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| SHLO > SEC Filings for SHLO > Form 10-K on 20-Dec-2007 | All Recent SEC Filings |
20-Dec-2007
Annual Report
(Dollar amounts in thousands)
Sustainable Business Model
The following narrative, which includes, among other things, a description of the results of operations of the Company for fiscal 2007 compared to fiscal 2006 and fiscal 2006 compared to fiscal 2005, reports significant variations and improvements in the Company's results since 2002 and prior, except for several unusual events in fiscal 2006 related to asset impairment, restructuring, and resolution of several contingencies. These results are the outcome of instituting a new sustainable business model for the Company built upon the concepts of process characterization and process optimization throughout the organization. Process characterization is based on self-analysis of the business processes of the Company by the process owners, who are the people in the organization responsible for the success or failure of that process. Process optimization represents the response to seeking a way to perform a business process in a more productive or efficient manner. Logically applying these steps requires establishing priorities in order that the most serious and rewarding issues are addressed sooner rather than later. Examples of the application of the concepts of process characterization and process optimization include identifying and overcoming causes of equipment downtime, reducing die changeover time, coil yield analysis, and obstacles to the accurate transmission of electronic data interchange.
The objective of instituting these concepts was to stabilize the Company and to achieve quality and productivity improvements in all processes of the Company's business, including plant operations and administrative functions. Since inception of the new business model in mid-year of fiscal 2002, the Company has been exiting unprofitable and non-strategic businesses and products and has achieved manufacturing cost reductions, launched new products, improved gross margins and reduced administrative costs. These efforts have led to improved working capital management and reduced cash requirements as well as contributed to positive cash generation and debt reduction.
During fiscal 2003, once stabilized, the Company began the process of renewal, capitalizing on its key capabilities. This phase continued throughout 2004. Fiscal 2005 began with the renewal phase continuing and leading to an emphasis on profitable growth during 2005 and beyond. The application of the Company's sustainable business model continued to be the focus of the Company's management for fiscal 2007. As noted below under "Forward-Looking Statements," the future success of the Company depends upon, among other factors, continuing to successfully institute this strategic initiative.
General
The Company is a supplier of numerous parts to both automobile OEMs and, as a Tier II supplier, to Tier I automotive part manufacturers who in turn supply OEMs. The parts that the Company produces supply many models of vehicles manufactured by nearly all vehicle manufacturers that produce vehicles in North America. As a result, the Company's revenues are very dependent upon the North American production of automobiles and light trucks, particularly traditional domestic manufacturers, such as General Motors, Chrysler and Ford. According to industry statistics, traditional domestic manufacturer production for fiscal 2007 declined by 5.9% and total North American car and light truck production for fiscal 2007 declined 2.1% from the production of fiscal 2006.
Another significant factor affecting the Company's revenues is the Company's ability to successfully bid on the production and supply of parts for models that will be newly introduced to the market by the Company's customers. These new model introductions typically go through a start of production phase with build levels that are higher than normal because the consumer supply network is filled to ensure adequate supply to the market, resulting in an increase in the Company's revenues at the beginning of the cycle.
Plant utilization levels are very important to profitability because of the capital-intensive nature of these operations. At October 31, 2007, the Company's facilities were operating at approximately 52.5% capacity. The
Company defines capacity as 20 working hours per day and five days per week. Utilization of capacity is dependent upon the releases against customer purchase orders that are used to establish production schedules and manpower and equipment requirements for each month and quarterly period of the fiscal year.
The majority of the Company's stamping and engineered welded blank operations purchase steel through the customers' steel programs. Under these programs, the Company pays the steel suppliers and passes on to the customers the steel price the customers negotiated with the steel suppliers. Although the Company takes ownership of the steel, the customers are responsible for all steel price fluctuations. The Company also purchases steel directly from domestic primary steel producers and steel service centers. Domestic steel pricing has generally been increasing recently for several reasons, including consolidation of supply, capacity restraints, higher raw material costs and the fluctuations of the U.S. dollar in relation to foreign currencies. Finally, the Company blanks and processes steel for some of its customers on a toll processing basis. Under these arrangements, the Company charges a tolling fee for the operations that it performs without acquiring ownership of the steel and being burdened with the attendant costs of ownership and risk of loss. Toll processing operations result in lower revenues but higher gross margins than operations where the Company takes ownership of the steel. Revenues from operations involving directly owned steel include a component of raw material cost whereas toll processing revenues do not.
