| KADANT INC Item 1A Risk Factors In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, we wish to caution readers that the following important factors, among others, in some cases have affected, and in the future could affect, our actual results and could cause our actual results in 2006 and beyond to differ materially from those expressed in any forward-looking statements made by us, or on our behalf |
| Our business is dependent on the condition of the pulp and paper industry |
| We sell products primarily to the pulp and paper industry, which is a cyclical industry |
| Generally, the financial condition of the global pulp and paper industry corresponds to the condition of the general economy, as well as to a number of other factors, including pulp and paper production capacity relative to demand |
| In recent years, the industry in certain geographic regions, notably North America, has been in a prolonged downcycle, resulting in depressed pulp and paper prices, decreased spending, mill closures, consolidations, and bankruptcies, all of which have adversely affected our business |
| As paper companies consolidate in response to market weakness, they frequently reduce capacity and postpone or even cancel capacity addition or expansion projects |
| These cyclical downturns can cause our sales to decline and adversely affect our profitability |
| 2005 Annual Report Our business is subject to economic, currency, political, and other risks associated with international sales and operations |
| During 2005, approximately 60prca of our sales were to customers outside the United States, principally in Europe and Asia |
| International revenues are subject to a number of risks, including the following: – agreements may be difficult to enforce and receivables difficult to collect through a foreign country’s legal system; – foreign customers may have longer payment cycles; – foreign countries may impose additional withholding taxes or otherwise tax our foreign income, impose tariffs, or adopt other restrictions on foreign trade; and – the protection of intellectual property in foreign countries may be more difficult to enforce |
| Although we seek to charge our customers in the same currency in which our operating costs are incurred, fluctuations in currency exchange rates may affect product demand and adversely affect the profitability in US dollars of products we provide in international markets where payment for our products and services is made in their local currencies |
| Any of these factors could have a material adverse impact on our business and results of operations |
| A significant portion of our international sales has, and may in the future, come from China |
| An increase in revenues, as well as our proposed acquisition of a manufacturing and assembly facility in China, will expose us to increased risk in the event of changes in the policies of the Chinese government, political unrest, unstable economic conditions, or other developments in China or in US-China relations that are adverse to trade, including enactment of protectionist legislation or trade restrictions |
| Orders from customers in China, particularly for large systems that have been tailored to a customer’s specific requirements, involve increased credit risk due to payment terms that are applicable to doing business in China |
| In addition, the timing of these orders is often difficult to predict |
| We are subject to intense competition in all our markets |
| We believe that the principal competitive factors affecting the markets for our products include quality, price, service, technical expertise, and product innovation |
| Our competitors include a number of large multinational corporations that may have substantially greater financial, marketing, and other resources than we do |
| As a result, they may be able to adapt more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the promotion and sale of their services and products |
| Competitors’ technologies may prove to be superior to ours |
| Our current products, those under development, and our ability to develop new technologies may not be sufficient to enable us to compete effectively |
| Competition, especially in China, could increase if new companies enter the market or if existing competitors expand their product lines or intensify efforts within existing product lines |
| Our debt may adversely affect our cash flow and may restrict our investment opportunities |
| On May 9, 2005, we entered into a Credit Agreement, consisting of a dlra60 million five-year term loan and a dlra25 million revolver |
| On May 11, 2005, we borrowed dlra60 million to fund the acquisition of Kadant Johnson under the term loan |
| We may also obtain additional long-term debt and working capital lines of credit to meet future financing needs, which would have the effect of increasing our total leverage |
| Our leverage could have negative consequences, including: – increasing our vulnerability to adverse economic and industry conditions, – limiting our ability to obtain additional financing, – limiting our ability to pay dividends on or repurchase our capital stock, – limiting our ability to acquire new products and technologies through acquisitions or licensing, and – limiting our flexibility in planning for, or reacting to, changes in our business and the industries in which we compete |
| 2005 Annual Report Our indebtedness bears interest at floating rates pursuant to the terms of the Credit Agreement |
| As a result, our interest payment obligations on this indebtedness will increase if interest rates increase |
| To reduce the exposure to floating rates, we have converted 60prca of the term loan to a fixed rate of interest through an interest rate swap |
| Our ability to satisfy our obligations and to reduce our total debt depends on our future operating performance and on economic, financial, competitive, and other factors beyond our control |
| Our business may not generate sufficient cash flows to meet these obligations or to successfully execute our business strategy |
| If we are unable to service our debt and fund our business, we may be forced to reduce or delay capital expenditures or research and development expenditures, seek additional financing or equity capital, restructure or refinance our debt, or sell assets |
