| CHANNELL COMMERCIAL CORP Item 1A Risk Factors Forward Looking Statements Certain statements contained in this Annual Report on Form 10-K are “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”), which provides certain “safe harbor” provisions for forward-looking statements |
| All forward-looking statements made in this Annual Report on Form 10-K are made pursuant to the Act |
| Forward-looking statements include statements that are predictive in nature; that depend upon or refer to future events or conditions; or that include words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” or variations or negatives thereof or by similar or comparable words or phrases |
| In addition, any statements that may be provided by our management concerning future financial performance, ongoing business strategies or prospects or our 7 ______________________________________________________________________ possible future actions are also forward-looking statements as defined by the Act |
| Forward-looking statements are based on current expectations and projections about future events and are subject to risks, uncertainties, and assumptions about us; and economic and market factors in the countries in which we do business, among other things |
| These statements are not guarantees of future performance, and we have no specific intentions to update these statements |
| References to “we” “us” or “our” are references to the Company |
| Actual events and results may differ materially from those expressed or forecasted in forward-looking statements due to a number of factors |
| The principal important risk factors that could cause our actual performance and future events and actions to differ materially from such forward-looking statements include, but are not limited to, the risk factors discussed below |
| The communications industry is in a state of rapid technological change |
| The introduction of new technologies, network architectures or changes in industry standards can render our existing products or products under development obsolete or unmarketable |
| For example, satellite, wireless and other communication technologies under development or currently being deployed may represent a threat to copper, coaxial and fiber optic-based systems by reducing the need for wire-line networks |
| Further, while we anticipate that a number of factors, including network capacity requirements, existing investments in wire-line networks, security and long-term cost effectiveness, will result in growth of wire-line networks, there can be no assurance that future advances or further development of these or other new technologies will not have a material adverse effect on our business |
| Our growth strategies are designed, in part, to take advantage of opportunities that we believe are emerging as a result of the development of enhanced voice, video, data and other transmission networks, and high-speed Internet access in the telecommunications industry |
| There can be no assurance that demand resulting from these emerging trends will continue or that our products will be met with market acceptance |
| Importance of New Product Development to Growth |
| A significant factor in our ability to grow and remain competitive will be our ability to anticipate changes in technology, industry standards and customer preferences, and to successfully develop and introduce new products on a timely basis |
| New product development often requires long-term forecasting of market trends, development and implementation of new designs and processes, and substantial capital commitment |
| Trends toward consolidation of the communications industry and convergence of technologies may require us to quickly adapt to rapidly changing market conditions and customer requirements |
| Trends in consumer preferences in Australia for the aesthetic design of water storage tanks may require us to redesign or develop new water tanks and accessory products |
| Our manufacturing and marketing expertise has enabled us to successfully develop and market new products in the past |
| However, any failure by us to anticipate or respond in a cost-effective and timely manner to technological developments or changes in industry standards or customer requirements, or any significant delays in product development or introduction, could have a material adverse effect on our business, operating results and financial condition |
| Concentration of Customers |
| The telecommunications industry is the largest industry in which we operate and is highly concentrated |
| A relatively small number of customers account for a large percentage of our available market |
| Consequently, our five largest customers accounted for 34dtta4prca and 48dtta7prca of our total net sales in 2005 and 2004, respectively |
| Verizon accounted for 17dtta5prca of our total net sales in 2005 and 21dtta7prca of our total net sales in 2004 |
| Mergers and acquisitions in the telecommunications industry, which are expected to continue, not only increase the concentration of the industry and of our customer base, but also from time to time delay customers’ capital expenditures as newly merged service providers consolidate operations |
| In the event one of our major customers were to terminate purchases of our products, our operating results would be adversely affected |
| Dependence on the Telecommunications Industry |
| Although we have recently diversified a portion of our business with the acquisition of Bushman Tanks, a manufacturer of water storage tanks, we expect that sales to the telecommunications industry will continue to represent a substantial portion of our total sales |
| Demand for products within this industry depends primarily on capital spending by service providers for constructing, rebuilding, maintaining or upgrading their systems |
| The amount of capital spending and, therefore, our sales and profitability, are affected by a variety of factors, including general economic conditions, access by service providers to financing, government regulation of service providers, demand for services and technological developments in the telecommunications technology |
| While the industry generally experienced above average growth in the late 1990’s, since 2001 the telecommunications equipment industry has been materially adversely affected by service providers’ reductions of their capital expenditures |
| Our success is dependent upon continued demand by the communications industry for products used in signal transmission systems, which may be affected by factors beyond our control, including the convergence of video, voice, and data transmission systems occurring within the broadband and telephone markets, continuing consolidation of companies within those markets and the provision of Internet access by broadband operators and local telephone companies |