Changes in the price of scrap steel can have a significant effect on the Company's results of operations because substantially all of its operations generate engineered scrap steel. Engineered scrap steel is a planned by-product of the Company's processing operations, and proceeds from the disposition of scrap steel contribute to gross margin by offsetting the increases in the cost of steel and the attendant costs of quality and availability. Changes in the price of steel impact the Company's results of operations because raw material costs are by far the largest component of cost of sales in processing directly owned steel. The Company actively manages its exposure to changes in the price of steel, and, in most instances, passes along the rising price of steel to its customers.
Critical Accounting Policies
Preparation of the Company's financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The Company believes its estimates and assumptions are reasonable; however, actual results and the timing of the recognition of such amounts could differ from those estimates. The Company has identified the items that follow as critical accounting policies and estimates utilized by management in the preparation of the Company's financial statements. These estimates were selected because of inherent imprecision that may result from applying judgment to the estimation process. The expenses and accrued liabilities or allowances related to these policies are initially based on the Company's best estimates at the time they are recorded. Adjustments are charged or credited to income and the related balance sheet account when actual experience differs from the expected experience underlying the estimates. The Company makes frequent comparisons of actual experience and expected experience in order to mitigate the likelihood that material adjustments will be required.
Revenue Recognition. In accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 104, the Company recognizes revenue when there is evidence of a sales agreement, the delivery of goods has occurred, the sales price is fixed or determinable and collectibility of revenue is reasonably assured. The Company records revenues upon shipment of product to customers and transfer of title under standard commercial terms. Price adjustments are recognized in the period when management believes that such amounts become probable, based on management's estimates.
Allowance for Doubtful Accounts. The Company evaluates the collectibility of accounts receivable based on several factors. In circumstances where the Company is aware of a specific customer's inability to meet its financial obligations, a specific allowance for doubtful accounts is recorded against amounts due to reduce the
net recognized receivable to the amount the Company reasonably believes will be collected. Additionally, the allowance for doubtful accounts is estimated based on historical experience of write-offs and the current financial condition of customers. The financial condition of the Company's customers is dependent on, among other things, the general economic environment, which may substantially change, thereby affecting the recoverability of amounts due to the Company from its customers.
Inventory Reserves. Inventories are valued at the lower of cost or market. Cost is determined on the first-in, first-out basis. Where appropriate, standard cost systems are used to determine cost and the standards are adjusted as necessary to ensure they approximate actual costs. Estimates of lower of cost or market value of inventory are based upon current economic conditions, historical sales quantities and patterns, and in some cases, the specific risk of loss on specifically identified inventories.
The Company values inventories on a regular basis to identify inventories on hand that may be obsolete or in excess of current future projected market demand. For inventory deemed to be obsolete, the Company provides a reserve for the full value of the inventory, net of estimated realizable value. Inventory that is in excess of current and projected use is reduced by an allowance to a level that approximates future demand. Additional inventory reserves may be required if actual market conditions differ from management's expectations.
Deferred Tax Assets. Deferred taxes are recognized at currently enacted tax rates for temporary differences between the financial reporting and income tax bases of assets and liabilities and operating loss and tax credit carryforwards. In assessing the realizability of deferred tax assets, the Company established a valuation allowance to record its deferred tax assets at an amount that is more likely than not to be realized. While future projections for taxable income and ongoing prudent and feasible tax planning strategies have been considered in assessing the need for the valuation allowance, in the event the Company were to determine that it would be able to realize its deferred tax assets in the future in excess of their recorded amount, an adjustment to the deferred tax assets would increase income in the period such determination was made. Likewise, should the Company determine that it would not be able to realize all or part of its net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to income in the period such determination was made.
Impairment of Long-lived Assets. The Company's long-lived assets primarily include property, plant and equipment. If an indicator of impairment exists for certain groups of property, plant and equipment, the Company will compare the forecasted undiscounted cash flows attributable to the assets to their carrying value. If the carrying values exceed the undiscounted cash flows, the Company then determines the fair values of the assets. If the carrying value exceeds the fair value of the assets, then an impairment charge is recognized for the difference.
