| CADMUS COMMUNICATIONS CORP/NEW ITEM 1A RISK FACTORS You should consider carefully the following factors, as well as the other information set forth in this Annual Report on Form 10-K for the year ended June 30, 2006 |
| Our business is influenced by many factors that are difficult to predict, involve uncertainties that may materially affect actual results and are often beyond our control |
| For other factors that may cause actual results to differ materially from those indicated in any forward-looking statement or projection contained in this report, see Forward-Looking Statements in Management’s Discussion and Analysis of Financial Condition and Results of Operations |
| Risks Relating To Our Business The printing industry is competitive and evolving; this competition may adversely affect our business |
| The printing industry is extremely competitive |
| We compete with numerous companies, some of which have greater financial resources than we do |
| We compete on the basis of market expertise, global production capabilities, ongoing customer service, quality of finished products, range of services offered, distribution capabilities, use of state of the art technology and price |
| We cannot assure you that we will be able to compete successfully with respect to any of these factors |
| Our failure to compete successfully could cause us to lose existing business or opportunities to generate new business and could result in decreased profitability, adversely affecting our business |
| In addition, there is excess capacity in the printing industry |
| This excess capacity increases the likelihood that printers may choose to, or will be forced to, lower prices to win additional volume or to protect existing volume |
| Although we do not compete primarily on price, there is no assurance that these capacity-related pricing issues will not adversely affect us |
| Certain revenues in the Publisher Services segment of our business are cyclical and dependent upon general economic conditions |
| Revenues from our customers who publish special interest and trade magazines are dependent upon general economic conditions |
| Although the special interest magazine market is traditionally less advertising sensitive than the general interest magazine market, demand in this market does depend in part on advertising revenue |
| In addition, both our STM and special interest magazine segments derive incremental revenue from the publication of special supplements to regular publications |
| Many of the special supplements are sponsored by advertisers or otherwise depend on advertising revenue |
| The number of special supplements that we produced for our publishing customers experienced a decline during the downturn in the advertising market |
| The evolution of technology and alternative delivery media may decrease the demand for our products and services |
| The technology we use in our operations is evolving |
| We could experience delays or difficulties in responding to changing technology, in addressing the increasingly sophisticated needs of our customers or in keeping pace with emerging industry standards |
| In addition, the cost required to respond to and integrate changing technologies may be greater than we anticipate |
| If we do not respond adequately to the need to integrate changing technologies in a timely manner, or if the investment required to so respond is greater than anticipated, our business, financial condition, results of operations and cash flow may be adversely affected |
| An increasing portion of the net sales and profitability of our Publisher Services segment is derived from editorial, issue management, content processing, marketing, electronic media and other non-print revenues |
| As a result of growth in these additional services, our business model is more sensitive to positive or negative changes in the number of pages published than positive or negative changes in the number of copies produced |
| 7 ______________________________________________________________________ [30]Table of Contents Nevertheless, we remain dependent on the distribution of scientific, technical, medical and other scholarly information in printed form |
| Usage of the internet and other electronic media continues to grow |
| We cannot assure you that the acceleration of the trend toward such electronic media will not decrease the demand for certain of our products which could result in lower profits and reduced cash flows |
| We will be required to make capital expenditures to maintain our facilities and may be required to make significant capital expenditures to remain technologically and economically competitive, which may disrupt our operations |
| Because production technologies continue to evolve, we must make periodic capital expenditures to maintain our facilities and may be required to make significant capital expenditures to remain technologically and economically competitive |
| If we cannot obtain adequate capital or do not respond adequately to the need to integrate changing technologies in a timely manner, our operating results, financial condition or cash flows may be adversely affected |
| The installation of new technology and equipment may also cause temporary disruption of operations and losses from operational inefficiencies |
| The impact on operational efficiency is affected by the length of any installation period |
| The Company incurred approximately dlra58dtta2 million in capital expenditures in fiscal 2006 and did sustain certain disruptions in operations and losses from operational inefficiencies related to a comprehensive equipment replacement and consolidation plan |
