ITEM 1A. RISK FACTORS
RISKS RELATING TO THE ENTEGRIS TRANSACTION
BECAUSE THE EXCHANGE RATIO IS FIXED AND WILL NOT BE ADJUSTED IN THE EVENT OF ANY CHANGE IN EITHER ENTEGRIS’ OR OUR STOCK PRICE, THE VALUE OF THE SHARES OF ENTEGRIS FOLLOWING THE CLOSING IS UNCERTAIN.
Upon completion of the Entegris Transaction, each share of CMC common stock outstanding immediately before the Entegris Transaction will be converted into and become exchangeable for $133 in cash and 0.4506 shares of Entegris common stock. This exchange ratio is fixed in the Merger Agreement and will not be adjusted for changes in the market price of either Entegris common stock or CMC common stock. The market prices of Entegris common stock and CMC common stock have fluctuated before and after the date of the announcement of the Merger Agreement and will continue to fluctuate.
Because part of the value of the merger consideration will depend on the market price of Entegris common stock at the time the Entegris Transaction is completed, CMC stockholders will not know or be able to determine the market value of the merger consideration they would receive upon completion of the Entegris Transaction.
Stock price changes may result from a variety of factors, including, among others, changes in CMC’s or Entegris’ respective businesses, operations and prospects, reductions or changes in U.S. and foreign government spending or budgetary policies, market assessments of the likelihood that the Entegris Transaction will be completed, interest rates, general market, industry, geopolitical and economic conditions and other factors generally affecting the respective prices of CMC’s or Entegris’ common stock, federal, state and local legislation, governmental regulation and legal developments in the industry segments in which CMC or Entegris operate, and the timing of the Entegris Transaction and receipt of required regulatory approvals.
Many of these factors are beyond CMC’s control, and CMC is not permitted to terminate the Merger Agreement solely due to a decline in the market price of Entegris common stock.
THE ENTEGRIS TRANSACTION MAY NOT BE COMPLETED WITHIN THE EXPECTED TIMEFRAME, OR AT ALL, AND FAILURE TO COMPLETE IT COULD ADVERSELY AFFECT OUR BUSINESS, RESULTS OF OPERATIONS, FINANCIAL CONDITIONS, AND THE MARKET PRICE OF OUR COMMON STOCK
There can be no assurance that the Entegris Transaction will be completed in the expected timeframe, or at all. The Merger Agreement contains a number of conditions that must be satisfied or waived prior to the completion of the Entegris Transaction, including (i) the receipt of all consents, approvals or authorizations of, declarations or filings under other applicable competition laws and foreign investment laws; (ii) the absence of certain legal impediments preventing the completion of the Merger; (iii) the authorization for listing of Entegris common stock to be issued in connection with the merger on the NASDAQ and (iv) the accuracy of the representations and warranties of the parties and the compliance by the parties with their respective covenants in the Merger Agreement.
There can be no assurance that all required consents and approvals will be obtained or that all closing conditions will otherwise be satisfied (or waived, if applicable), and, if all required consents and approvals are obtained and all closing conditions
are satisfied (or waived, if applicable), we can provide no assurance as to the terms, conditions and timing of such consents and approvals or that the Entegris Transaction will be completed in a timely manner or at all. Many of the conditions to completion of the Entegris Transaction are not within either our or Entegris’ control, and we cannot predict when or if these conditions will be satisfied (or waived, as applicable). Even if regulatory approval is obtained, it is possible conditions will be imposed that could result in a material delay in, or the abandonment of, the Entegris Transaction or otherwise have an adverse effect on us.
If the Entegris Transaction is not completed within the expected timeframe or at all, we may be subject to a number of material risks. The price of our common stock may decline to the extent that current market prices reflect a market assumption that the Entegris Transaction will be completed. In addition, some costs related to the Entegris Transaction must be paid whether or not the Entegris Transaction is completed, and we have incurred, and will continue to incur, significant costs, expenses and fees for professional services and other transaction costs in connection with the proposed transaction, as well as the diversion of management and resources towards the Entegris Transaction, for which we will have received little or no benefit if completion of the Entegris Transaction does not occur. We may also experience negative reactions from our investors, employees, customers, suppliers, vendors, strategic partners or others that deal with us.
THE ANNOUNCEMENT AND PENDENCY OF THE ENTEGRIS TRANSACTION COULD ADVERSELY AFFECT OUR BUSINESS, RESULTS OF OPERATIONS, FINANCIAL CONDITION, AND THE MARKET PRICE OF OUR COMMON STOCK
The announcement and pendency of the Entegris Transaction could cause disruptions in and create uncertainty surrounding our business, which could have an adverse effect on our business, results of operations, financial condition and the market price of our common stock. These risks to our business include the following, all of which could be exacerbated by a delay in the completion of the Entegris Transaction: (i) the effect of restrictions placed on us and our subsidiaries’ ability to operate our businesses under the Merger Agreement, including our ability to pursue alternatives to the proposed transaction as further described below; (ii) the risk of disruption resulting from the proposed transaction, including the diversion of our management’s attention from ongoing business operations; (iii) the effect of the announcement of the proposed transaction on our ability to retain and hire employees; (iv) the effect of the announcement of the proposed transaction on our business relationships, operating results and businesses generally; (v) the occurrence of any event giving rise to the right of a party to terminate the Merger Agreement; and (vi) the effect of any legal proceedings that may be instituted against us related to the Entegris Transaction as further described below.
