Protests in Middle East, North Africa spur look at corporate risk disclosures globally -Westlaw Business
Feb. 18 (Westlaw Business) The winds of change blowing across the Northern Sahara all but demand a look at foreign operations disclosures, particularly as many companies are deeply entrenched in preparing this year’s annual reports. Political risk has many guises—war, expropriation, currency devaluation—but for companies doing business abroad, these risks don’t begin to give a complete picture of potential threats to earnings. Just six weeks into 2011, a number of well-known companies have already provided a glimpse of what’s keeping their board members awake at night.
Due to timing of the spreading unrest in the Middle East, early 10-K filers, for the most part, haven’t specifically referenced the risks posed by the actual and potential events in the region. One company, however, Noble Energy, included some very pointed disclosures about just what the turmoil could mean for its business:
“Civil unrest could continue to spread throughout the region and involve other areas such as the Gaza Strip or nations such as Syria, Yemen, Lebanon or others. Such unrest, if it continues to spread or grow in intensity, could lead to civil wars; regime changes resulting in governments that are hostile to the US and/or Israel, such as has previously occurred in the region; violations of the 1979 Egypt-Israel Peace Treaty; or regional conflict,” Noble Energy said.
Noble, which has extensive interests in the newly discovered gas fields of the Eastern Mediterranean (among others) goes on to cite a litany of serious potential risks to the company’s operations in the region including:
— volatility in crude oil prices and supply (affecting the company and global economy at large);
— “capital market reassessment of risk” (making capital more difficult to come by);
— security concerns in Israel affecting entry and exit of personnel and supplies to the country;
— reduced market demand in Israel;
— security concerns for evacuation of personnel;
— lack of available drilling rig and oilfield equipment should third party providers exit the region;
— loss of property and business interruption; and
— changing fiscal regimes of countries where Noble operates.
Another early filer from the oil patch, Schlumberger, has also disclosed risks specific to its foreign operations. Non-U.S. revenue accounts for 76% of the company’s consolidated revenue in 2010 (down from 84% the year before). While not directly referencing events in the Middle East and North Africa region, nevertheless, Schlumberger warns of risks including: deprivation of contract rights; “restrictions under the United States Foreign Corrupt Practices Act or similar legislation in other countries”; expropriation; confiscatory taxation; “trade restrictions or embargoes imposed by the United States or other countries”; and “social unrest, acts of terrorism, war or other armed conflict” among others.
Not surprisingly, high tech companies and defense contractors have particularly acute risks to overseas operations. Fifty-two percent of Honeywell’s 2010 revenues came from outside the U.S. The company cited risks including: foreign investment laws; transactions with state-owned enterprises and potential nationalization of private enterprises; and the ability to hire and maintain the safety of employees abroad.
United Technologies cited foreign countries’ differing legal systems and customs as posing special challenges. Offset arrangements, for instance, in which contractors may be required to locally source goods and services, or provide other financial concessions, may provide penalties for failure to perform. In addition to similarly couched risks, Boeing warned of “the uncertainty of the ability of non-U.S. customers to finance purchases,” as well as “uncertainties and restrictions concerning the availability of funding credit or guarantees.”
Although Northrop Grumman says international business makes up only five percent of its total revenues, the legendary defense contractor still faces substantial regulatory risk including “relating to import-export control, technology transfer restrictions, repatriation of earnings, exchange controls, the Foreign Corrupt Practices Act and the anti-boycott provisions of the U.S. Export Administration Act.” Goodrich Corp., another high-tech manufacturer based in Charlotte, North Carolina, warns of many of the same risks as its industry counterparts, as well as dividend remittance restrictions and price and currency controls. “Significant labor strikes, work stoppages, political unrest, war or terrorist activities in any of the areas where we conduct operations,” cautions Goodrich, “could result in a prolonged interruption of our business.”
A different kind of tech company, Broadcom, has a different kind of disquiet for its international business. Not only does substantially all the company’s manufacturing, assembly and testing take place outside the U.S., but the Broadcom’s products wind up there as well. “Products shipped to international destinations, primarily in Asia, represented 97.2%, 94.8% and 91.8% of [Broadcom’s] product revenue in 2010, 2009 and 2008, respectively.”
Given its export business, for Broadcom, the value of American currency creates a risk normally associated with foreign governments. “Accordingly,” notes Broadcom in its 10-K filed this month, “an increase in the value of the U.S. dollar relative to foreign currencies could make our products less competitive in international markets or require us to assume the risk of denominating certain sales in foreign currencies. We anticipate that these factors will impact our business to a greater degree as we further expand our international business activities.”
As seen in the late summer controversy surrounding RIM’s BlackBerry service in India and the UAE, web-dependent companies face a discrete brand of risks. Not only must these businesses depend upon suspect infrastructures to even keep the internet online, government fiats can wreak havoc on operations and may be ostensibly based on any number of justifications.
Online auctioneer eBay, for example, comes under an unexpected degree of scrutiny based on the very nature of its business. With its proprietary remittance business, PayPal, the eBay faces extraordinary oversight as a potential vessel for money laundering. Moreover, in some jurisdictions, including California and France, the company has had to combat state action seeking to regulate eBay as a “pawnbroker.” As such, the ability of the company to do business in some jurisdictions, given its business model, remains a source of continuing risk.
Amazon.com, an industry trailblazer (to the extent the decade-old trail can be considered no longer blazing), cites technology infrastructure and internet penetration abroad, as well as business licensing or certification requirements as real risks. Difficulties in staffing, language, culture and “employee/employer relationships” also pose a threat to the Amazon’s overseas operations.