| Our ability to attract, train and retain key executives and other qualified employees is crucial to our results of operations and future growth |
| We rely to a significant extent on our executive officers and other key management personnel |
| There can be no assurance that we will be able to continue to retain our executive officers and key management personnel or attract additional qualified management in the future |
| Our business strategy also depends on our ability to attract and retain associates who have relevant experience in the publishing industry |
| There can be no assurance that we will be able to continue to attract and retain such associates |
| The editorial services we provide as part of our content processing business relies on a pool of qualified copy editors |
| In our STM business, we also rely on the services of specialized editors, and some of these positions require a minimum of a Master’s or Ph |
| D degree in the specific field |
| Our ability to provide quality editorial services will depend on our ability to attract and retain this pool of editors |
| In addition, to provide accurate, high-quality printed products in a timely fashion we must maintain an adequate staff of skilled technicians, including compositors, desktop publishing technicians, prepress personnel, pressmen, bindery operators and fulfillment personnel |
| Accordingly, our ability to maintain and increase our productivity and profitability will depend, in part, on our ability to employ, train and retain the skilled technicians necessary to meet our commitments |
| From time-to-time: • the industry experiences shortages of qualified technicians, and we may not be able to maintain an adequate skilled labor force necessary to operate efficiently; • our labor expenses may increase as a result of shortages of skilled technicians; or • we may have to curtail our planned internal growth as a result of labor shortages |
| If any of these events were to occur, it could adversely affect our business |
| Decreases in the types and amount of research funding could decrease the demand for our journal services |
| In our Publisher Services segment, we provide content processing and production services primarily to publishers of scientific, technical, medical and other scholarly journals |
| The supply of research papers published in these journals is related to the amount of research funding provided by the federal government and private companies |
| In the future, the federal government or private companies could decrease the type and amount of 8 ______________________________________________________________________ [31]Table of Contents funding that they provide for scientific, technical, medical and other scholarly research |
| A significant decrease in research funding might decrease the number of pages published or the number of journal copies printed for our customers, which would decrease our cash flow |
| Some of our employees belong to labor unions and certain actions by such employees, such as strikes or work stoppages, could adversely affect our operations or cause us to incur costs |
| We employ approximately 3cmam300 persons, approximately 16prca of whom are covered by collective bargaining agreements |
| If unionized employees were to engage in a concerted strike or other work stoppage, or if other employees were to become unionized, we could experience a disruption of operations, higher labor costs or both |
| We cannot assure you that a strike or other disruption of operations or work stoppage would not have a material adverse effect on our ability to serve our customers |
| Our foreign operations subject us to additional operational and financial risk |
| We have increased our overseas activities in recent years |
| Our wholly-owned content processing subsidiary, KnowledgeWorks Global Limited, provides copy-editing, composition and data conversion services from its facilities in Mumbai and Chennai, India |
| We have also developed publication print production capabilities in Singapore and China through contractual relationships with local affiliated printers |
| In our Specialty Packaging segment, we have a network of affiliated packaging printers located in close proximity to our customers’ offshore assembly operations in the Dominican Republic, Costa Rica, Honduras, mainland China, Thailand and India |
| In addition, our Specialty Packaging segment has entered into a joint venture in Hong Kong and is in the process of establishing wholly-owned subsidiaries in mainland China, Thailand and India |
| As a result of our overseas activities, our results of operations may be increasingly affected by international and foreign political, economic and operating conditions in or affecting these countries |
| Our foreign operations also subject us to currency exchange fluctuations and the risk of imposition of exchange controls |
| For example, an appreciation in the Indian rupee against the US dollar would increase our cost of operations in India |
| Increases in our cost of operations or losses on foreign currency exchange may negatively impact our results of operations |
| Our long-term business strategy includes pursuing acquisitions |
| We believe opportunities exist both to consolidate market share and broaden our solutions in our markets and other related markets |
| We intend to pursue complementary acquisitions that enhance our position in content processing, production and distribution |
| We also seek opportunities that create operating efficiencies and cost savings |