THE MERGER AGREEMENT CONTAINS PROVISIONS THAT COULD DISCOURAGE OR DETER A POTENTIAL COMPETING ACQUIRER THAT MIGHT BE WILLING TO PAY MORE TO EFFECT A BUSINESS COMBINATION WITH US
Unless and until the Merger Agreement is terminated in accordance with its terms, subject to certain specified exceptions, we are not permitted to solicit, seek, initiate or knowingly facilitate or knowingly encourage any inquiries regarding, or the making of, or any submission or announcement of a proposal or offer that constitutes, or would reasonably be expected to lead to, any acquisition proposal or engage in, continue or otherwise participate in any discussions or negotiations regarding, or furnish to any other person any non-public information in connection with or for the purpose of encouraging or facilitating, any acquisition proposal or any inquiry or proposal that could reasonably be expected to lead to an acquisition proposal.
These provisions could discourage a potential competing acquirer from considering or proposing an acquisition or merger, even if it were prepared to pay consideration with a higher value than that implied by the merger consideration.
CMC WILL INCUR SIGNIFICANT TRANSACTION-RELATED AND INTEGRATION COSTS IN CONNECTION WITH THE ENTEGRIS TRANSACTION
We have incurred and expect to incur a number of non-recurring costs associated with combining our operations with that of Entegris, as well as transaction fees and other costs related to the Entegris Transaction. These costs and expenses include fees paid to financial, legal and accounting advisors, facilities and systems consolidation costs, severance and other potential employment-related costs, including retention and severance payments that may be made to certain CMC employees, filing fees, printing expenses and other related charges. Some of these costs are payable by us regardless of whether the Entegris Transaction is completed.
The combined company will also incur integration costs in connection with the merger. There are a large number of processes, policies, procedures, operations, technologies and systems that must be integrated in connection with the merger and the integration of the two companies’ businesses. Although we expect that the elimination of duplicative costs, strategic benefits, additional income as well as the realization of other efficiencies related to the integration of the businesses may offset incremental transaction-related and integration costs over time, any net benefit may not be achieved in the near term or at all. Many of these costs will be borne by us even if the merger is not completed. While we have assumed that certain expenses would be incurred in connection with the Entegris Transaction and the other transactions contemplated by the Merger Agreement, there are many factors beyond our control that could affect the total amount or the timing of the integration and implementation expenses.
LITIGATION RELATING TO THE ENTEGRIS TRANSACTION HAS BEEN FILED AGAINST US AND OUR BOARD OF DIRECTORS, AND ADDITIONAL LITIGATION MAY BE FILED AGAINST US AND OUR BOARD OF DIRECTORS IN THE FUTURE, WHICH COULD PREVENT OR DELAY THE COMPLETION OF THE ENTEGRIS TRANSACTION OR RESULT IN THE PAYMENT OF DAMAGES
Litigation relating to the Entegris Transaction has been filed against us and our board of directors, and though we believe we have mooted all claims that were filed it is possible that additional litigation by our stockholders may be filed against us and our board of directors in the future. The outcome of any litigation is uncertain and any such lawsuits could prevent or delay the completion of the Entegris Transaction and may be costly and distracting to our management.
RISKS RELATING TO OUR BUSINESS, STRATEGY AND OPERATIONS
OUR BUSINESS AND RESULTS OF OPERATIONS MAY CONTINUE TO BE ADVERSELY AFFECTED BY THE ONGOING CORONAVIRUS (COVID-19) PANDEMIC AND RELATED ADVERSE IMPACT TO WORLDWIDE ECONOMIC AND INDUSTRY CONDITIONS
The global impact of the Pandemic, which has created significant volatility, uncertainty and economic disruption across the world and in the countries and locations in which we and our customers and suppliers operate, continues in varying degrees and locations, especially in places experiencing low vaccination rates and/or the spread of variants of the COVID-19 virus. Overall, our Electronic Materials segment has remained generally stable throughout the Pandemic, and strengthened through fiscal 2020 and 2021 and into our first and second quarters of fiscal 2022, with increased demand conditions from the prior year in each of our Electronic Materials businesses, despite the ongoing nature of the Pandemic. With respect to our Performance Materials segment, while the Pandemic has had a significant adverse impact on our Performance Materials’ PIM business, which first appeared during the second half of our fiscal 2020 and continued through our first quarter of fiscal 2022, as the demand for drag reducing agents (“DRAs”) declined significantly due to the ongoing dislocation in the energy sector caused by the Pandemic, demand for our PIM products strengthened significantly in our second quarter of fiscal 2022. Despite the improvement in demand conditions to date in fiscal 2022 year over year and sequentially, recovery has been lower than anticipated, and certain factors such as inflationary costs related to raw materials continue to adversely affect the PIM reporting unit. The extent to which the ongoing Pandemic may further impact our business, operations, results of operations and financial condition is uncertain and difficult to estimate, and depends on numerous evolving factors that we may not be able to accurately predict, which may include: an ongoing adverse global economic environment with respect to inflationary pressures and supply chain dislocations that could further reduce demand and/or pricing for our products and services; Disruptions to our supply chain in connection with the sourcing of or pricing for materials, equipment and logistics or other services and support necessary to our business as a longer term result of the Pandemic and efforts to contain the spread of the Pandemic; Adverse impacts on our business and those of our customers resulting from renewed actions taken by governments, businesses, or the general public in an effort to limit exposure to and spread of such infectious diseases, such as renewed travel restrictions, quarantines, and business shutdowns or slowdowns; Negative impacts to our operations, including reductions in production levels, research and development (“R&D”) activities, and qualification activities with our customers; and, deterioration of worldwide credit and financial markets that could limit our ability to obtain external financing to fund our operations and capital expenditures, result in losses on our holdings of cash and investments due to failures of financial institutions and other parties, and result in losses on our accounts receivables due to credit defaults or our customers’ inability to pay. These effects, alone or taken together, could have a material adverse effect on our business, results of operations, legal exposure, or financial condition. A further sustained or prolonged outbreak or return of the Pandemic in the places in which we do business, such as that seen in the spread of variants of the COVID-19 virus through our first and second quarters of fiscal 2022, could exacerbate the adverse impact of such measures on our Company.
