| SCIENTIFIC TECHNOLOGIES INC Item 1A Risk Factors Because of the variety of factors and uncertainties affecting our operating results, past financial performance and historical trends may not be a reliable indicator of future performance |
| These factors, as well as other factors affecting our operating performance, may result in significant volatility in our common stock price |
| Among the factors which could affect our future business, financial condition or operating results are the following: Our operating results may fluctuate |
| We have experienced fluctuations in annual and quarterly operating results and anticipate that these fluctuations will continue, which may cause the trading price of our common stock to decline |
| These fluctuations are caused by a number of factors described below and elsewhere in this section, including: * the level and timing of customer orders; * fluctuations in demand for complementary third party products with which our products are sold; * changes in the mix of our products sold; * timing of operating expenditures; * timing of new product introductions; * fluctuations in prices charged by our suppliers; * seasonality of sales within our core markets; * volatility in supply and demand affecting industrial control products generally, such as increases in the supply of competitive products and declines in selling prices; and * economic conditions in the US and abroad |
| Our sales are dependent on independent distributors |
| A majority of our sales are through third party distributors, system integrators and original equipment manufacturers |
| These resellers are not required to offer our products exclusively |
| We cannot assure that a reseller will continue to offer our products |
| In addition many of our resellers are privately owned firms which may not be well capitalized, as was demonstrated by the failure of two of our distributors during 2001 |
| If our ability to sell products through these third parties is impaired, our results of operations would likely suffer |
| The industrial manufacturing equipment industry, and the markets of customers that use our products, are highly cyclical |
| Our continued success depends in large part on the vibrancy of various industries that use our products |
| We operate in a cyclical industry that has been subject to significant economic downturns often in connection with, or in anticipation of, declines in general economic conditions |
| These types of downturns have occurred numerous times in the past, most recently in 2001 |
| During such downturns, we experience reduced product demand, erosion of average selling prices and gross margins |
| Our business could be harmed in the future by additional cyclical downturns in the industrial manufacturing equipment industry or by slower growth by any of the markets served by our customers &apos products |
| The markets in which we participate are intensely competitive |
| Our core markets are intensely competitive |
| Many competitors have substantially greater name recognition and technical, marketing, distribution and financial resources than we have, and we may not be able to compete successfully with them in the future |
| Competitive pressures could also reduce market acceptance of our products and result in price reductions, decreases in revenues and increases in expenses |
| Competition in our core markets is based primarily on performance, quality, price and availability |
| If we do not compete successfully on these and other factors, our business, financial condition and operating results would be harmed |
| Average sales prices of our products generally decline over time |
| Average sales prices in the industrial manufacturing equipment market tend to decline over time as a result of competition, technological advances, manufacturing efficiencies and other factors |
| Declines in average sales prices for our products, if not offset by reductions in the cost of producing those products or by sales of new products with higher gross margins, would decrease our gross margins, could cause a negative adjustment to the value of our inventories and could materially and adversely affect our operating results |
| We do not have long term contracts with our customers |
| Our customers generally purchase our products on a purchase-order basis and do not have long-term contracts with us |
| The loss of one or more significant customers, or a decline in overall orders from our customers, would harm our business and operating results |
| In addition, the lack of long-term sales contracts and significant order backlog makes it difficult for us to forecast future sales with certainty or to accurately forecast component and product requirements |
| These factors expose us to a number of risks: * if we overestimate our requirements we may be obligated to purchase more components or third-party products than are required; * if we underestimate our requirements, our suppliers may have an inadequate product or product component inventory, which could interrupt manufacturing of our products and result in delays in shipments and revenues; * we may also experience shortages of product components from time to time, which also could delay the manufacturing of our products; and * over or under production can lead to higher expenses, lower than anticipated revenues, and reduced margins |
| We may be unable to increase our international sales |
| We are attempting to develop, integrate and expand our international distribution networks in an effort to increase international sales of our products |
| We may not be successful in developing or expanding our international distribution network or in marketing and selling products in foreign markets |
| If the revenues generated by our international sales are not adequate to recover the expense of establishing, expanding, and maintaining an international distribution network, our business, financial condition, and results of operations could be materially adversely affected |
| If international sales become a more significant component of net sales, our business would be more vulnerable to risks inherent in doing business internationally, including: * difficulties in managing foreign resellers; * longer payment cycles and problems in collecting accounts receivable; * the effects of seasonal customer demand; * changes in regulatory requirements; * difficulties in meeting the requirements of different international product regulations; * risks relating to intellectual property rights; * increased expenses due to efforts to localize our product offerings; * export restrictions, tariffs and other trade barriers; * fluctuations in currency exchange rates; and * potentially adverse tax consequences and political instability |