| 8 ______________________________________________________________________ Limited Backlog |
| Our customers typically require prompt shipment of our products within a narrow timeframe |
| As a result, we have historically operated with a relatively small backlog |
| Sales and operating results in any quarter are principally dependent upon orders booked and products shipped in that quarter |
| Further, our customers generally do not enter into long-term supply contracts providing for future purchase commitments for our products |
| These factors, when combined with our operating leverage (see “Operating Leverage” below) and the need to incur certain capital expenditures and expenses in part based upon the expectation of future sales, may place our operating results at risk to changing customer buying patterns |
| If sales levels in a particular period do not coincide with our expectations, operating results for that period may be materially and adversely affected |
| Our cost of sales may be materially affected by increases in the market prices of the raw materials, including resins, used in our manufacturing processes |
| We do not engage in hedging transactions for such materials, although we periodically enter into purchase agreements for certain raw materials for as much as one year or more |
| There can be no assurance that price increases in raw materials can be passed on to our customers through increases in product prices |
| In addition, in order to position ourselves as a full-line product supplier, we rely on certain manufacturers to supply products, including grade level boxes that complement the products manufactured by us |
| Although we believe there are multiple sources of supply for these products, disruptions or delays in the supply of such products could have a material adverse effect on sales of our own products |
| Energy Costs and Availability |
| Our cost of sales may be materially affected by increases in the market prices of electricity, natural gas and water used in our manufacturing processes |
| California is the site of our largest manufacturing operation |
| The energy costs of California manufacturing firms may increase |
| There exists the possibility of interruption(s) in the supply of energy to California’s manufacturing firms |
| There can be no assurance that our energy costs can be passed on to our customers through increases in product prices |
| Further, disruptions or delays in the supply of electricity, natural gas and water to us could have a material adverse effect on sales of our products |
| In the event of any acquisition by us, there can be no assurance that we will be able to identify and acquire attractive acquisition candidates, profitably manage any such acquired businesses or successfully integrate such acquired businesses into our business without substantial costs, delays or other problems |
| Acquisitions involve a number of special risks, including, but not limited to, adverse short-term effects on our reported financial condition or results of operations, diversion of management’s attention, dependence on retention, hiring and training of key personnel, risks associated with unanticipated problems or liabilities and amortization of acquired intangible assets, some or all of which could have a material adverse effect on our business, financial condition or results of operations |
| We acquired Bushman Tanks in August 2004 |
| The successful integration of this business into our business requires among other things the retention of key personnel, the implementation of the Oracle information system used by all of our other businesses, the implementation of financial accounting and internal controls required by all US publicly owned corporations, the time and attention of our executive management, the integration of management styles and culture as well as the hiring of people necessary to implement the aforementioned items and to expand the business |
| By the end of 2006, management expects this integration effort to be completed |
| In addition, there can be no assurance that any businesses acquired in the future will be profitable at the time of acquisition or will achieve sales and profitability justifying our investment therein or that we will realize the synergies expected from such acquisitions |
| The failure to obtain any or all of the desired results from acquisitions could have a material adverse effect on our business, financial condition and results of operations |
| Because the fixed costs of facilities, product development, engineering, tooling and manufacturing are a relatively high percentage of total costs, our ability to operate profitably is dependent on generating a sufficient volume of product sales, thereby spreading fixed costs over the sales base |
| Due to this “operating leverage”, a reduction in sales or the rate of sales growth has had in the past and could have in the future a disproportionately adverse effect on our financial results |
| Seasonality and Fluctuations in Operating Results |
| Our business is seasonal in nature, with the first and fourth quarters generally reflecting lower sales due to the impact of adverse weather conditions on construction projects that may alter or postpone the needs of customers for delivery of our telecommunications products |
| In addition, first quarter sales may also reflect telecommunication customer delays in implementation of their annual capital expenditure plans |
| The water storage tank business in Australia is traditionally slow during the fourth quarter due to holidays and restrictions on the number of days in which large trucks can utilize major roads to deliver water storage tanks to customers |
| Our operating results may also fluctuate significantly from quarter to quarter due to several other factors, including the volume and timing of orders from and shipments to major customers, the timing of new product introductions and deployment as well as the 9 ______________________________________________________________________ availability of products by us or our competitors, weather conditions in Australia, which may affect the sales of water storage tanks as a large percentage of sales occur at outdoor agricultural farm fairs, the overall level of capital expenditures by broadband operators and telephone companies, market acceptance of new and enhanced versions of our products, variations in the mix of products we sell, and the availability and costs of raw materials |
| Risks Associated with International Operations |
| International sales, including export sales from US operations, accounted for 48dtta5prca, 33dtta9prca, and 21dtta2prca of our net sales in 2005, 2004 and 2003, respectively |
| The percentage of international sales to our total sales has increased with the acquisition of the Bushman Tanks business |