DEMAND FOR OUR PRODUCTS FLUCTUATES AND OUR BUSINESS MAY BE ADVERSELY AFFECTED BY WORLDWIDE ECONOMIC, INDUSTRY AND OTHER CONDITIONS
Our business is affected by economic and industry conditions, such as those still being adversely affected by the Pandemic, and the majority of our revenue derives from our Electronic Materials segment, which is primarily dependent upon semiconductor industry demand. With respect to our Electronic Materials segment, historically, semiconductor industry demand has fluctuated due to economic and industry cycles and seasonal shifts in demand, which can affect our business, causing demand for our electronic materials products to fluctuate. For example, prior to the Pandemic, the relatively soft demand conditions in the semiconductor industry that had commenced in our second fiscal quarter of 2019 and continued into our first fiscal quarter of 2020 had begun to ameliorate in the beginning of the second fiscal quarter of 2020. While our Electronic Materials segment experienced relatively stable conditions during the second half of fiscal 2020 and strengthened through fiscal 2021 and our first and second quarters of fiscal 2022, uncertainty remains as to our fiscal 2022 demand conditions for the semiconductor industry given the continued impact of the Pandemic, albeit ameliorating, and related macroeconomic and geopolitical challenges such as those occasioned by Russia’s invasion of Ukraine and the resulting ongoing conflict, including inflationary pressures, supply chain and logistics challenges, as well as related including supply constraints at some of our customers serving certain areas, such as the automotive and industrial sectors. Furthermore, competitive dynamics within the semiconductor industry may impact our
business. Our limited visibility to future customer orders makes it difficult for us to predict industry trends, especially during unusual adverse circumstances, such as the Pandemic and related macroeconomic and geopolitical factors. If the global economy or the semiconductor industry does not continue to improve or weakens again, whether in general or as a result of the Pandemic or other specific factors, such as macroeconomic factors, or unpredictable events such as natural disasters, geopolitical conditions such as those related to Russia’s invasion of Ukraine and the ongoing conflict, and international trade tensions, civil unrest, or additional global health crises, we could experience material adverse impacts on our results of operations and financial condition. Some additional factors that may affect demand for our electronic materials products include: demand trends for different types of electronic devices such as logic versus memory integrated circuit (“IC”) devices, or digital versus analog IC devices; the various technology nodes at which those products are manufactured; customers' efficiencies in the use of CMP consumables and/or high-purity process chemicals (“electronic chemicals”); customers’ device architectures and specific manufacturing processes; the short order to delivery time for our products; quarter-to-quarter changes in customer order patterns; market share and competitive gains and losses; and pricing changes by us and our competitors.
As to our Performance Materials segment, although demand for our PIM products increased in the first and second quarters of fiscal 2022, our PIM business may be further impacted by changes in the oil and gas industries, such as the ongoing significant dislocation in these industries caused by the Pandemic and supply chain related challenges. Expectations about future prices and price volatility in the sector, which affect our customers’ activity levels, are important in determining future spending levels for customers of our PIM products and services. The ongoing volatility in worldwide oil and natural gas prices and markets are an example of historical volatility in this sector, and such volatility is likely to continue in the future. As is currently the case, prices for oil and natural gas are subject to wide fluctuations in response to relatively minor or major changes in the supply of and demand for oil and natural gas, market uncertainty and a variety of additional factors that are beyond our control. These factors include, but are not limited to, decreases or increases in supplies from U.S. shale production or other oil production, geopolitical conditions, including armed conflict such as Russia’s invasion of Ukraine and international trade tensions, sovereign debt crises, the domestic and foreign supply of oil and natural gas, the level of consumer demand due to economic growth or contraction such as seen related to the Pandemic, and related factors in countries such as China, weather conditions, domestic and foreign governmental regulations and taxes, the price and availability of alternative fuels, the health of international economic and credit markets, the ability of the members of the Organization of the Petroleum Exporting Countries and other state-controlled oil companies to agree upon and maintain oil price and production controls, and general economic conditions, such as those currently seen arising from the Pandemic.