The Company cannot predict the occurrence of future impairment-triggering events. Such events may include, but are not limited to, significant industry or economic trends and strategic decisions made in response to changes in the economic and competitive conditions impacting the Company's business. The Company has committed to cease operation of the Cleveland Stamping facility. As a result, the Company recorded an impairment charge related to the long-lived assets of the Company's Cleveland Stamping facility. See Note 2 to the consolidated financial statements for a discussion of impairment charges recorded in fiscal 2007 and 2006.
Group Insurance and Workers' Compensation Accruals. The Company is self-insured for group insurance and workers' compensation and reviews these accruals on a monthly basis to adjust the balances as determined necessary. The Company reviews claims data and lag analysis as the primary indicators of the accruals. Additionally, the Company reviews specific large insurance claims to determine whether there is a need for additional accrual on a case-by-case basis. Changes in the claim lag periods and the specific occurrences could materially impact the required accrual balance period-to-period.
Pension and Other Post-retirement Costs and Liabilities. The Company has recorded significant pension and other post-retirement benefit liabilities that are developed from actuarial valuations. The determination of the Company's pension liabilities requires key assumptions regarding discount rates used to determine the present
value of future benefit payments and the expected return on plan assets. The discount rate is also significant to the development of other post-retirement liabilities. The Company determines these assumptions in consultation with, and after input from, its actuaries.
The discount rate reflects the estimated rate at which the pension and other post-retirement liabilities could be settled at the end of the year. When determining the discount rate, the Company considers the most recent available interest rates on Moody's Aa Corporate bonds with maturities of at least twenty years as of year-end. Based upon this analysis, the Company increased the discount rate used to measure its pension and post-retirement liabilities to 6.00% at October 31, 2007 from 5.77% at October 31, 2006. A change of 25 basis points in the discount rate would increase or decrease expense on an annual basis by approximately $107.
The assumed long-term rate of return on pension assets is applied to the market value of plan assets to derive a reduction to pension expense that approximates the expected average rate of asset investment return over ten or more years. A decrease in the expected long-term rate of return will increase pension expense whereas an increase in the expected long-term rate will reduce pension expense. Decreases in the level of plan assets will serve to increase the amount of pension expense whereas increases in the level of actual plan assets will serve to decrease the amount of pension expense. Any shortfall in the actual return on plan assets from the expected return will increase pension expense in future years due to the amortization of the shortfall, whereas any excess in the actual return on plan assets from the expected return will reduce pension expense in future periods due to the amortization of the excess. A change of 25 basis points in the assumed rate of return on pension assets would increase or decrease pension assets by approximately $155.
The Company's investment policy for assets of the plans is to maintain an allocation generally of 40% to 60% in equity securities, 40% to 60% in debt securities, and 0% to 10% in real estate. Equity security investments are structured to achieve an equal balance between growth and value stocks. The Company determines the annual rate of return on pension assets by first analyzing the composition of its asset portfolio. Historical rates of return are applied to the portfolio. The Company's investment advisors and actuaries review this computed rate of return. Industry comparables and other outside guidance are also considered in the annual selection of the expected rates of return on pension assets.
For the twelve months ended October 31, 2007, the actual return on pension plans' assets for all of the Company's plans approximated 13.6% to 15.2%, which was a higher rate of return than the 7.25% to 7.50% expected rates of return on plan assets used to derive pension expense.
If the amount of the accumulated benefit obligation in excess of the fair value of plan assets is large enough, the Company may be required, by law to make additional contributions to the pension plans. Actual results that differ from these estimates may result in more or less future Company funding into the pension plans than is planned by management.
Results of Operations
Year Ended October 31, 2007 Compared to Year Ended October 31, 2006
Revenues. Sales for fiscal 2007 were $590,414, a decrease of $29,961, or 4.8% from fiscal 2006 sales of $620,375. The sales decrease since fiscal 2006 reflects the overall reduction in North American car and light truck production that has occurred primarily during the second and third quarters of fiscal 2007 and a reduction in heavy truck and lawn and garden equipment demand experienced in fiscal 2007. The sales decrease also reflects the closure of the Company's Cleveland Stamping facility, where production of parts for two major customers concluded during the first and second quarters of fiscal 2007. According to industry statistics, North American car and light truck production for fiscal 2007 was 2.1% below the production levels of fiscal 2006. For the traditional domestic manufacturers, the Company's largest customers through direct sales or sales to Tier I suppliers, the production of cars and light trucks in fiscal 2007 was 5.9% below the production levels of fiscal 2006.
