| CARAUSTAR INDUSTRIES INC ITEM 1A RISK FACTORS Investors should consider the following risk factors, in addition to the other information presented in this annual report and the other reports and registration statements we file from time to time with the SEC, in evaluating us, our business and an investment in our securities |
| Any of the following risks, as well as other risks, uncertainties, and possibly inaccurate assumptions underlying our plans and expectations, could result in harm to our business and financial results and cause the value of our securities to decline, which in turn could cause investors to lose all or part of their investment in our Company |
| Investors are advised that it is impossible to identify or predict all risks that could affect us |
| Thus, the risks below are not the only ones facing our Company, and additional risks not currently known to us or that we currently deem immaterial also may impair our business |
| Our business and financial performance may be harmed by future increases in raw material and other operating costs |
| Our primary raw material is recycled paper, which is known in our industry as “recovered fiber |
| ” The cost of recovered fiber has, at times, fluctuated greatly because of factors such as shortages or surpluses created by market or industry conditions |
| Although we have historically raised the selling prices of our products in response to raw material price increases, sometimes raw material prices have increased so quickly or to such levels that we 8 ______________________________________________________________________ [31]Table of Contents have been unable to pass the price increases through to our customers on a timely basis, which has adversely affected our operating margins |
| We cannot give assurance that we will be able to pass such price changes through to our customers on a timely basis and maintain our margins in the face of raw material cost fluctuations in the future |
| More recently, we have announced price increases on our products to help offset increases in other operating costs as well, such as energy, freight, employee benefits and insurance |
| Although we seek to realize the full benefit of these announced price increases, our ability to do so is dependent on numerous factors, such as customer acceptance of these increases, pricing strategies of our competitors, and contractual commitments that may limit our ability to raise prices |
| Our operating margins and cash flow may be adversely affected by rising energy costs |
| Excluding raw materials and labor, energy is our most significant manufacturing cost |
| Energy consists of electrical purchases and fuel used to generate steam used in the paper making process and to operate our paperboard machines and all of our other converting machinery |
| In 2004, the average energy cost in our mill system was approximately dlra57 per ton |
| In 2005, our energy costs increased by 28dtta1prca to dlra73 per ton, due primarily to an increase in the cost of natural gas |
| Until the last several years, our business had not been significantly affected by energy costs, and we historically have not passed energy cost increases through to our customers |
| Although we have responded to some more recent energy cost increases by raising our selling prices, our ability to realize the full benefit of these price increases is dependent on, and limited by the dynamics described above under “— Our business and financial performance may be harmed by future increases in raw material and other operating costs,” such as the customer relations, competitive, contractual issues that affect our pricing strategies generally |
| Consequently, we have not been able to pass through to our customers all of the energy cost increases we have incurred |
| As a result, our operating margins have been adversely affected |
| Although we continue to evaluate our energy costs and consider ways to factor energy costs into our pricing, we cannot give assurance that our operating margins and results of operations will not continue to be adversely affected by rising energy costs |
| Our business and financial performance may be adversely affected by downturns in industrial production, housing and construction and the consumption of nondurable and durable goods |
| Demand for our products in our four principal end use markets is primarily driven by the following factors: • Tube, core and composite container — industrial production, construction spending and consumer nondurable consumption • Folding cartons — consumer nondurable consumption and industrial production • Gypsum wallboard facing paper — long-term interest rates, single and multifamily construction, repair and remodeling construction and commercial construction • Specialty paperboard products — consumer nondurable consumption and consumer durable consumption Downturns in any of these sectors will result in decreased demand for our products |
| In particular, our business has been adversely affected in recent periods by the general slow-down in industrial demand |
| These conditions are beyond our ability to control, but have had, and will continue to have, a significant impact on our sales and results of operations |
| We are adversely affected by the cycles, conditions and problems inherent in our industry |
| Our operating results tend to reflect the general cyclical nature of the business in which we operate |
| In addition, our industry has suffered from excess capacity |
| Our industry also is capital intensive, which leads to 9 ______________________________________________________________________ [32]Table of Contents high fixed costs and generally results in continued production as long as prices are sufficient to cover variable costs |
| These conditions have contributed to substantial price competition and volatility within our industry |