Further, adverse global economic, industry and other conditions could have other negative effects on our Company. For instance, we could experience negative impacts on cash flows due to the inability of our customers to pay their obligations to us, or our production processes and profitability could be harmed if our suppliers significantly raise their prices, or cannot fulfill their obligations, to us. As a result of these or other conditions, and as experienced in the second quarter of our fiscal year 2021 with the impairment charge we took in our PIM business unit, further described in Note 9 of “Notes to the Consolidated Financial Statements” included in Item 8 of Part II of our Annual Report on Form 10-K for the fiscal year ended September 30, 2021, we also might have to further reduce the carrying value of goodwill and other intangible assets, which could harm our financial position and results of operations.
WE HAVE A CONCENTRATED PRODUCT RANGE WITHIN EACH OF OUR SEGMENTS AND OUR PRODUCTS MAY BECOME OBSOLETE, OR TECHNOLOGICAL CHANGES MAY REDUCE OR LIMIT INCREASES IN THE CONSUMPTION OF OUR PRODUCTS
Although our product offerings have expanded over the past several years, including as a result of the acquisitions of KMG and ITS, our business remains substantially dependent on products in our Electronic Materials segment, such as CMP slurries, pads and electronic chemicals, and materials technologies, which account for the majority of our revenue. The product offerings in our Performance Materials segment are similarly concentrated. As such, our business would suffer if these products became obsolete or if consumption of these products decreased. Our success depends on our ability to keep pace with technological changes and advances in the industries in which we operate, particularly the semiconductor industry, to adapt, improve and customize our products in response to evolving customer needs and industry trends, and to differentiate our products from those of our competitors. Since its inception, the semiconductor industry, which is the largest industry in which we operate, has experienced technological changes and advances in the design, manufacture, performance and application of IC devices. Our customers continually pursue lower cost of ownership and higher quality and performance of materials consumed in their manufacturing processes, including products in our Electronic Materials business segment, as a means to reduce costs, increase the yield in their manufacturing facilities, and achieve desired performance of the IC devices they produce. We expect these technological changes, and this drive toward lower costs, higher quality and performance and higher yields, will continue in the future. Potential technology developments in the semiconductor industry, as well as our customers' efforts to reduce consumption of CMP consumables, including through use of smaller quantities, could render our products less important to the IC device manufacturing process.
A SIGNIFICANT AMOUNT OF OUR BUSINESS COMES FROM A LIMITED NUMBER OF LARGE CUSTOMERS AND OUR REVENUE AND PROFITS COULD DECREASE SIGNIFICANTLY IF WE LOST ONE OR MORE OF THESE CUSTOMERS OR BUSINESS FROM THEM
Our customer base is concentrated among a limited number of large customers in each of our segments. Currently, our principal business supplies electronic materials primarily to the semiconductor industry. The semiconductor industry has been consolidating as the larger semiconductor manufacturers have generally grown faster than the smaller ones, through business gains, mergers and acquisitions, and strategic alliances. Industry analysts predict that this trend will continue, which means the semiconductor industry will continue to be comprised of fewer and larger participants in the future if their prediction is correct. In addition, our customer base in our PIM business is also somewhat concentrated, with large entities predominant, and outside of the U.S., these entities frequently are state-owned or sponsored, and limited in number per country. One or more of these principal customers could stop buying products from us or could substantially reduce the quantity of products purchased from us. Our principal customers in both our segments also hold considerable purchasing power, which can impact the pricing and terms of sale of our products. Any deferral or significant reduction in the quantity or price of products sold to these principal customers, an inability to raise prices to address cost pressures or otherwise, or a weakening of the financial condition of or failure to perform contractual obligations by one of these principal customers, could significantly harm our business, financial condition and results of operations.
ANY PROBLEM OR DISRUPTION IN OUR SUPPLY CHAIN, INCLUDING SUPPLY OF OUR MOST IMPORTANT RAW MATERIALS, OR IN OUR ABILITY TO MANUFACTURE OR DELIVER OUR PRODUCTS TO OUR CUSTOMERS, COULD ADVERSELY AFFECT OUR RESULTS OF OPERATIONS
We depend on our supply chain to enable us to meet the demands of our customers. Our supply chain includes the raw materials we use to manufacture our products, our production operations and the means by which we deliver our products to our customers. Our business could be adversely affected by any problem or interruption in the supply of the key raw materials we use in our products, including raw materials that do not meet the stringent quality and consistency requirements of our customers, any problem or interruption that may occur during production or delivery of our products, such as weather-related problems, natural disasters, logistics challenges, global public health crises such as the ongoing Pandemic, geopolitical issues such as those related to Russia’s invasion of Ukraine and the ongoing conflict, trade or labor-related issues, civil unrest, or any difficulty in producing sufficient quantities of our products to meet growing demand from our customers. In particular, natural disasters and severe weather conditions have the potential to adversely affect our operations, damage facilities and increase our costs, and those conditions may also have an indirect effect on our operations by disrupting services provided by service companies or suppliers with whom we have a business relationship. Additionally, some of our full-time employees are represented by labor unions, works councils or comparable organizations, particularly in Europe. An extended work stoppage, slowdown or other action by our employees could significantly disrupt our business. As our current agreements with labor unions and works councils expire, we cannot provide assurance that new agreements will be reached at the end of each period without union action, or that a new agreement will be reached on terms satisfactory to us. Future labor contracts may be on terms that result in higher labor costs to us, which also could adversely affect our results of operations. As experienced in the second half of our fiscal 2021 and ongoing through the first half of our fiscal 2022, our supply chain may also be negatively impacted by unanticipated price increases due to factors such as inflation or to supply restrictions beyond the control of our Company or our raw materials suppliers, such as those related to or arising from the Pandemic.