Gross Profit. Gross profit for fiscal 2007 was $57,167, a decrease of $1,090 from the gross profit of fiscal 2006 of $58,257. As a percentage of sales, gross profit in fiscal 2007 was 9.7% compared to 9.4% in fiscal 2006. Gross profit for fiscal 2007 declined on the lower volume of sales in fiscal 2007 compared to fiscal 2006. The effect on gross profit of the reduced fiscal 2007 sales volume was approximately $8,400. Gross profit was also adversely affected by the increased material content in the products produced and sold during fiscal 2007 compared to the prior fiscal year. The effect of greater material content on gross profit was a decrease of approximately $5,000. Gross profit was further reduced by less recovery of engineered scrap in fiscal 2007 compared to fiscal 2006, the effect of which was a reduction in gross profit of approximately $4,400. These negative factors were offset by reduced manufacturing expenses of approximately $16,700 in fiscal 2007 compared to fiscal 2006. Personnel and personnel related expenses decreased approximately $9,100, manufacturing supplies, expenses and repair materials decreased by approximately $2,300, utilities decreased by $450, depreciation expense decreased by approximately $1,400 and personal property and real estate taxes decreased by $3,450 in fiscal 2007 compared to fiscal 2006. The provision for personal property taxes in 2006 included a reserve of $2,324 for a matter contested with the Ohio Board of Tax Appeals concerning the Company's acquisition of the automotive division of MTD Products Inc. Fiscal 2007 reflects the absence of the fiscal 2006 charge and a negotiated resolution of another personal property tax valuation issue concerning jigs, dies and fixtures at an amount less than the Company accrued. The reduction in manufacturing expenses in fiscal 2007 compared to fiscal 2006, exclusive of the personal property tax matters, were the result of cost reduction efforts implemented in response to reduced production volumes, including the closure of the Company's Cleveland Stamping facility and the effect of freezing the Company's cash balance pension plan for non-bargaining employees.
Selling, General and Administrative Expenses. Selling, general and administrative expenses were $32,801 or 5.6% of fiscal 2007 sales. For fiscal 2006, selling general and administrative expenses were $37,669 or 6.1% of fiscal 2006 sales. In fiscal 2007, selling general and administrative expenses decreased by $4,868 from fiscal 2006, which included expenses related to two contingencies for which reserves were provided in the fourth quarter of fiscal 2006.
In connection with the bankruptcy of a steel supplier the Company had asserted that its obligations to the supplier were properly offset by amounts that the supplier owed to the Company. The Company's position was not sustained in court proceedings and as a result the Company and the supplier negotiated a settlement of $907 in September 2006 that was recorded in the fourth quarter in selling, general and administrative expenses.
Previous management of the Company had entered an alleged purchase commitment with a supplier for the purchase of certain equipment. The supplier sued the Company for failure to fulfill the obligations under the alleged commitment. During the fourth quarter, a jury found in favor of the supplier and awarded the supplier damages and pre-judgment interest amounting to $2,726. The Company is appealing this decision. However, considering the adverse decision the Company evaluated the probable outcome upon appeal and provided an accrual of $2,726 representing damages plus pre-judgment interest. This amount was charged to selling, general and administrative expenses.
In fiscal 2007, selling, general and administrative fees were further reduced by lower depreciation expense and lower professional fees, offset by increasing personnel and personnel related expenses.
Asset Impairment and Restructuring Charge. In October 2006, management presented to the Board of Directors an assessment of the business at its Cleveland Stamping facility. This facility, which is leased from MTD Products Inc ("MTD") as part of the acquisition by the Company of MTD Automotive in 1999, was faced with declining business volumes. The two major customers of the Cleveland Stamping facility have balanced out programs for which the Company provides components during the first and second quarters of fiscal 2007. The Company committed to a plan to cease operation of the Cleveland facility. As a result, the Company recorded an impairment charge of $3,072 to reduce long-lived assets, acquired since the acquisition, to their estimated fair value. During fiscal 2007, the Company incurred further asset impairment charges of $137 related to resolution of issues related to the remaining long-lived assets at the Company's Cleveland Stamping facility.
