ITEM 1A - Risk Factors
The following risks and uncertainties, as well as other factors described elsewhere in this report or in other filings of the Company with the SEC, could adversely affect the Company’s business, financial condition and results of operations. Additional risks and uncertainties that are not presently known to the Company, or that are not currently believed by the Company to be material, may also harm the Company’s business operations and financial results.
Component Supply Risk
The Company depends upon its suppliers for the supply of the primary components for its products. Such components are subject to significant price volatility beyond the control or influence of the Company. Petroleum- based products, from which WD-40 and 3-IN-ONE are manufactured, have had significant price volatility in the past, and may in the future. Rising oil prices also impact the Company’s cost of transporting its products. As component and raw material costs are the main contribution to cost of goods sold for all of the Company’s products, any significant fluctuation in the costs of components could also have a material impact on the gross margins realized on the Company’s products. Specifically, future can prices are exposed to fluctuations resulting from changes in tariffs on steel as well as general supply and demand economics; therefore, any significant increase or decrease in steel tariffs and/or the supply and demand of steel could have a significant impact on the costs of purchasing cans and the Company’s cost of goods. In the event there is significant price volatility or component costs increases, the Company may not be able to maintain, or may choose not to maintain, its gross margins by raising its product prices. Should the Company choose to increase product prices, such increases may adversely affect demand and unit sales. Increases in the prices for the components could have a material adverse effect on the Company’s business, operating results, financial position and cash flows.
Reliance on Supply Chain
The Company relies on third party contract manufacturers for the production of its finished goods. The Company does not have direct control over the management or business of the primary contract manufacturers utilized in the manufacturing of the Company’s products, except indirectly through terms as negotiated in contracts with those manufacturers. Should the terms of doing business with the Company’s primary contract manufacturers change, the Company’s cost structure may be affected, which could have a direct impact on the Company’s profit margins.
The Company’s contract manufacturers rely upon two key vendors for the supply of empty cans used in the production of WD-40, Carpet Fresh, 3-IN-ONE, Spot Shot, X-14 and 1001 products. Additionally, the Company relies on single manufacturers for the production of 2000 Flushes and X-14 automatic toilet bowl cleaners, X-14 hard surface cleaners, Carpet Fresh powder and Lava bar soap. The loss of any of these suppliers or manufacturers could disrupt or interrupt the production of the Company’s products. Although the Company has a business continuity plan to help mitigate the potential loss of suppliers or manufacturers, the inability to replace lost suppliers or manufacturers in a reasonable amount of time could have a material adverse effect on the Company’s business, operating results, financial position and cash flows.
The Company also relies on third party logistics providers for the distribution of its products to customers. The Company does not have direct control over the management or business of the logistics providers, except indirectly through terms as negotiated in contracts. Should the terms of doing business with the Company’s logistics providers change, the distribution of products to customers may be disrupted, which could have a direct impact on the Company’s profitability. The inability to replace lost logistics providers in a reasonable amount of time could also have a material adverse effect on the Company’s business, operating results, financial position and cash flows.
Additionally, as the Company continues to focus on innovation, there is an increasing need for global and multiple sourcing strategies. The inability of the Company to find adequate sourcing to support innovation initiatives could have a material adverse effect on the Company’s business, operating results, financial position and cash flows.
Competition
The market for the Company’s products is highly competitive and is expected to be increasingly competitive in the future. The Company’s products compete both within their own product classes as well as within product distribution channels, competing with many other products for store placement and shelf space. Competition in international markets varies by country. The Company is aware of many competing products, some of which sell for lower prices. In addition, many of the Company’s competitors have significantly greater financial, technical, product development, marketing and other resources.
These considerations as well as increased competition generally could result in price reductions, reduced gross margins, and a loss of market share, any of which could have a material adverse effect on the Company’s business, operating results, financial position and cash flows. There can be no assurance that the Company will be able to compete successfully against current and future competitors or that competitive pressures faced by the Company will not materially adversely affect its business, operating results, financial position and cash flows.