We believe it would be difficult to promptly secure alternative sources of key raw materials in the event one of our suppliers becomes unable to supply us with sufficient quantities of raw materials that meet the quality and technical specifications required by us and our customers, or the costs of such raw materials increase in an untenable manner. Requalifying and/or transferring our sourcing to a new supplier would likely result in manufacturing delays and additional costs. In addition, new contract terms, forced production or manufacturing changes, contractual amendments to existing agreements with, or non-performance by, our suppliers, including any significant financial distress our suppliers may suffer, could adversely affect us. Also, if we change the supplier or type of key raw materials we use to make our products, in particular our electronic materials products, or are required to purchase them from a different manufacturer or manufacturing facility or otherwise modify our products, in certain circumstances our customers might have to requalify our products for their manufacturing processes and products. The requalification process could take a significant amount of time and expense to complete and could occupy technical resources of our customers that might otherwise be used to evaluate our new products, thus delaying potential revenue growth, or motivate our customers to consider purchasing products from our competitors, possibly interrupting or reducing our sales of products to these customers, especially sales of our electronic materials products to our semiconductor industry customers, but also with respect to our PIM products to our pipeline and adjacent industry customers. In addition, government authorities in the foreign countries in which we operate may require or incentivize the use of local suppliers that are our competitors, which could adversely impact our business, including our results of operations.
OUR BUSINESS COULD BE ADVERSELY IMPACTED IF WE ARE NOT SUCCESSFUL IN ACHIEVING TARGETED SAVINGS AND EFFICIENCIES FROM COST REDUCTION INITIATIVES
To mitigate cost challenges and improve our business and financial performance, we have initiated an enterprise-wide cost optimization program, called “Future Forward,” designed to reduce expenses and enhance operational efficiencies. The Future Forward Program has and may include position eliminations, location rationalization, and reductions in outside services and discretionary spending, as well as other actions to reduce costs. We may not realize anticipated cost savings or other benefits from such initiatives, whether at all or according to timetables we have established. If we are unable to realize the anticipated benefits, our ability to fund other initiatives may be adversely affected, and failure to implement these initiatives in accordance with our plans could adversely affect our business.
OUR BUSINESS COULD BE SERIOUSLY HARMED IF OUR COMPETITORS DEVELOP COMPETITIVE PRODUCTS, OFFER BETTER PRICING, SERVICE OR OTHER TERMS, OR OBTAIN OR ASSERT CERTAIN INTELLECTUAL PROPERTY RIGHTS
Competition from other electronic materials or performance materials providers or any new entrants could seriously harm our business and results of operations, and this competition could continue to increase. Competition has and will likely continue to impact the prices we are able to charge for our products, as well as our overall business. In addition, our competitors could have, obtain or assert intellectual property rights that could affect or restrict our ability to market our existing products and/or to innovate and develop new products, thus increasing our costs of doing business, could attempt to introduce products similar to ours following the expiration of our patents, or could attempt to introduce products that do not fall within the scope of our intellectual property rights.
WE ARE SUBJECT TO RISKS ASSOCIATED WITH OUR INTERNATIONAL OPERATIONS
We currently have operations and a large customer base outside the U.S. Approximately 68% of our revenue was generated by sales to customers outside the U.S. for the fiscal year ended September 30, 2021. We may encounter risks in doing business in certain countries other than the U.S., including, but not limited to, adverse changes in economic and political conditions, both in foreign locations and in the U.S. with respect to non-U.S. operations of U.S. businesses like ours, geopolitical issues such as those related to Russia’s invasion of Ukraine and the ongoing conflict, trade tensions, global health crises such as the ongoing Pandemic, civil unrest, fluctuation in exchange rates, changes in international trade requirements and sanctions and/or tariffs that affect our business and that of our customers and suppliers, compliance with a variety of foreign laws and regulations and related audits and investigations, as well as difficulty in enforcing business and customer contracts and agreements, including protection of intellectual property rights. We also may encounter risks that we may not be able to repatriate additional earnings from our operations outside the U.S., derive anticipated tax benefits of these operations or recover the investments made in them, whether due to regulatory or policy changes in the U.S. or in the countries outside of the U.S. in which we do business, or other factors.
In particular, China continues to be an important market for the semiconductor industry, and an area of continued potential growth for us. As business between China and the rest of the world has continued to grow, there is risk that geopolitical, political, diplomatic and national security factors, changes in U.S. and foreign laws and regulations, the imposition of trade restrictions, tariffs and taxes, and global public health crises such as the Pandemic could adversely affect business for companies like ours. This is due in significant part to the complex relationships among China, the U.S., and other countries, especially those in the Asia Pacific region, such as Taiwan, which also is important to our Company with respect to our customers as well as our operations, which could have a material adverse impact on our business. In addition, there are risks that the Chinese government may, among other things, require the use of local suppliers, compel companies that do business in China to partner with local companies to conduct business, or, provide incentives to government-backed local customers to buy from local suppliers rather than companies like ours, all of which could adversely impact our business, including our results of operations. Also, as seen in the past several years, there are risks that the U.S. government may impose additional export restrictions on technology and products that companies that operate in the semiconductor industry supply to or use in China, which could adversely impact our business and our results of operations.
