renewal or early termination. We will lose business and our revenues will decrease if a significant number of customers:
•
do not submit additional purchase orders;
•
do not enter into new agreements with us; or
•
elect to terminate their relationship with us.
If we do not effectively manage our business in the face of fluctuations in the size of our organization, our business may be disrupted.
We have grown both organically and as a result of acquisitions. However, we significantly reduce or expand our workforce and facilities in response to rapid changes in demand for our products due to prevailing global market conditions. These rapid fluctuations place strains on our resources and systems. If we do not effectively manage our resources and systems, our businesses may be adversely affected.
Uncertainty in demand for our products may result in increased costs of production, an inability to service our customers, or higher inventory levels which may adversely affect our results of operations and financial condition.
We have very little visibility into our customers’ future purchasing patterns and are highly dependent on our customers’ forecasts. These forecasts are non-binding and often highly unreliable. Given the fluctuation in growth rates and cyclical demand for our products, as well as our reliance on often-imprecise customer forecasts, it is difficult to accurately manage our production schedule, equipment and personnel needs and our raw material and working capital requirements.
Our failure to effectively manage these issues may result in:
•
production delays;
•
increased costs of production;
•
excessive inventory levels and reduced financial liquidity;
•
an inability to make timely deliveries; and
•
a decrease in profits.
A decrease in availability of our key raw materials could adversely affect our profit margins.
We use several types of raw materials in the manufacturing of our products, including:
•
precious metals such as silver;
•
other base metals such as copper and brass; and
•
ferrite cores.
Some of these materials are produced by a limited number of suppliers. We may be unable to obtain these raw materials in sufficient quantities or in a timely manner to meet the demand for our products. The lack of availability or a delay in obtaining any of the raw materials used in our products could adversely affect our manufacturing costs and profit margins. In addition, if the price of our raw materials increases significantly over a short period of time due to increased market demand or shortage of supply, customers may be unwilling to bear the increased price for our products and we may be forced to sell our products containing these materials at prices that reduce our profit margins.
Costs associated with precious metals and base metals may not be recoverable.
Some of our raw materials, such as precious metals and certain base metals, are considered commodities and are subject to price volatility. We attempt to limit our exposure to fluctuations in the cost of precious materials, including silver, by holding the majority of our precious metal inventory through leasing or consignment arrangements with our suppliers. We then typically purchase the precious metal from our supplier at the current market price on the day after shipment to our customer and pass this cost on to our customer. We try to limit our exposure to base metal price fluctuations by attempting to pass through the cost of base metals to our customers, typically by indexing the cost of the base metal, so that our cost of the base metal closely relates to the price we charge our customers, but we may not always be successful in indexing these costs or fully passing through costs to our customers.
Leasing/consignment fee increases are primarily caused by increases in interest rates or volatility in the price of the consigned material. Fees charged by the consignor are driven by interest rates and the market price of the consigned
material. The market price of the consigned material is determined by the supply of, and the demand for, the material. Consignment fees may increase if interest rates or the price of the consigned material increase.
Our results of operations and liquidity will be negatively impacted if:
•
we are unable to enter into new leasing or consignment arrangements with similarly favorable terms after our existing agreements terminate;
•
our leasing or consignment fees increase significantly in a short period of time and we are unable to recover these increased costs through higher sale prices; and
•
we are unable to pass through higher base metals costs to our customers.
Competition may result in lower prices for our products and reduced sales.
Both Electronics and Electrical frequently encounter strong competition within individual product lines from various competitors throughout the world. We compete principally on the basis of:
•
product quality and reliability;
•
global design and manufacturing capabilities;
•
breadth of product line;
•
customer service;
•
price; and
•
on-time delivery.
Our inability to successfully compete on any or all of the above factors may result in reduced sales.
Fluctuations in foreign currency exchange rates may adversely affect our operating results.
We manufacture and sell our products in various regions of the world and export and import these products to and from a large number of countries. Fluctuations in exchange rates could negatively impact our cost of production and sales which, in turn, could decrease our operating results and cash flow. In addition, if the functional currency of our manufacturing costs strengthened compared to the functional currency of our competitors’ manufacturing costs, our products may become more costly than our competitors’. Although we engage in limited hedging transactions, including foreign currency contracts, to reduce our transaction and economic exposure to foreign currency fluctuations, these measures may not eliminate or substantially reduce our risk in the future.
Our international operations subject us to the risks of unfavorable political, regulatory, labor and tax conditions in other countries.