| We may not be able to obtain additional financing or refinance existing debt or sell assets on terms acceptable to us or at all |
| Restrictions in our Credit Agreement may limit our activities |
| Our Credit Agreement contains, and future debt instruments to which we may become subject may contain, restrictive covenants that limit our ability to engage in activities that could otherwise benefit us, including restrictions on our ability and the ability of our subsidiaries to: – incur additional indebtedness, – pay dividends on, redeem, or repurchase our capital stock, – make investments, – create liens, – sell assets, – enter into transactions with affiliates, and – consolidate, merge, or transfer all or substantially all of our assets and the assets of our subsidiaries |
| We are also required to meet specified financial ratios under the terms of our Credit Agreement |
| Our ability to comply with these financial restrictions and covenants is dependent on our future performance, which is subject to prevailing economic conditions and other factors, including factors that are beyond our control such as foreign exchange rates, interest rates, changes in technology, and changes in the level of competition |
| Our failure to comply with any of these restrictions or covenants may result in an event of default under our Credit Agreement, which could permit acceleration of the debt under that instrument and require us to repay that debt before its scheduled due date |
| If an event of default occurs, we may not have sufficient funds available to make the required payments under our indebtedness |
| If we are unable to repay amounts owed under our Credit Agreement, those lenders may be entitled to foreclose on and sell the collateral that secures our borrowings under the agreement |
| Our Kadant Composites LLC subsidiary is responsible for certain continued warranty obligations associated with its former composites business, even though it has disposed of this business |
| On October 21, 2005, Kadant Composites LLC sold its composites business |
| As part of the transaction, Kadant Composites LLC retained the warranty obligation associated with products manufactured prior to the sale date |
| Our consolidated results will continue to be impacted by these warranty obligations and we may be unable to accurately predict the potential liabilities related to these product warranties |
| In 2003 and 2004, Kadant Composites LLC experienced a significant increase in warranty claims and warranty expense related to its composite decking products including, but not limited to, contraction of certain deck boards and excessive oxidation that affects the integrity of the plastic used in some of its decking products |
| Included in the increased warranty expense was the cost of exchanging material held by its distributors with new material that, we believe, is not susceptible to this oxidation issue, and our best estimate of future potential costs related to valid claims arising from installed products |
| In 2005, Kadant Composites LLC experienced a higher-than-expected level of warranty claims associated with previously identified product issues |
| Although Kadant Composites LLC increased the warranty provisions accordingly, the reserve established may not be sufficient if Kadant 10 ______________________________________________________________________ [33]Table of Contents Kadant Inc |
| 2005 Annual Report Composites LLC incurs warranty claims higher than anticipated |
| It is reasonably possible that the ultimate settlement of such warranty claims may exceed the amount of the warranty reserve |
| In addition, there can be no assurance that other problems will not develop |
| A continued high level of warranty claims or expenses would have an adverse impact on the warranty reserve and would adversely affect our consolidated results |
| Our inability to successfully integrate Kadant Johnson into our business could have a material adverse effect on our business |
| On May 11, 2005, we acquired Kadant Johnson |
| The integration of Kadant Johnson into our business will involve the merger of employees, products, and services over multiple US and international locations |
| We may not be successful in integrating this business into our current structure, or in obtaining the anticipated cost savings or synergies from the acquisition |
| To meet our quarterly certification requirements and in anticipation of incorporating Kadant Johnson into our 2006 Sarbanes-Oxley compliance process, we will also be performing a detailed review of Kadant Johnson’s internal control structure to ensure that its controls over financial reporting are consistent with our policies and procedures |
| Given the multi-location structure of the Kadant Johnson business, this review will take significant time and effort, similar to our Sarbanes-Oxley compliance efforts in 2004, and will involve significant cost |
| During this process, we may identify control deficiencies in addition to those disclosed elsewhere in this periodic report |
| Our ability to realize the value of the goodwill and other intangibles recorded for this acquisition will depend on the future cash flows of the Kadant Johnson business |
| If these future cash flows are below what we anticipated, we may incur future impairment losses associated with goodwill and intangibles, which could have a material adverse effect on our results of operations |
| Our inability to successfully complete the acquisition of a manufacturing and assembly plant in China could adversely affect our business |
| Our strategy includes the ability to manufacture components and equipment in low-cost regions such as China |
| We recently entered into an Asset Purchase Agreement to acquire a Chinese supplier of stock-preparation equipment |
| This acquisition is subject to a number of conditions, including the negotiation and signing of a definitive purchase agreement and satisfaction of customary conditions and regulatory approvals, and there is no assurance that we will be able to complete this acquisition on favorable terms or on a timely basis |
| Our inability to successfully complete the acquisition would delay the implementation of our strategy to manufacture parts and components for stock-preparation equipment in a low-cost region, and could adversely affect our ability to compete cost-effectively in Asia and other markets |