In fiscal 2006, the Company also recorded a restructuring charge related to approximately 200 employees for severance, health insurance and curtailment of the retirement plan for employees of the Cleveland plant. The restructuring charge was $1,625. In February 2007, the Company finalized negotiations with the employees of the Cleveland Stamping facility and recorded an additional charge of $100 for severance and benefits.
Other. Interest expense for fiscal 2007 was $7,486, an increase of $1,403 from interest expense of $6,083 incurred in fiscal 2006. The increase in interest expense compared to the prior fiscal year resulted from a higher level of average borrowed funds and an increase in the interest rate. Borrowed funds averaged $96,453 during fiscal 2007 and the weighted average interest rate was 7.00%. In fiscal 2006, the average of borrowed funds was $93,807, with a weighted average interest rate of 6.36%.
Other income was $442 for fiscal 2007 and is comparable to fiscal 2006.
The provision for income taxes for fiscal 2007 was $7,535 on income before taxes of $17,085, for an effective tax rate of 44.1%. The effective tax rate for fiscal 2007 reflects the inability of the Company to provide tax benefit on the losses of the Company's Mexican subsidiary, offset by the recognition of research and development tax credits related to the current year and to prior years that are being realized by amending the tax returns of those years.
The provision for income taxes for fiscal 2006 was $3,124 on income before taxes of $10,242 for an effective tax rate of 30.5%. The provision for income taxes for fiscal 2006 reflected the recognition of a benefit in the tax provision of $1,488 related to state tax credits during the second quarter of fiscal 2006. In previous fiscal years, the Company had provided a reserve related to the Ohio Manufacturer's Grant (formerly known as the Ohio Machinery and Equipment Credit) due to the uncertainty regarding the realization of such tax credits. In September 2005, the United States Court of Appeals for the Sixth Circuit ruled that this credit was unconstitutional. This ruling was appealed to the U.S. Supreme Court. On May 15, 2006, the U.S. Supreme Court dismissed the Sixth Circuit Court's ruling. As a result of the U.S. Supreme Court's action, the Ohio Machinery and Equipment credit remains constitutional and the Company, therefore, eliminated the reserves related to this issue.
Net Income. Net income for fiscal 2007 was $9,550 or $0.58 per share, basic and diluted. In fiscal 2006, net income was $7,118, or $0.44 per share, basic and $0.43 per share, diluted.
Year Ended October 31, 2006 Compared to Year Ended October 31, 2005
Revenues. Sales for fiscal 2006 were $620,375 compared to sales of $634,579 for fiscal 2005, a decrease of $14,204, or 2.2%. In the fourth quarter of fiscal 2006, the Company's sales decreased by $18,962 from the fourth quarter of 2005, or 10.7%. The year over year sales decrease that occurred during the fourth quarter of fiscal 2006 reflected the decline in North American car and light truck production that occurred in the fourth quarter of fiscal 2006 and in fiscal 2006 as a whole. According to industry statistics, North American car and light truck production for fiscal 2006 was 1.9% below production levels of fiscal 2005. In the fourth quarter of fiscal 2006, the decrease of North American car and light truck production from the levels of fiscal 2005 was 10.5%. For the traditional domestic manufacturers, the production decreases were 15.4% and 5.1% for the fourth quarter and annual periods of fiscal 2006. The traditional domestic car and light truck manufacturers, through direct sales or through sales by the Company to Tier I suppliers, are the most significant of the Company's customers.
Gross Profit. Gross profit for fiscal 2006 was $58,257, a decrease of $21,590 from the gross profit of fiscal 2005 of $79,847. As a percentage of sales, gross profit in fiscal 2006 was 9.4% compared to 12.6% in fiscal 2005. Gross profit in fiscal 2006 was negatively affected by an increase in the material content of products sold during fiscal 2006 compared to fiscal 2005 by approximately $14,100. Gross profit was further reduced by the lower volume of product sold in fiscal 2006 compared to fiscal 2005 in the amount of $4,500. Gross profit
was also adversely affected by increased manufacturing expenses in fiscal 2006 compared to fiscal 2005, which was the net result of several factors. In the fourth quarter of fiscal 2006, the Company recorded an accrual for personal property tax of $2,324. This amount represents an estimate of personal property tax due on the contested valuation of assets that the Company acquired in connection with the acquisition of the automotive division of MTD Products Inc. . . .
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