In addition, we have operations and customers located in the United Kingdom, which exited the European Union (“EU”). As the transitional provisions under which the United Kingdom and the EU had agreed to operate expired at the end of December 2020, and the parties are still in the process of implementing new trade agreements, the related impacts on our business remain unclear.
LEGAL, COMPLIANCE AND REGULATORY RISKS
WE ARE SUBJECT TO EXTENSIVE ENVIRONMENTAL LAWS AND REGULATIONS AND MAY INCUR COSTS THAT HAVE AN ADVERSE EFFECT ON OUR FINANCIAL CONDITION AS A RESULT OF VIOLATIONS OF OR LIABILITIES UNDER THEM
Like other companies involved in environmentally sensitive businesses, our operations and properties are subject to extensive and stringent federal, state, local and foreign Environmental, Health and Safety (“EHS”) laws and regulations, including those concerning, among other things:
•the marketing, sale, use and registration of our chemical products, such as pentachlorophenol (“penta”), which is part of the wood treatment business in our Performance Materials segment;
•the treatment, storage and disposal of wastes;
•the investigation and remediation of contaminated media including but not limited to soil and groundwater;
•the discharge of effluents into waterways;
•the emission of substances into the air; and
•other matters relating to environmental protection and various health and safety matters.
The United States EPA and other federal and state agencies in the U.S., as well as comparable agencies in other countries where we have facilities or sell our products, have the authority to promulgate regulations that could have a material adverse impact on our operations. These EHS laws and regulations may require permits for certain types of operations, require the installation of expensive pollution control equipment, place restrictions upon operations or impose substantial liability for pollution and other EHS concerns resulting from our operations. Compliance with EHS laws and regulations has resulted in ongoing costs for us and could restrict our ability to modify or expand our facilities, continue production, require us to install costly emission control equipment, or incur significant other expenses, including environmental compliance costs. We continue to manage environmental compliance activities at certain sites, such as at KMG-Bernuth’s Tuscaloosa, Alabama facility as described in Note 19 of “Notes to the Consolidated Financial Statements” included in Item 8 of Part II of our Annual Report on Form 10-K for the fiscal year ended September 30, 2021 and in Note 13 of Part 1 of this Report on Form 10-Q. We have incurred, and expect to continue to incur, significant costs to comply with EHS laws or to address liabilities for contamination resulting from past or present operations. Federal, state and foreign governmental authorities may seek fines and penalties, as well as injunctive relief, for violation of EHS laws and regulations, and could, among other things, impose liability on us to cleanup or to respond to potential damages to the environment or natural resources resulting from a release of pesticides, hazardous materials or other chemicals into the environment. We maintain insurance coverage for sudden and accidental environmental pollution or damages. We do not believe that insurance coverage for environmental pollution or damage that occurs over time is available at a reasonable cost. Also, we do not believe that insurance coverage for the full potential liability that could be caused by sudden and accidental pollution incidents is available at a reasonable cost. Accordingly, we may be subject to an uninsured or under-insured loss in such cases; the KMG-Bernuth warehouse fire, as described in Note 13 of Part 1 of this Report on Form 10-Q, may be such an instance.
The distribution, sale and use of our products is subject to prior governmental approvals and thereafter ongoing governmental regulation: Our products are subject to laws administered by federal, state and foreign governments, including regulations requiring registration, approval and labeling. The labeling requirements restrict the use and type of application for our products. More stringent restrictions could make our products less desirable which would adversely affect our sales and profitability. All venues where our penta products are used also require registration prior to marketing or use.
Governmental regulatory authorities have required, and may require in the future, that certain scientific testing and data production be provided on our products. Under the Federal Insecticide, Fungicide and Rodenticide Act (“FIFRA”), the EPA requires registrants to submit a wide range of scientific data to support U.S. registrations. This requirement significantly increases our Operating expenses, and we expect those expenses will continue in the future while we operate the wood treatment business. Because scientific analyses are constantly improving, we cannot determine with certainty whether or not new or additional tests may be required by regulatory authorities. While good laboratory practice standards specify the minimum protocols and procedures that must be followed in order to ensure the quality and integrity of data related to these tests submitted to the EPA, there can be no assurance that the EPA will not request certain tests or studies be repeated. In addition, more stringent legislation or requirements may be imposed in the future and proposed amendments to the Toxic Substances Control Act could result in increased regulatory controls , additional testing of chemicals we manufacture and could increase the costs of compliance for our operations. We can provide no assurance that the cost of such compliance will not adversely affect our profitability. Our products could also be subject to other future regulatory action that may result in restricting or completely banning their use which could have an adverse effect on our performance and results of operations.
1. The Registration, Evaluation and Authorization of Chemicals (“REACH”) legislation may affect our ability to manufacture and sell certain products in the EU: REACH requires chemical manufacturers and importers in the EU to prove the safety of their products. We were required to pre-register certain products and file comprehensive reports, including testing data, on each chemical substance, and perform chemical safety assessments. Additionally, substances of high concern are subject to an authorization process. Authorization may result in restrictions on certain uses of products or even prohibitions on the manufacture or importation of products. The full registration requirements of REACH have been phased in over several years, and we have incurred additional expense to cause the registration of our products under these regulations. REACH may also affect our ability to import, manufacture and sell certain products in the EU. In addition, other countries and regions of the world already have or may adopt legislation similar to REACH that affect our business, affect our ability to import, manufacture or sell certain products in these jurisdictions, and have required or will require us to incur increased costs.