| In the event of a recession, demand and prices are likely to drop substantially |
| Our profitability historically has been more sensitive to price changes than to changes in volume |
| Future decreases in prices for our products could adversely affect our operating results |
| These factors, coupled with our substantially leveraged financial position, may adversely affect our ability to respond to competition and to other market conditions or to otherwise take advantage of business opportunities |
| Our business may suffer from risks associated with growth and acquisitions |
| Historically, we have grown our business, revenues and production capacity to a significant degree through acquisitions |
| In the current difficult operating climate facing our industry and our financial position, the pace of our acquisition activity, and accordingly, our revenue growth, has slowed significantly as we have focused on conserving cash and maximizing the productivity of our existing facilities |
| However, we expect to continue evaluating and pursuing acquisition opportunities on a selective basis, subject to available funding and credit flexibility |
| Growth through acquisitions involves risks, many of which may continue to affect us based on acquisitions we have completed in the past |
| We cannot give assurance that our acquired businesses will achieve the same levels of revenue, profit or productivity as our existing locations or otherwise perform as we expect |
| Acquisitions also involve specific risks |
| Some of these risks include: • assumption of unanticipated liabilities and contingencies; • diversion of management’s attention; and • possible reduction of our reported earnings because of: • goodwill and intangible asset impairment; • increased interest costs; • issuances of additional securities or incurrence of debt; and • difficulties in integrating acquired businesses |
| As we grow, we can give no assurance that we will be able to: • use the increased production capacity of any new or improved facilities; • identify suitable acquisition candidates; • complete additional acquisitions; or • integrate acquired businesses into our operations |
| If we cannot raise the necessary capital for, or use our stock to finance, acquisitions, expansion plans or other significant corporate opportunities, our growth may be impaired |
| As described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources,” our senior credit facility and senior subordinated debt obligations impose limitations on our ability to make acquisitions or other strategic investments |
| Without additional capital, we may have to curtail any acquisition and expansion plans or forego other significant corporate opportunities that may be vital to our long-term success |
| If our revenues and cash flow do not meet expectations, then we may lose our ability to borrow money or to do so on terms that we consider favorable |
| Conditions in the capital markets also will affect our ability to borrow, as well as the terms of those borrowings |
| In addition, our financial performance and the conditions of the capital markets will also affect the value of our common stock, which could make it a less attractive form of consideration in making acquisitions |
| All of these factors could also make it difficult or impossible for us to expand in the future |
| 10 ______________________________________________________________________ [33]Table of Contents Our substantial indebtedness could adversely affect our cash flow and our ability to fulfill our obligations under our indebtedness |
| We have a substantial amount of outstanding indebtedness |
| See “Selected Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources” and the consolidated financial statements included in Part II, Item 8 of this annual report |
| In addition, as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Off-Balance Sheet Arrangements — Joint Venture Financings,” we have provided credit support to our joint ventures for which we could also be liable |
| We continually assess, and have made recent strategic decisions, including the sale of our Standard Gypsum joint venture, aimed at reducing our overall indebtedness |
| Our substantial level of indebtedness, including the potential debt reduction mentioned above, increases the possibility that we may be unable to generate cash sufficient to pay when due the principal of, interest on or other amounts due in respect of our indebtedness |
| We may also obtain additional long-term debt, increasing the risks discussed below |
| Our substantial leverage could have significant consequences to holders of our debt and equity securities |
| For example, it could: • make it more difficult for us to satisfy our obligations with respect to our indebtedness, including compliance with financial covenants; • increase our vulnerability to general adverse economic and industry conditions; • limit our ability to obtain additional financing; • require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, reducing the amount of our cash flow available for other purposes, including capital expenditures and other general corporate purposes; • require us to sell debt or equity securities or to sell some of our core assets, possibly on unfavorable terms, to meet payment obligations; • restrict us from making strategic acquisitions, introducing new technologies or exploiting business opportunities; • limit our flexibility in planning for, or reacting to, changes in our business and our industry; • place us at a possible competitive disadvantage compared to our competitors that have less debt; • adversely affect the value of our common stock and • affect our viability as a going concern |