Expedia, the online travel agent, has particular risks emerging from its investments in China. “Significant uncertainties exist regarding the interpretation and enforcement of Chinese laws and regulations including permits and license requirements, and such uncertainties could limit the available legal protections relating to our investments,” the company warns.
China worries are no stranger to Google. The company notes that more than half (52%) of its revenues in 2010 came from outside the U.S. Significant as this chunk of business is, it comes at a cost, such as numerous and sometimes conflicting laws and regulations include internal control and disclosure rules, data privacy and filtering requirements, anti-corruption laws, such as the Foreign Corrupt Practices Act, and other local laws prohibiting corrupt payments to governmental officials, and anti-competition regulations, among others. Violations of these laws and regulations could result in fines and penalties, criminal sanctions against us, our officers, or our employees, prohibitions on the conduct of our business and on our ability to offer our products and services in one or more countries, and could also materially affect our brand, our international expansion efforts, our ability to attract and retain employees, our business, and our operating results.
With so many U.S. companies outsourcing some if not all of their manufacturing operations, at some levels, most suppliers of consumer products will have similar risks. Whirlpool, for example, will not face any unique risks posed by Luddites abroad. The company does face supply chain risks, though—risks that can compromise its ability to produce and deliver its products. Like many U.S. manufacturers, Whirlpool notes that the Foreign Corrupt Practices Act (FCPA) may put the company at a disadvantage to its competitors that may not be subject to similar regulations.
Mattress-making doesn’t seem an especially controversial industry, yet Sealy discloses significant concern with a number of risks to its international operations. Licensing as an element of the company’s business model discloses concerns not seen in most filings.
“We currently conduct significant international operations and may pursue additional international opportunities. Our international operations are subject to the risks of operating in an international environment, including the potential imposition of trade or foreign exchange restrictions, tariff and other tax increases, fluctuations in exchange rates, inflation and unstable political situations. We have also limited our ability to independently expand in certain international markets where we have granted licenses to manufacture and sell Sealy bedding products. Our licensees in Australia, Jamaica and the United Kingdom have perpetual licenses, subject to limited termination rights. Our licensees in the Dominican Republic, the Bahamas, Continental European Union countries, Brazil, Israel, Japan, Saudi Arabia, South Africa and Thailand hold licenses for fixed terms with limited renewal rights.”
Although one can expect many companies to disclose worries of tensions in the Middle East and North Africa region, Goodyear Tire & Rubber has worries closer to home. The company concedes that [c]ertain regions, including Latin America, Asia, the Middle East and Africa, are inherently more economically and politically volatile and as a result, [its] business units that operate in these regions could be subject to significant fluctuations in sales and operating income from quarter to quarter. Because a significant percentage of [Goodyear’s] operating income in recent years has come from these regions, adverse fluctuations in the operating results in these regions could have a disproportionate impact on [the company’s] results of operations in future periods.
Goodyear then goes on to cite the specific risks confronting the company from its operations in Venezuela, and that country’s experiments with currency manipulation.
“The future results of our Venezuelan operations will be affected by many factors, including our ability to take actions to mitigate the effect of the devaluations, further actions of the Venezuelan government, economic conditions in Venezuela such as inflation and consumer spending, and the availability of raw materials, utilities and energy. Goodyear Venezuela contributes a significant portion of the sales and operating income of our Latin American Tire segment. As a result, any disruption of Goodyear Venezuela’s operations or of our ability to pay suppliers or repatriate funds from Venezuela could have a material adverse impact on the future performance of our Latin American Tire segment and could materially adversely affect our results of operations, financial condition and liquidity.”
Other companies with recognizable names such as Owens-Illinois, Clear Channel Communications, Kansas City Southern and Lear Corp. have already filed 10-K forms this year, and all disclose risks stemming from their international operations.
Kansas City Southern has to worry not only about escalating violence in Mexico, but the risk of that government terminating the concession of subsidiary KCS Mexico.
Clear Channel, with its burgeoning billboard business notes “International regulation of the outdoor advertising industry can vary by municipality, region and country but generally limits the size, placement, nature and density of out-of-home displays. Other regulations may limit the subject matter and language of out-of-home displays.”
Jet-maker Lear has “substantial manufacturing and distribution facilities in many foreign countries, including Mexico and countries in Europe, Central and South America, Africa and Asia.” Lear terms “substantial” its exposure to risks like withholding and other taxes on remittances, increases in working capital requirements, expropriation, and “political, economic and civil instability (including acts of terrorism, civil unrest, drug-cartel related and other forms of violence and outbreaks of war).”
In 2010, Owens-Illinois booked $4.7 billion in net sales from its international operations, representing 71% of the company’s sales. In addition to the garden variety political risks disclosed by virtually all companies doing business abroad, O-I also cited the risk of hyperinflation in certain countries where it does business.
Many of the disclosures in this year’s 10-K filings will be seemingly duplicative. Foreign currency risk is nothing new; the risk of war, terrorism or civil unrest has never been far away even in the most placid times. In spite of their many common denominators, different industries still maintain varying levels of exposure to often unique risks. The challenge for filers is, as always, to anticipate where these risks will pop up next.
This article was first published by ThomsonReuters’ Westlaw Business Currents, a leading provider of legal analysis and news on governance, transactions and legal risk. Visit Westlaw Business Currents online at http://currents.westlawbusiness.com.