2. The classification of penta as a Persistent Organic Pollutant (“POP”) under the Stockholm Convention adversely affected our ability to manufacture or sell our penta products and completed our exit of this business in the second quarter of fiscal 2022. We took a restructuring charge in our fourth fiscal quarter of 2019, and asset impairment charges in each the fourth quarter of fiscal 2019, the fourth quarter of fiscal 2020, each of our quarters of fiscal 2021, and the first quarter of fiscal 2022, related to the decisions to close our wood treatment facilities and to exit the wood treatment business, as described further in Note 8 of Part 1 of this Report on Form 10-Q and in Note 10 of “Notes to the Consolidated Financial Statements” included in Item 8 of Part II of our Annual Report on Form 10-K for the fiscal year ended September 30, 2021. No assurance can be given that we will not incur significant expenditures in connection with completing closure of the wood treatment facilities.
3. Our use of hazardous materials exposes us to potential liabilities: Our manufacturing and distribution of chemical products, such as our electronic chemicals, involves the controlled use of hazardous materials. Our operations, therefore, are subject to various associated risks, including chemical spills, discharges or releases of toxic or hazardous substances or gases, fires, mechanical failure, storage facility leaks and similar events. Our suppliers are subject to similar risks that may adversely impact the availability of raw materials. While we adapt our manufacturing and distribution processes to the environmental control standards of regulatory authorities, we cannot completely eliminate the risk of accidental contamination or injury from hazardous or regulated materials, including injury of our employees, individuals who handle our products or goods treated with our products, or others who claim to have been exposed to our products, nor can we completely eliminate the unanticipated interruption or suspension of operations at our facilities due to such events. We may be held liable for significant damages or fines in the event of contamination or injury, and such assessed damages or fines could have an adverse effect on our financial performance and results of operations.
CURRENT OR FUTURE CLIMATE CHANGE REGULATIONS COULD RESULT IN INCREASED OPERATING COSTS AND REDUCED DEMAND FOR OUR PRODUCTS
The U.S. has rejoined the Paris Climate Accord but to date, has not ratified the Kyoto Protocol. The Clean Air Act has been interpreted to regulate greenhouse gas (“GHG”) emissions and the EPA is using its existing regulatory authority to develop regulations requiring reduction in GHG emissions from various categories of sources, such as when a permit is required due to emissions of other pollutants. Because of the lack of any comprehensive legislation program addressing GHGs, a number of U.S. federal laws related to GHG emissions have been considered by the U.S. Congress from time to time and various state, local and regional regulations and initiatives have been enacted or are being considered related to GHGs.
Member States of the EU each have an overall cap on emissions, which are approved by the European Commission, and implement the EU Emissions Trading Directive as a commitment to the Kyoto Protocol. GHG emissions are regulated by Member States through the EU Emission Trading System and the EU Effort Sharing Decision/Regulation depending upon the industry sector. Organizations apply to the Member State for an allowance of GHG emissions. These allowances are tradable so as to enable companies that manage to reduce their GHG emissions to sell their excess allowances to companies that are not reaching their emissions objectives. Failure to purchase sufficient allowances will require the purchase of allowances at a current market price.
Any laws or regulations that may be adopted to restrict or reduce emissions of GHGs could cause an increase to our raw material costs, require us to incur increased operating costs, and have an adverse effect on demand for our products and our financial performance and results for our business.
In addition to GHG and climate change regulatory developments and legislation, we are continuing to evaluate and assess the potential impact on our business of the ongoing transition worldwide to a low carbon, resilient economy as well as physical effects resulting from climate change.
OUR PRODUCTS MAY BE RENDERED OBSOLETE OR LESS ATTRACTIVE BY CHANGES IN INDUSTRY REQUIREMENTS OR BY SUPPLY-CHAIN DRIVEN PRESSURES TO SHIFT TO ENVIRONMENTALLY PREFERABLE ALTERNATIVES
Changes in regulatory, legislative and industry requirements, or changes driven by supply-chain pressures, may shift current customers away from products using penta, products containing hazardous materials, or certain of our other products and toward alternative products that are believed to have fewer environmental effects. The EPA, foreign and state regulators, local governments, private environmental advocacy organizations, investors and investor advisory firms, and a number of large industrial companies have proposed or adopted policies designed to decrease the use of a variety of chemicals, including penta and others included in certain of our products, such as those containing hazardous materials, or to counteract the growth of certain industries such as those in which customers served by our PIM products operate. Our ability to anticipate changes in regulatory, legislative, investor, and industry requirements, or changes driven by supply-chain pressures, may affect our ability to remain competitive. Further, we may not be able to comply with changed or new regulatory or industrial standards that may be necessary for us to remain competitive.
We cannot provide assurance that the EPA, foreign and state regulators or local governments will not restrict the uses of certain of our products, like penta, or ban the use of one or more of these products or the raw materials in them. Similarly, companies who use our products may voluntarily decide to reduce significantly or cease the use of our products. As a result, our products may become obsolete or less attractive to our customers.