| We are subject to many environmental laws and regulations that require significant expenditures for compliance and remediation efforts, and changes in the law could increase those expenses and adversely affect our operations |
| Compliance with the environmental requirements of international, federal, state and local governments significantly affects our business |
| Among other things, these requirements regulate the discharge of materials into the water, air and land and govern the use and disposal of hazardous substances |
| These regulations are complex, and our compliance with them can be affected by a myriad of factors, including rates of production, changes in applicable standards or interpretations, human error, equipment malfunction and other factors |
| From time to time we have and may continue to find that we have inadvertently failed to meet specific regulations or standards despite our efforts to comply with them |
| Under environmental laws, we also can be held strictly liable if hazardous substances are found on real property we have ever owned, operated or used as a disposal site |
| Despite our compliance efforts, risk of environmental liability is part of the nature of our business |
| We maintain and generate hazardous substances at some facilities, and although we do not believe that any related liabilities or remedial costs will be material, we cannot give assurance that environmental liabilities, including compliance and response costs, will not have a material adverse effect on our business |
| In addition, future events may lead to additional compliance or other costs that could have a material adverse effect on our business |
| Such 11 ______________________________________________________________________ [34]Table of Contents future events could include changes in, or new interpretations of, existing laws, regulations or enforcement policies, discoveries of past releases, failure of indemnitors to fulfill their obligations, or further investigation of the potential health hazards of certain products or business activities |
| Our industry is highly competitive and price fluctuations and volatility could diminish our sales volume and revenues |
| The industry in which we operate is highly competitive |
| Our competitors include other large, vertically integrated paperboard, packaging and gypsum wall board manufacturing companies, including National Gypsum Company, The Newark Group, Inc, Rock-Tenn Company, Smurfit-Stone Container Corporation, Sonoco Products Company and USG Corporation, along with numerous smaller paperboard and packaging companies |
| As a result of product substitution, we also compete indirectly with manufacturers of similar products using other materials |
| In addition, we face increasing competition from foreign paperboard and packaging producers as a result of the continued migration of US manufacturing offshore to lower labor cost environments and the emergence of new foreign competitors in these countries |
| We also face competition due to product substitution such as flexible packaging |
| The industry in which we compete is particularly sensitive to price pressure, as well as other factors, including quality, service, innovation and design, with varying emphasis on these factors depending on the product line |
| To the extent that one or more of our competitors becomes more successful with respect to any key competitive factors, our ability to attract and retain customers could be materially adversely affected |
| Some of our competitors are less leveraged than we are and have access to greater resources |
| These companies may be able to adapt more quickly to new or emerging technologies, respond to changes in customer requirements and withstand industry-wide pricing pressures |
| If our facilities are not as cost efficient as those of our competitors or if our competitors lower prices, we may need to temporarily or permanently close such facilities, which would negatively affect our sales volume and revenues |
| We have incurred and may incur additional material restructuring charges in the future, and we may not be successful in achieving the cost reductions contemplated by our recent and future restructuring activities |
| Restructuring has been a primary component of our management’s strategy to address the decrease in demand resulting from secular trends and generally weak domestic economic conditions |
| Between 2001 and 2005, restructuring and asset impairment charges have totaled dlra190dtta9 million, of which approximately dlra166dtta3 million have been noncash charges |
| We have also experienced increases in near-term manufacturing and selling, general and administrative costs as a result of transitioning of business within our mill and converting systems to other company facilities |
| Our restructuring efforts have been directed toward reducing costs through manufacturing and converting facilities rationalization |
| However, we can give no assurance that the cost reductions contemplated by our recent and future restructuring activities will be achieved within the expected time frame, or at all |
| Any delays or failure in delivering products to our customers due to our facilities rationalization may result in order cancellations or termination of customer relationships, all of which could adversely impact our competitive position and would offset any cost savings we might have achieved |
| Restructurings involve numerous risks, such as the diversion of management and employee attention, disruptions in customer relationships, production and capacity, and execution risks |
| Although under current market conditions, we expect that restructuring charges will continue to decline, we may continue to incur material restructuring charges in the future, which may exceed our expectations if market conditions change |