| The existence or occurrence of any one of these factors could have a material adverse effect on our business, financial condition, and results of operations |
| Our business could suffer if we experience delays or are unable to transition certain of our products to conformance with new European hazardous substance regulations |
| The legislative and commercial actions in Europe regarding hazardous substances have brought a new level of environmental awareness to industrial equipment industries |
| Certain of our products that may fall within the scope of the Restriction on Hazardous Substances (RoHS) Directive may be required to conform to the new emerging restrictions and conventions |
| Delays or failure to transition current products to environmental compliance for the broad range of countries where our products are deployed may negatively impact revenues |
| Further, many of our commercial parts suppliers and contract manufacturers have begun or completed the conversion to meet this new emerging requirement |
| Should these efforts be delayed our supply chain of qualified components could prevent STI from meeting the deadline for compliance |
| Also our cost to become compliant could become more than currently projected, therefore negatively impacting our revenues and margin performance |
| We may not be able to manufacture and deliver our products as quickly as our customers require, which could cause us to lose sales and would harm our reputation |
| We may not be able to manufacture products and deliver them to our customers at the times and in the volumes they require |
| Manufacturing delays and interruptions can occur for many reasons, including, but not limited to: * the failure of a supplier to deliver needed components on a timely basis or with acceptable quality; * lack of sufficient capacity; * poor manufacturing yields; * equipment failures; * manufacturing personnel shortages; * labor disputes; * transportation disruptions; * changes in import/export regulations; * infrastructure failures at the facilities of our offshore contract manufacturer; * natural disasters; * acts of terrorism; and * political instability |
| Manufacturing certain of our products is complex |
| The yield, or percentage of products manufactured that conform to required specifications, can decrease for many reasons, including materials containing impurities, equipment not functioning in accordance with requirements or human error |
| If our yield is lower than we expect, we may not be able to deliver products on time which could result in lost sales |
| If we fail to manufacture and deliver products in a timely fashion, our reputation may be harmed, we may jeopardize existing orders and lose potential future sales, and we may be forced to pay penalties to our customers |
| We depend heavily upon suppliers and outsourced manufacturers, several of which are located outside of the US Disruption of our access to these supplies and services, or problems with the quality of supplies or services, could prevent us from filling customer orders and harm our business |
| The principal components of our products are purchased from outside vendors |
| We generally buy components under purchase orders, do not have long-term agreements with our suppliers, and we generally do not maintain large inventories of components |
| Any termination of, or significant disruption of, our relationships with the suppliers of our product components may prevent us from filling customer orders in a timely manner which could result in customer dissatisfaction and lost sales |
| For some of our products, including private label products, we rely on third party manufacturers for subassembly of products and for final assembly, quality assurance, and testing of some of our products |
| These outsourcing arrangements and any future outsourcing arrangements involve numerous risks, including reduced control over product quality, delivery schedules, manufacturing yields, and costs |
| For certain products that we private label, we are dependent on third party suppliers |
| We rely on third party suppliers for several finished products that we sell under the STI brand name |
| If we do not manage the relationship with the supplier properly or if the supplier stops providing us with these products, we may not be able to find replacement products in a timely manner or at all |
| This may prevent us from fulfilling customer orders and have an adverse impact on our financial results |
| Our business could suffer if we do not respond to technological change and new product development demands of our customers |
| The market for our products is characterized by changing technology, evolving industry standards, changes in customer needs and new product introductions |
| Our future success will depend on our ability to respond to emerging industry standards, hazardous material regulations, product disposal and recycling regulations, enhance current products, develop new products, and achieve market acceptance of those products, all on a timely and cost-effective basis |
| The introduction of new products also requires that we manage the transition from older products in order to minimize disruption of customer orders, avoid excessive levels of older product inventories and ensure that adequate supplies of new products can be delivered to meet customer demands |
| Product errors or defects could result in product recalls and claims against us We manufacture machine safety and automation sensing products, many of which are used in manufacturing, construction and other industrial environments |
| Errors or defects in our products could contribute to injuries, and could subject us to product liability claims |
| Any such claims would divert managementapstas attention from our core business, would be expensive to defend, and could result in sizeable damage awards against us |
| Our existing product liability insurance coverage may be inadequate to protect us from any liabilities we might incur, and we may not be able to maintain this insurance or do so at a reasonable cost or on reasonable terms |
| Any product liability claim brought against us, with or without merit, could also increase our product liability insurance rates or prevent us from securing any coverage in the future |
| If a product liability claim or series of claims is brought against us for uninsured liabilities or is in excess of our insurance coverage, our business would suffer |
| In addition, such claims may require us to recall some of our products, which could result in significant costs to us |
| An adverse evaluation of our internal controls over financial reporting could damage public perception of our financial statements and cause our stock price to decline |
| Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 (Section 404), beginning with our Annual Report on Form 10-K for the fiscal year ending December 31, 2007, we will be required to furnish a report by our management on our internal control over financial reporting |
| The report must contain a statement as to whether or not our internal controls over financial reporting are effective |
| In addition, our independent auditors must attest to and report on managementapstas assessment of such internal controls |
| We have begun to expend significant resources to perform the system and process documentation and evaluation needed to comply with Section 404 |
| However, if we and our auditors are unable to adequately test our internal controls, or if during this process we identify one or more significant deficiencies or material weaknesses in our internal controls over financial reporting which we are unable to remedy prior to December 31, 2007, we may be unable to assert that our internal controls over financial reporting are effective or our auditors may be unable to attest that our managementapstas report is fairly stated |
| In such case, we could lose investor confidence in the accuracy and completeness of our financial reports, which could have an adverse effect on our stock price |
| During 2004 we identified certain internal control weaknesses related to: (1) inadequate preparation and insufficient review and analysis of certain financial statement account reconciliations primarily relating to inventory and accounts receivable valuation; (2) lack of documented policies and procedures related to changes and updates in the accounting system; and (3) lack of sufficient personnel with appropriate qualifications and training in certain key accounting roles and adherence to certain control disciplines within the accounting and financial reporting function |
| Management believes these weaknesses have been corrected in 2005 |
| Our business could suffer if we are unable to protect and enforce our intellectual property rights |
| We rely on a combination of patent, trademark, trade secret laws and contractual restrictions to establish and protect proprietary rights in our products and services |
| There can be no assurance that our patents, trademarks, or contractual arrangements or other steps taken by us to protect our intellectual property will prove sufficient to prevent misappropriation of our technology or defer independent third party development of similar technologies |
| Moreover, there can be no assurance that the technology licenses granted to us from our parent company will continue to be available |
| The loss of any of our proprietary technology could require us to obtain technology of lower quality or performance standards or at greater cost, which could materially adversely affect our business, results of operations and financial condition |
| Also, competitors may develop their own intellectual property or technologies, obtain their own patents, or challenge the validity of, or be able to design around, our patents |
| The laws of certain foreign countries may not protect our products, services or intellectual property rights to the same extent as do the laws of the United States |
| We may initiate claims or litigation against other third parties for infringement of proprietary rights or to establish the validity of proprietary rights |
| Similarly, our competitors may initiate claims or litigation against us alleging infringement of their proprietary rights or improper use of their intellectual property |
| Litigation relating to intellectual property to which we may become a party is subject to numerous risks and uncertainties, including the risk of counterclaims or other litigation against us, and we may not be successful in any such litigation |
| Our ability to develop and market our products is dependent upon our retention of certain executive officers and other key personnel |
| We are greatly dependent on the ability to retain key management and technical personnel, and our future success is highly dependent upon the personal efforts of our management and technical personnel |
| The loss of services of any one of them could have a material adverse effect on our business, financial condition, and results of operations |
| Our success will also be dependent in part upon our ability to attract, retain, and motivate highly skilled employees |
| We may need to offer additional compensation or incentives to attract and retain these and other employees |
| Our operations have been and may continue to be negatively impacted by uncertain global economic and political conditions |
| Our business may suffer as a result of general economic and political conditions in the US and abroad |
| In 2003 and 2002, there was a rapid and severe downturn in the US market and global economy |
| This downturn has been compounded by terrorist activity, such as the attacks in the US on September 11, 2001, and the military activity in Afghanistan, Iraq and the Middle East |
| Additional terrorist acts or acts of war could cause damage or disruption to us or to our suppliers and our customers |
| Fears of global recession, war, and terrorism may continue to have seriously detrimental effects on the US and global economies |
| Such conditions could further dampen consumer confidence and cause our customers to slow or cease spending on our products |
| If these events continue, our operations may be negatively impacted |
| The seasonality inherent in our business could cause our operating results to fluctuate |
| The industrial manufacturing equipment industry in which we compete has historically been subject to seasonality |
| This is also true with respect to European markets in which we compete where business activity declines due to vacations taken in the summer months |
| This seasonality, combined with other factors such as the variability in our operating results described above, renders quarter-to-quarter comparisons of our results of operations unreliable as indicia of our overall performance |
| Our parent company has voting control over us |
| Approximately eighty-six percent (86prca) of our capital stock is currently held by our parent corporation, Scientific Technology Incorporated, a California corporation |
| As a result, our parent has control over matters requiring approval by our shareholders, including the election of directors and the approval of mergers or similar transactions, even if other shareholders disagree |
| This control, along with provisions of Oregon law affecting acquisitions and business combinations, may delay, deter or prevent a third party from acquiring or merging with us and prevent shareholders from realizing a premium price for their shares associated with an acquisition |
| This voting control and provisions of Oregon law may also have a negative effect on the market price of our common stock |