We manufacture and assemble most of our products in locations outside the United States, including China, Mexico and Tunisia and a majority of our revenues are derived from sales to customers outside the United States. Our future operations and earnings may be adversely affected by the risks related to, or any other problems arising from, operating in international locations and markets.
Risks inherent in doing business internationally may include:
•
the inability to repatriate cash on a timely basis;
•
economic and political instability;
•
expropriation and nationalization;
•
trade restrictions;
•
capital and exchange control programs;
•
transportation delays;
•
foreign currency fluctuations; and
•
unexpected changes in the laws and policies of the United States or of the countries in which we manufacture and sell our products.
Electronics has the majority of its non-automotive manufacturing operations in the PRC. Our presence in the PRC has enabled Electronics to maintain lower manufacturing costs and to adjust our work force to demand levels for our products. Although the PRC has a large and growing economy, the potential economic, political, legal and labor developments entail uncertainties and risks. For example, wages have been increasing over the last several years in the southern coastal provinces. While the PRC has been receptive to foreign investment, we cannot be certain that its current policies will continue indefinitely into the future. In the event of any changes that adversely affect our ability to
conduct our operations within the PRC, our businesses may suffer. We also have manufacturing operations in Tunisia and Mexico, which are subject to unique risks, including earthquakes in Tunisia and those associated with Middle Eastern and Mexican geo-political events.
We have benefited over recent years from favorable tax treatment as a result of our international operations. We operate in countries where we realize favorable income tax treatment relative to the U.S. statutory rate. We have also been granted special tax incentives commonly known as tax holidays in countries such as the PRC and Tunisia. This favorable situation could change if these countries were to increase rates or discontinue the special tax incentives, or if we discontinue our manufacturing operations in any of these countries and do not replace the operations with operations in other locations with similar tax incentives. For example, the withholding tax rate on dividend payments from most of our PRC subsidiaries is expected to be 5% starting in 2008. In addition, the corporate income tax rate for PRC companies will be 15% or 25% after the applicable holiday and transition period expire, depending on whether the company qualifies as a high-technology company or meets other conditions. Accordingly, in the event of changes in laws and regulations affecting our international operations, we may not be able to continue to take advantage of similar benefits in the future.
Shifting our operations between regions may entail considerable expense.
In the past we have shifted our operations from one region to another in order to maximize manufacturing and operational efficiency. We may close one or more additional factories in the future. This could entail significant one-time earnings charges to account for severance, long-lived asset impairments, write-offs, write downs and moving expenses, as well as certain adverse tax consequences including the loss of specialized tax incentives or non-deductible expenses. In addition, as we implement transfers of our operations we may experience disruptions, including strikes or other types of labor unrest resulting from layoffs or termination of employees.
Liquidity requirements could necessitate movements of existing cash balances which may be subject to restrictions or cause unfavorable tax and earnings consequences.
A significant portion of our cash is held offshore by our international subsidiaries and is predominantly denominated in currencies other than the U.S. dollar. While we intend to use a significant amount of the cash held overseas to fund our international operations and growth, if we encounter a significant domestic need for liquidity that we cannot fulfill through borrowings, equity offerings, or other internal or external sources, we may experience unfavorable tax and earnings consequences if this cash is transferred to the United States. These adverse consequences would occur if the transfer of cash into the United States is taxed and no offsetting foreign tax credit is available to offset the U.S. tax liability, resulting in lower earnings. In addition, we may be prohibited from transferring cash from the PRC. For example, foreign exchange ceilings imposed by local governments and sometimes lengthy approval processes which foreign governments require for international cash transfers may delay our internal cash transfers from time to time. We have not experienced any significant liquidity restrictions in any country in which we operate and none are presently foreseen.
With the exception of approximately $25.1 million of retained earnings as of December 28, 2007 in primarily the PRC that are restricted in accordance with the PRC Foreign Investment Enterprises Law, substantially all retained earnings are free from legal or contractual restrictions. This law restricts 10% of our net earnings in the PRC, up to a maximum amount equal to 50% of the total capital we have invested in the PRC.
Losing the services of our executive officers or our other highly qualified and experienced employees could adversely affect our business.
Our success depends upon the continued contributions of our executive officers and management, many of whom have many years of experience and would be extremely difficult to replace. We must also attract and maintain experienced and highly skilled engineering, sales and marketing and managerial personnel. Competition for qualified personnel is intense in our industries, and we may not be successful in hiring and retaining these people. If we lose the services of our executive officers or cannot attract and retain other qualified personnel, our businesses could be adversely affected.