| Nonetheless, we cannot assure you that we will identify suitable acquisitions or that such acquisitions can be made at an acceptable price |
| If we acquire additional businesses, those businesses may require substantial capital |
| Although we will be able to borrow under our senior bank credit facility under certain circumstances to fund acquisitions, we cannot assure you that such borrowings will be available in sufficient amounts or that other financing will be available in amounts and on terms that we deem acceptable |
| In accordance with the senior bank credit facility, as amended, further limitations are placed on the Company’s ability to execute acquisitions based on the total leverage ratio which is computed from time to time |
| Based on the total leverage ratio computed as of June 30, 2006, the Company is prohibited from executing acquisitions without consent from the lenders or until such time as the total leverage ratio declines as required in the senior bank credit facility, as amended |
| Furthermore, the integration of acquired businesses may result in unforeseen difficulties that require a disproportionate amount of management’s attention and our other resources |
| Finally, we cannot assure you that we will achieve synergies and efficiencies anticipated when making acquisitions or comparable to those from past acquisitions |
| 9 ______________________________________________________________________ [32]Table of Contents Industry consolidation of customers and increased competition for those customers may result in increased expenses and reduced revenue and market position |
| The continuing consolidation of publishing companies has reduced the pool of available customers |
| In addition, large publishing companies often have preferred provider arrangements with specific printing companies |
| As smaller publishing companies are consolidated into the larger companies, the smaller publishing companies are often required to use the printing company with which the acquiring company has established an arrangement |
| If our customers were to merge or consolidate with publishing companies utilizing other printing companies, we could lose our customers to competing printing companies |
| If we were to lose a significant portion of our current base of customers to competing printing companies, our business, financial condition, results of operations and cash flow could be materially adversely affected |
| Increases in prices or shortages of paper and other raw materials could cause disruptions in our services to customers |
| The principal raw material used in our business is paper, which represents a significant portion of our cost of materials |
| Historically, we have generally been able to pass increases in the cost of paper on to our customers |
| However, we cannot assure you that we will be able to continue to do so |
| Although we believe that we have been successful in negotiating favorable price relationships with our paper vendors, prices in the overall paper market are beyond our control |
| If we are unable to continue to pass any price increases on to our customers, future paper price increases could adversely affect our margins and profits |
| Due to the significance of paper in our business, we are dependent upon the availability of paper |
| In periods of high demand, certain paper grades have been in short supply, including grades we use in our business |
| In addition, during periods of tight supply, many paper producers allocate shipments of paper based upon historical purchase levels of customers |
| Although we generally have not experienced significant difficulty in obtaining adequate quantities of paper, unforeseen developments in the overall paper markets could result in a decrease in the supply of paper and could cause either or both of our net sales or profits to decline |
| We use a variety of other raw materials including ink, film, offset plates, chemicals and solvents, glue, wire and subcontracted components |
| In general, we have not experienced any significant difficulty in obtaining these raw materials |
| We cannot assure you, however, that a shortage of any of these raw materials will not occur in the future or will not potentially adversely affect the financial results of our business |
| Increases in fuel and other energy costs may have a negative impact on our financial results |
| Fuel and other energy costs represent a significant portion of our overall costs, both directly through expenses incurred in running our production facilities and indirectly through freight rates, costs of raw materials and similar costs |
| Although Cadmus typically passes through to its customers increases in the cost of materials and freight rates, we may not be able to pass all such future increases directly to our customers, due to price competition |
| In that instance, increases in fuel and other energy costs, particularly resulting from increased natural gas prices, could adversely affect operating costs or customer demand and thereby negatively impact our operating results, financial condition or cash flows |
| Our cost reduction initiatives may not produce the expected cost savings or improve our profitability |
| Over the last four years, we have implemented a number of cost reduction initiatives |
| We expect that these initiatives will result in cost savings and will position us to capitalize on improving economic conditions |
| However, we cannot assure you that we will be able to achieve all of the cost savings that we expect to realize from our recent initiatives |
| In particular, we may experience unexpected cost increases that offset the savings that we achieve |