| In anticipation of completing this acquisition, we have terminated our efforts to construct an assembly and manufacturing facility outside Beijing |
| We may not be able to recoup our expenses to date associated with the formation of our subsidiary to operate this facility, such as the design and construction of the facility, and other costs incurred in connection with this effort |
| Our inability to successfully identify and complete acquisitions or successfully integrate any new or previous acquisitions could have a material adverse effect on our business |
| Our strategy includes the acquisition of technologies and businesses that complement or augment our existing products and services |
| Promising acquisitions are difficult to identify and complete for a number of reasons, including competition among prospective buyers and the need for regulatory, including antitrust, approvals |
| We do incur costs from time to time associated with potential acquisitions, which are deferred during the due diligence phase |
| Future operating results could be negatively impacted in any quarter in which we determine that a potential acquisition will not close and such associated costs are expensed |
| Any acquisition we may complete may be made at a substantial premium over the fair value of the net assets of the acquired company |
| We may not be able to complete future acquisitions, integrate any acquired businesses successfully into our existing businesses, make such businesses profitable, or realize anticipated cost savings or synergies, if 11 ______________________________________________________________________ [34]Table of Contents Kadant Inc |
| 2005 Annual Report any, from these acquisitions |
| In addition, we have previously acquired several companies and businesses and, as a result, we have recorded significant goodwill and intangible assets on our balance sheet |
| Any future impairment losses identified will be recorded as reductions to operating income, which could have a material adverse effect on our results of operations |
| Our ability to realize the value of the goodwill and intangibles that we have recorded will depend on the future performance and cash flows of these businesses, which will depend, in part, on how well we have integrated these businesses |
| Our inability to obtain the anticipated benefits from the restructuring of our Kadant Lamort subsidiary would have a negative effect on our future operating results |
| In an effort to improve operating performance at our Kadant Lamort subsidiary in France, we approved a restructuring of that subsidiary on November 18, 2004 |
| This restructuring is intended to strengthen Kadant Lamort’s competitive position in the European paper industry |
| We accrued a restructuring charge of dlra9dtta2 million in the fourth quarter of 2004 for severance and other termination costs in connection with the workforce reduction |
| If we are unable to obtain the anticipated benefits from this restructuring, our future operating results would be negatively impacted |
| Natural gas is a significant cost in the manufacture of our fiber-based granular products, and our results from operations will be adversely affected by continued high natural gas costs |
| We use natural gas in the production of our fiber-based granular products the price of which increased dramatically at the end of 2005 |
| We seek to manage our exposure to natural gas price fluctuations by entering into short-term forward contracts to purchase specified quantities of natural gas from a supplier |
| We may not be able to effectively manage our exposure to natural gas price fluctuations |
| Continued high costs of natural gas will adversely affect our consolidated results if we are unable to effectively manage our exposure or pass these costs on to customers in the form of surcharges |
| We are dependent on two mills for the raw material used in our fiber-based granules, and we may not be able to obtain raw material on commercially reasonable terms |
| We are dependent on two paper mills for the fiber used in the manufacture of our fiber-based granular products |
| These mills have the exclusive right to supply the papermaking byproducts used in the manufacturing process |
| Due to manufacturing changes at the mills, we recently had some difficulty obtaining sufficient raw material to operate at optimal production levels |
| We are working with the mills to ensure a stable supply of raw material |
| To date, we have been able to meet all of our customer delivery requirements, but there can be no assurance that we will be able to meet future delivery requirements |
| Although we believe our relationship with the mills is good, the mills could decide not to renew the contract when it expires at the end of 2007, or may not agree to renew on commercially reasonable terms |
| If the mills were unable or unwilling to supply us sufficient fiber, we would be forced to find an alternative supply for this raw material |
| We may be unable to find an alternative supply on commercially reasonable terms or could incur excessive transportation costs if an alternative supplier were found, which would increase our manufacturing costs and might prevent prices for our products from being competitive |
| Our inability to protect our intellectual property could have a material adverse effect on our business |
| In addition, third parties may claim that we infringe their intellectual property, and we could suffer significant litigation or licensing expense as a result |
| We place considerable emphasis on obtaining patent and trade secret protection for significant new technologies, products, and processes because of the length of time and expense associated with bringing new products through the development process and into the marketplace |
| 2005 Annual Report develop patentable products and obtain and enforce patent protection for our products both in the United States and in other countries |
| We own numerous US and foreign patents, and we intend to file additional applications, as appropriate, for patents covering our products |
| Patents may not be issued for any pending or future patent applications owned by or licensed to us, and the claims allowed under any issued patents may not be sufficiently broad to protect our technology |