Public health epidemics (such as flu strains, or severe acute respiratory syndrome) or other natural disasters (such as earthquakes or fires) may disrupt operations in affected regions and affect operating results.
Electronics and, to a lesser extent, Electrical, maintain extensive manufacturing operations in the PRC and other emerging economies, as do many of our customers and suppliers. A sustained interruption of our manufacturing operations, or those of our customers or suppliers, resulting from complications caused by a public health epidemic or other natural disasters could have a material adverse effect on our business and results of operations.
The unavailability of insurance against certain business risks may adversely affect our future operating results.
As part of our comprehensive risk management program, we purchase insurance coverage against certain business risks. If any of our insurance carriers discontinues an insurance policy or significantly reduces available coverage or increases in the deductibles and we cannot find another insurance carrier to write comparable coverage at similar costs, we may be subject to increased costs of uninsured losses which may adversely affect our operating results.
Environmental liability and compliance obligations may affect our operations and results.
Our manufacturing operations are subject to a variety of environmental laws and regulations as well as internal programs and policies governing:
•
air emissions;
•
wastewater discharges;
•
the storage, use, handling, disposal and remediation of hazardous substances, wastes and chemicals; and
•
employee health and safety.
If violations of environmental laws should occur, we could be held liable for damages, penalties, fines and remedial actions for contamination discovered at our present or former facilities. Our operations and results could be adversely affected by any material obligations arising from existing laws or new regulations that may be enacted in the future. We may also be held liable for past disposal of hazardous substances generated by our business or businesses we acquire.
An increase in our debt levels could adversely affect our financial position, liquidity and perception of our financial condition in the financial markets.
We entered into an agreement on January 8, 2008 with JPMorgan Chase Bank, N.A. and J.P. Morgan Securities, Inc. to arrange and syndicate a $200.0 million senior term loan facility and a $300.0 million senior revolving credit facility. The principal purpose of this agreement, which is expected to close at the end of February 2008, is to fund the acquisition of Sonion A/S. Borrowing against this agreement will increase our outstanding debt. Because this financing will decrease our ratio of earnings to fixed charges and adversely affect other leverage criteria, the marketplace could react negatively to our new debt levels, which in turn could affect our share price. Covenants with our lenders under this agreement, that require our compliance with specific financial ratios, may also make it difficult for us to obtain additional financing on acceptable terms for future acquisitions and other corporate needs. Although at present we anticipate no difficulty in meeting such covenants in the normal course of operations, our ability to remain in compliance with the covenants may be adversely affected by future events beyond our control. If we breach any of these covenants, than we may be declared to be in default. This may result in our lenders electing to declare our outstanding borrowings immediately due and payable and terminate all commitments to extend further credit. If the lenders accelerate the repayment of borrowings, we cannot provide assurance that we will have sufficient assets to repay our credit facilities and other indebtedness. See “Liquidity and Capital Resources” in Item 7.
Our results may be negatively affected by changing interest rates.
We are subject to market risk from exposure to changes in interest rates. We do not expect changes in interest rates to have a material effect on income or cash flows in the future, although there can be no assurances that interest rates will not significantly change. To address the risk of changing interest rates, we may utilize derivatives or other financial instruments.
Item 1b
Item 9a
Controls and Procedures
Controls and Procedures
Based on their evaluation as of December 28, 2007, our Chief Executive Officer and Chief Financial Officer, have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) were effective to ensure that information required to be disclosed by us in the reports that we file or submit is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Act is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended). Our management assessed the effectiveness of our internal control over financial reporting as of December 28, 2007. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. Our management has concluded that, as of December 28, 2007, our internal control over financial reporting is effective based on these criteria. Our independent registered public accounting firm has issued an audit report on the effectiveness of our internal control over financial reporting, which is included herein.
There were no changes in our internal controls over financial reporting during the quarter ended December 28, 2007 that have materially affected, or are reasonably likely to materially affect our internal controls over financial reporting.
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Technitrol, Inc. have been detected.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Technitrol, Inc.:
We have audited Technitrol, Inc. and subsidiaries’ internal control over financial reporting as of December 28, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Technitrol, Inc. and subsidiaries’ 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 Management’s Report 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, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included 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 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 its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that 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, Technitrol, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 28, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Technitrol, Inc. and subsidiaries as of December 28, 2007 and December 29, 2006, and the related consolidated statements of operations, cash flows, and shareholders’ equity for each of the years in the three-year period ended December 28, 2007, and our report dated February 25, 2008 expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
Philadelphia, Pennsylvania
February 25, 2008
Item 9b