| Our failure to realize cost savings could adversely affect our profitability |
| 10 ______________________________________________________________________ [33]Table of Contents Our production facilities may suffer business interruptions which could increase our operating costs, decrease our sales or cause us to lose customers |
| The reliability of our production facilities is critical to the success of our business |
| Our facilities might be damaged or interrupted by fire, flood, power loss, telecommunications failure, break-ins, earthquakes, terrorist attacks, war or similar events |
| Equipment malfunctions, computer viruses, physical or electronic break-ins and similar disruptions might cause interruptions and delays in our printing services and could significantly diminish our reputation and brand name and prevent us from providing services |
| Although we believe we have taken adequate steps to address these risks, damage to, or unreliability of, our production facilities could have a material adverse effect on our business, financial condition, results of operations and cash flow |
| Our printing and other facilities are subject to environmental laws and regulations, which may subject us to liability or require us to incur costs |
| We use various materials in our operations which contain substances considered hazardous or toxic under environmental laws |
| In addition, our operations are subject to federal, state and local environmental laws and regulations relating to, among other things, air emissions, waste generation, handling, management and disposal, waste water treatment and discharge and remediation of soil and groundwater contamination |
| Permits are required for the operation of certain of our businesses, and these permits are subject to renewal, modification and, in some circumstances, revocation |
| Our operations also generate wastes which are disposed of off-site |
| Under certain environmental laws, including the Comprehensive Environmental Response, Compensation and Liability Act, as amended (“CERCLA,” commonly referred to as “Superfund”) and similar state laws and regulations, we may be liable for costs and damages relating to soil and groundwater contamination at these off-site disposal locations, or at our own facilities |
| In the past, such matters have not had a material impact on our business or operations |
| We are not currently aware of any environmental matters that are likely to have a material adverse effect on our business, financial condition, results of operations and cash flow |
| However, we cannot assure you that such matters will not have such an impact on us |
| Furthermore, future changes to environmental laws and regulations may give rise to additional costs or liabilities that could have a material adverse impact on us |
| We may not protect our technology effectively, which would allow competitors to duplicate our products and services, or our products and services may infringe on claims of intellectual property rights of third parties |
| Our success and ability to compete depend, in part, upon our technology |
| Among our assets are our proprietary information and intellectual property rights |
| We rely on a combination of copyright, trademark and patent laws, trade secrets, confidentiality procedures and contractual provisions to protect these assets |
| Unauthorized use and misuse of our intellectual property could have a material adverse effect on our business, financial condition and results of operations, and there can be no assurance that our legal remedies would adequately compensate us for the damages caused by unauthorized use |
| In addition, licenses for a number of software products have been granted to us |
| Although we believe that the risk that we will lose any material license is remote, any loss could have a material adverse effect on our business, financial condition, results of operations and cash flow |
| We do not believe that any of our products, services or activities infringe upon the intellectual property rights of third parties in any material respect |
| There can be no assurance, however, that third parties will not claim infringement by us with respect to current or future products, services or activities |
| Any infringement claim, with or without merit, could result in substantial costs and diversion of management and financial resources, and a successful claim could effectively block our ability to use or license products and services or cost us money |
| 11 ______________________________________________________________________ [34]Table of Contents We may not be able to operate effectively given our high levels of indebtedness which could also adversely impact interest expense |
| A large percentage of our capital structure is represented by debt |
| We must operate within the covenants and limitations imposed by our debt agreements |
| Although we believe we have a plan in place to reduce leverage and to operate within the limitations of our debt agreements, our high levels of indebtedness could limit our future plans or have a material adverse effect on our business, financial condition, results of operations and cash flows |
| In addition, a portion of our interest expense is subject to the prevailing market interest rates in effect from time to time |
| While we believe we have an appropriate mix of fixed and floating rate debt instruments and a plan to reduce leverage, an increase in market rates of interest could have a material adverse effect on our business, financial condition, results of operations and cash flows |