GENERAL COMMERCIAL, OPERATIONAL, FINANCIAL AND REGULATORY RISKS
BECAUSE WE RELY ON OUR INTELLECTUAL PROPERTY, OUR FAILURE TO ADEQUATELY OBTAIN OR PROTECT IT COULD SIGNIFICANTLY HARM OUR BUSINESS
Protection of intellectual property is particularly important in the semiconductor industry, which is the primary industry in which we participate, because we develop complex technical formulas and processes for products that are proprietary in nature and differentiate our products from those of our competitors. Our intellectual property is important to our success and ability to compete. We attempt to protect our intellectual property rights through a combination of patent, trademark, copyright and trade secret laws, as well as employee and third-party nondisclosure and assignment agreements. In addition, we protect our product differentiation through various other means, such as proprietary supply arrangements for certain raw materials, and use of certain manufacturing technologies. Due to our international operations, we pursue protection in different jurisdictions, which may provide varying degrees of protection, and we cannot provide assurance that we can obtain adequate protection in each such jurisdiction. Our failure to obtain or maintain adequate protection of our intellectual property rights for any reason, including through the patent prosecution process or in the event of litigation related to such intellectual property, which we pursue when necessary to protect our rights against others who are found to be misusing our intellectual property, could seriously harm our business. In addition, certain types of intellectual property, such as patents, expire after a certain period of time, and products protected by our patents then lose such protection, so we refresh our intellectual property portfolio on an ongoing basis through continued innovation, and failure to do so could adversely affect our business. Also, the costs of obtaining or protecting our intellectual property could negatively affect our operating results.
OUR INABILITY TO ATTRACT AND RETAIN KEY PERSONNEL COULD CAUSE OUR BUSINESS TO SUFFER
We utilize and rely upon a global workforce. If we fail to attract and retain the necessary managerial, technical and customer support personnel, our business and our ability to maintain existing and obtain new customers, develop new products and provide acceptable levels of customer service could suffer. We compete worldwide with other participants in the industries in which we conduct business for qualified personnel, particularly those with significant experience in the semiconductor and pipeline industries. The loss of services of key employees, or our inability to obtain or maintain visas or other travel or residency documents on their behalf with respect to our business needs, could harm our business and results of operations.
CERTAIN CRITICAL INFORMATION SYSTEMS COULD BE SUSCEPTIBLE TO CYBERSECURITY AND OTHER THREATS OR VULNERABILITIES
We maintain and rely upon certain critical information systems for the effective operation of our business. These information systems include, but are not limited to, telecommunications, the Internet, our corporate intranet, various computer hardware and software applications, production control systems, enterprise resource planning systems, network communications, and email. These information systems may be owned and maintained by us, our outsourced providers, or third parties such as vendors, contractors, and Cloud providers. All these information systems are subject to disruption, breach or failure from various sources including, but not limited to, attacks, degradation, and failures resulting from potential sources, including viruses, malware, denial of service, ransomware, destructive or inadequate code, power failures, and physical damage. Confidential and/or sensitive information stored on these information systems, or transmitted to or from Cloud storage, could be intentionally or unintentionally compromised, lost, and/or stolen. While we have implemented security procedures and virus protection software, intrusion
prevention systems, access control, and emergency recovery processes to mitigate risks like these with respect to information systems that are under our control, they are not fail-safe and may be subject to breaches or failures. Further, we cannot assure that third parties upon whom we rely for various IT services will maintain sufficient vigilance and controls over their systems. Our inability to use or access these information systems at critical points in time, or unauthorized releases of personal or confidential information, could unfavorably impact the timely and efficient operation of our business, including our results of operations, and our reputation, as well as our relationships with our employees or other individuals whose information may have been affected by such cybersecurity incidents.
In addition, regulatory authorities have increased their focus on how companies collect, process, use, store, share and transmit personal data. Privacy security laws and regulations, including the United Kingdom’s Data Protection Act 2018 and the EU General Data Protection Regulation 2016, and similar laws in countries such as Korea and Taiwan, among others, pose increasingly complex compliance challenges, which may increase compliance costs, and any failure to comply with data privacy laws and regulations could result in significant penalties that could adversely affect our business and results of operations.
OUR EXISTING CREDIT AGREEMENT COULD RESTRICT, AND THE MERGER AGREEMENT RESTRICTS, OUR BUSINESS ACTIVITIES
Our Amended Credit Agreement contains financial and other covenants that may restrict our business activities or our ability to execute our strategic objectives, and our failure to comply with these covenants could result in a default under it. The Merger Agreement places additional restrictions on our business activities and on our ability to raise capital and/or incur debt.
THE MARKET PRICE FOR OUR COMMON STOCK MAY FLUCTUATE SIGNIFICANTLY AND RAPIDLY
The market price of our common stock has fluctuated and could continue to fluctuate significantly as a result of factors such as: the Entegris Transaction, economic, geopolitical (i.e., Russia’s invasion of Ukraine), global public health (i.e., the Pandemic), political and stock market conditions generally and specifically as they may impact participants in the semiconductor and related industries; and/or participants in oil and gas related industries; changes in financial estimates and recommendations by securities analysts who follow our stock; earnings and other announcements, and changes in market evaluations, by securities analysts, investors, market participants or others, of or related to, us or participants in the semiconductor and related industries; changes in business, trade or regulatory conditions affecting us or participants in the semiconductor and related industries; announcements or implementation by us, our competitors, or our customers of technological innovations, new products or different business strategies; changes in our capital deployment strategy, issuances of shares of our capital stock or entering into a business combination or other strategic transaction; and trading volume of our common stock.