| Due to our international sales, we are subject to the risks of conducting business internationally, including unexpected changes in or impositions of legislative or regulatory requirements, fluctuations in the US dollar, which could materially adversely affect US dollar revenues or operating expenses, tariffs and other barriers and restrictions, longer collection cycles, greater difficulty in accounts receivable collection, potentially adverse taxes and the burdens of complying with a variety of international laws and communications standards |
| We are also subject to general geopolitical risks, such as political and economic instability and changes in diplomatic and trade relationships, in connection with our international operations |
| There can be no assurance that these risks of conducting business internationally will not have a material adverse effect on our business |
| The industries in which we operate are highly competitive |
| The level and intensity of competition may increase in the future |
| Our competitors in the telecommunications industry include companies that are much larger than us, such as Tyco, 3M, Marconi, Arris and Corning |
| Our business strategy includes increased focus on telephone connectivity |
| There can be no assurance that we will be able to compete successfully against our competitors, most of whom have access to greater financial resources than we do |
| Our competitors in the Australian water storage tank business includes Nylex, which is much larger than us, as well as smaller companies that have market position in specific geographic regions |
| There can be no assurances that we will be able to successfully compete against these competitors or increase our sales by obtaining a higher market share |
| Disruptions at Our Manufacturing Facility; Leases with Related Party |
| The majority of our manufacturing operations are currently located at our facilities in Temecula, California, which also includes our principal warehouse and corporate office operations |
| Our success depends in large part on the orderly operation of these facilities |
| Because our manufacturing operations and administrative departments are concentrated at this facility, a fire, earthquake, power interruption or other disaster at this facility could materially and adversely affect our business and results of operations |
| We maintain property and business interruption insurance on this facility |
| We currently lease a portion of our Temecula facilities from The Channell Family Trust, an affiliate of William H Channell, Sr, our principal stockholder and Chairman of the Board, and Jacqueline M Channell, a director and our corporate secretary |
| We believe the terms of these leases are no less favorable than would be available from an unrelated third party after arm’s length negotiations |
| Although these leases expire in, or have renewal options through, the year 2015, there can be no assurance that we will be able to agree on additional renewal terms for the properties currently leased by us |
| Our failure to renew the leases would require us to relocate our existing facilities, which could have a material adverse effect on our business, financial condition or results of operations |
| We currently lease four facilities in Australia from the former owners of Bushman Tanks |
| Although we believe these leases are in total in excess of fair market value by dlra27cmam000 per year, we do not believe that amount is significant compared to total manufacturing costs and thus does not place us of a competitive disadvantage |
| Although we also have renewal options through the year 2015 under these leases, there can be no assurance that we and the former owners will be able to agree on additional renewal terms for the properties currently leased by us |
| Our failure to renew the leases would require us to relocate our existing facilities, which could have a material adverse effect on our business, financial condition or results of operations |
| Dependence on Key Personnel |
| Our future success depends in part on our ability to attract and retain key executive, engineering, marketing and sales personnel |
| Our key personnel includes William H Channell, Sr, Chairman of the Board, William H Channell, Jr, President and Chief Executive Officer and our other executive officers |
| The market for qualified personnel in the communications industry is competitive and the loss of certain key personnel could have a material adverse effect on us |
| We have employment contracts with William H Channell, Jr |
| Changing Regulatory Environment |
| The communications industry is subject to regulation in the United States and other countries |
| Changes in current or future laws or regulations, in the United States or elsewhere, could materially adversely affect our business |
| Government regulation in Australia has increased demand for water storage tanks by requiring the installation of water storage tanks or other water conservation products in new homes built in selected regions |
| There can be no assurances that these regulations will remain in affect |
| A lessening of these regulations most likely would lead to lower demand for water storage products and thus negatively affect our sales |
| 10 ______________________________________________________________________ Uncertain Ability to Manage Industry Volatility |
| Our business has required and is expected to continue to require significant resources in terms of personnel, management and other infrastructure |
| Our ability to manage effectively the volatility of the telecommunications industry requires us to attract, train, motivate and manage new employees successfully, to integrate new employees into our overall operations and to continue to improve our operational, financial and management information systems |
| Environmental Matters |
| We are subject to a wide variety of federal, state and local environmental laws and regulations and use a limited number of chemicals that are classified or could be classified as hazardous or similar substances |
| Although we believe that our operations are in compliance in all material respects with current environmental laws and regulations, our failure to comply with such laws and regulations could have a material adverse effect on us |
| Weather Matters |
| Our business may be affected by adverse changes in weather patterns in Australia that may affect the demand for water storage tanks |
| Prior to 2005 Australia experienced a severe water shortage for several years due to less rainfall, inadequate national infrastructure to store water for use during drought periods and the growth in population in non urban areas |
| In 2005, Australia received a significant amount of rainfall |
| A change in the weather pattern which provides additional rainfall and lessens the effect of the drought could have a negative impact on the demand for water storage tanks |