| The recognition of these restructuring charges can cause our reported financial results for a given period to differ materially from our own expectations and those of investors generally, and can accordingly cause the trading prices of our securities to fluctuate significantly depending on the degree to which investors consider these charges relevant in evaluating our financial results and prospects |
| Significant disruptions to our operations may materially and adversely affect our earnings |
| We operate approximately 100 mills and converting facilities in the United States and in certain foreign countries |
| Natural disasters, such as hurricanes, tornadoes, fires, ice storms, wind storms, floodings and other weather conditions, unforeseen operating problems and other events beyond our control may adversely affect the 12 ______________________________________________________________________ [35]Table of Contents operations of our mills and converting facilities, which in turn would materially and adversely affect our earnings |
| Any losses due to such events may not be covered by our existing insurance policies |
| In the event that an occurrence of a natural disaster affected multiple locations, this event could materially and adversely affect our earnings |
| In addition, a significant percentage of our hourly employees are represented by labor unions, with all principal union contracts expiring between 2006 and 2009 |
| Although we consider our relations with our employees to be good, we cannot provide any assurance that the union contracts will be renewed in a timely manner, on terms acceptable to us, or at all, or that there will not be any work stoppage or other labor disturbance at any of our facilities |
| Work stoppages or other labor disturbances at one or more of our facilities may cause significant disruptions to our operations at such facilities, which may materially and adversely impact our results of operations |
| Our business is subject to changing regulation of corporate governance and public disclosure that have increased both our costs and the risk of noncompliance |
| Because our common shares are publicly traded, we are subject to certain rules and regulations of federal, state and financial market exchange entities charged with the protection of investors and the oversight of companies whose securities are publicly traded |
| These entities, including the Public Company Accounting Oversight Board, the SEC and Nasdaq, have in recent years issued new requirements and regulations, most notably the Sarbanes-Oxley Act of 2002 |
| From time to time since the adoption of the Sarbanes-Oxley Act of 2002, these authorities have continued to develop additional regulations or interpretations of existing regulations |
| Our ongoing efforts to comply with these regulations and interpretations have resulted in, and are likely to continue resulting in, increased general and administrative expenses and diversion of management time and attention from revenue-generating activities to compliance activities |
| In particular, our efforts to prepare to comply with Section 404 of the Sarbanes-Oxley Act and related regulations regarding our management’s required assessment of our internal control over financial reporting and our independent auditors’ attestation of that assessment has required the commitment of significant financial and managerial resources |
| In part to prepare for compliance with Section 404, as well as to generally improve our internal control environment, we have undertaken substantial measures, including, among other things, costly projects to centralize our accounting functions and reorganize our information technology department |
| These projects have represented operational risks requiring significant resources to complete in a timely manner in order to enable us to comply with the Section 404 requirements |
| Because these new and changed laws, regulations and standards are subject to varying interpretations, their application in practice may continue to evolve over time as new guidance is provided by regulatory and governing bodies |
| This evolution may result in continuing uncertainty regarding compliance matters and impose additional costs on us to revise our disclosure and governance practices accordingly |
| The failure to effectively modernize and implement our information systems will adversely affect our operations, and the failure to complete the transition to our new information infrastructure could adversely affect our business |
| The success of our business has become increasingly dependent on our ability to integrate computer technology into our operations |
| Complex computer systems have become indispensable to the timely processing of the volume of transactions generated by our daily operations |
| Our ability to obtain and service business depends on our ability to convey, internally and externally, accurate and timely information processed on these complex systems |
| We are in the process of replacing our core systems and reengineering our processes |
| These systems are very complex and interdependent and are critical to our success |
| Due to the extensive replacement of these systems and processes we are at risk for a system failure that could, among other problems, result in service interruptions or the production of incorrect data |
| Such system, process or programming failures, or the cumulative effect of such failures, including any resulting reliance upon information found to be inaccurate or unreliable, could result in the loss of existing customers, difficulty attracting new customers, problems in determining cost of production and establishing appropriate pricing, regulatory problems, increases in operating expenses and other material adverse consequences or material effects on our business, financial condition and results of operations |