| Any issued patents owned by or licensed to us may be challenged, invalidated, or circumvented, and the rights under these patents may not provide us with competitive advantages |
| A patent relating to our fiber-based granular products expired in the second quarter of 2004 |
| As a result, we could be subject to increased competition in this market, which could have an adverse effect on this business |
| In addition, competitors may design around our technology or develop competing technologies |
| Intellectual property rights may also be unavailable or limited in some foreign countries, which could make it easier for competitors to capture increased market share |
| We could incur substantial costs to defend ourselves in suits brought against us or in suits in which we may assert our patent rights against others |
| An unfavorable outcome of any such litigation could have a material adverse effect on our business and results of operations |
| In addition, as our patents expire, we rely on trade secrets and proprietary know-how to protect our products |
| We cannot be sure the steps we have taken or will take in the future will be adequate to deter misappropriation of our proprietary information and intellectual property |
| We seek to protect trade secrets and proprietary know-how, in part, through confidentiality agreements with our collaborators, employees, and consultants |
| These agreements may be breached, we may not have adequate remedies for any breach, and our trade secrets may otherwise become known or be independently developed by our competitors |
| Third parties may assert claims against us to the effect that we are infringing on their intellectual property rights |
| We could incur substantial costs and diversion of management resources in defending these claims, which could have a material adverse effect on our business, financial condition, and results of operations |
| In addition, parties making these claims could secure a judgment awarding substantial damages, as well as injunctive or other equitable relief, which could effectively block our ability to make, use, sell, distribute, or market our products and services in the United States or abroad |
| In the event that a claim relating to intellectual property is asserted against us, or third parties not affiliated with us hold pending or issued patents that relate to our products or technology, we may seek licenses to such intellectual property or challenge those patents |
| However, we may be unable to obtain these licenses on commercially reasonable terms, if at all, and our challenge of the patents may be unsuccessful |
| Our failure to obtain the necessary licenses or other rights could prohibit the sale, manufacture, or distribution of our products and, therefore, could have a material adverse effect on our business, financial condition, and results of operations |
| Fluctuations in our quarterly operating results may cause our stock price to decline |
| Given the nature of the markets in which we participate and the effect of Staff Accounting Bulletin (SAB) Nodtta 104, “Revenue Recognition,” we may not be able to reliably predict future revenues and profitability, and unexpected changes may cause us to adjust our operations |
| A large proportion of our costs are fixed, due in part to our significant selling, research and development, and manufacturing costs |
| Thus, small declines in revenues could disproportionately affect our operating results |
| Other factors that could affect our quarterly operating results include: – failure of our products to pass contractually agreed upon acceptance tests, which would delay or prohibit recognition of revenues under SAB Nodtta 104; – failure of a customer, particularly in China, to comply with an order’s contractual obligations; – adverse changes in demand for and market acceptance of our products; – competitive pressures resulting in lower sales prices of our products; – adverse changes in the pulp and paper industry; – delays or problems in our introduction of new products; – our competitors’ announcements of new products, services, or technological innovations; – contractual liabilities incurred by us related to guarantees of our product performance; 13 ______________________________________________________________________ [36]Table of Contents Kadant Inc |
| 2005 Annual Report – increased costs of raw materials or supplies, including the cost of energy; and – changes in the timing of product orders |
| Anti-takeover provisions in our charter documents, under Delaware law, and in our shareholder rights plan could prevent or delay transactions that our shareholders may favor |
| Provisions of our charter and bylaws may discourage, delay, or prevent a merger or acquisition that our shareholders may consider favorable, including transactions in which shareholders might otherwise receive a premium for their shares |
| For example, these provisions: – authorize the issuance of “blank check” preferred stock without any need for action by shareholders; – provide for a classified board of directors with staggered three-year terms; – require supermajority shareholder voting to effect various amendments to our charter and bylaws; – eliminate the ability of our shareholders to call special meetings of shareholders; – prohibit shareholder action by written consent; and – establish advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted on by shareholders at shareholder meetings |
| In addition, our board of directors has adopted a shareholder rights plan intended to protect shareholders in the event of an unfair or coercive offer to acquire our company and to provide our board of directors with adequate time to evaluate unsolicited offers |
| Preferred stock purchase rights have been distributed to our common shareholders pursuant to the rights plan |
| This rights plan may have anti-takeover effects |
| The rights plan will cause substantial dilution to a person or group that attempts to acquire us on terms that our board of directors does not believe are in our best interests and those of our shareholders and may discourage, delay, or prevent a merger or acquisition that shareholders may consider favorable, including transactions in which shareholders might otherwise receive a premium for their shares |