Volume Growth
A large percentage of the Company’s revenue comes from mature markets that are subject to increased competition. During fiscal year 2007, approximately 52% of the Company’s sales were generated in U.S. markets. In the U.S., the markets for lubricants, household products and hand cleaners are considered mature and are generally characterized by high household penetration. The Company’s ability to achieve volume growth is dependent on its ability to drive growth through innovation and investment in its established brands and its ability to capture market share from competitors. During fiscal year 2006, the Company increased prices on a majority of its product portfolio. Price increases may slow volume growth or create declines in volume in the short term as customers adjust to price increases. If the Company is unable to increase market share in existing product lines, or bring innovation to grow its product categories, or develop, acquire or successfully launch new products, or successfully penetrate new and developing markets, the Company may not achieve its volume growth objectives.
Political and Economic Risks
The Company’s domestic and international operations are exposed to the risk of political and economic uncertainties. Changes in political and economic conditions may affect product cost, availability, distribution, pricing, purchasing, and consumption patterns. While the Company seeks to manage its business in consideration of these risks, there can be no assurance that the Company will be successful in doing so.
As the Company’s sales extend to various countries around the globe, financial results in affected areas are exposed to a higher degree of risk. Examples of regions currently exposed to such types of risk include Latin America, the Middle East and parts of Asia. There can be no assurance that the Company will be able to successfully mitigate against current and future risks associated with political and economic uncertainties, or that the risks faced by the Company will not materially adversely affect its business, operating results, financial position and cash flows. As sales grow within various regions around the world, the Company’s exposure to this risk will increase.
International Operations
The Company’s sales outside of the U.S. were approximately 48% of net sales in fiscal year 2007. The Company has faced and will continue to face substantial risks associated with having foreign operations, including restrictions on repatriating foreign profits back to the U.S. and the imposition of tariffs or trade restrictions. These risks could have a significant impact on the Company’s ability to sell its products on a competitive basis in international markets and may have a material adverse effect on the Company’s results of operations or financial position.
Also, the Company’s operations outside of the U.S. are subject to the risk of new and different legal and regulatory requirements in local jurisdictions, potential difficulties in staffing and managing local operations, potentially higher incidence of fraud or corruption, credit risk of local customers or distributors and potentially adverse tax consequences.
The Company is also exposed to foreign currency exchange rate risk with respect to its sales, profits, and assets and liabilities denominated in currencies other than the U.S. dollar. Although the Company uses instruments to hedge certain foreign currency risks, it is not fully protected against foreign currency fluctuations and, therefore, the Company’s reported earnings will be affected by changes in foreign currency exchange rates.
Business Risks
With the trend toward consolidation in the retail marketplace, the Company’s customer base is shifting toward fewer, but larger, customers who purchase in larger volumes. A large percentage of the Company’s sales are to mass retail customers. Sales to one of these customers (Wal-Mart and affiliates) accounted for approximately 13% of the Company’s net sales in fiscal year 2007. Additionally, each of the Company’s individual brands may be subjected to customer sales concentration. The loss of, or reduction in, orders from any of the Company’s most significant customers could have a material adverse effect on the Company’s brand values, business and financial results.
Large customers also seek price reductions, added support or promotional concessions, which may negatively impact the Company’s ability to maintain existing profit margins.
The Company does not typically enter into long-term contracts with its customers. Accordingly, these customers could reduce their purchasing levels or cease buying products from the Company at any time and for any reason. In addition, the Company is subject to changes in customer purchasing patterns. These types of changes may result from changes in the manner in which customers purchase and manage inventory levels, or display and promote products within their stores. Other potential factors such as customer disputes regarding shipments, fees, merchandise condition or related matters may also impact operating results.
The Company also faces the risk of diminishing product categories or shifts within these categories. Currently, the Company faces challenges related to its household products brands. Household products have short differentiated life cycles and often need continuous innovation to address consumers’ changing needs and tastes. As a result of the dynamic nature of these product categories, the ability to understand consumer preferences and innovate is key to the Company’s ongoing success. In the event that the Company is unable to meet consumer preferences through innovation, its brands and product offerings may be at risk of impairment.