PHOENIX COLOR CORP - 10-K Annual Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2004

Commission File Number 333-50995

PHOENIX COLOR CORP.
(Exact name of registrant as specified in its charter)

Delaware		22-2269911
(State or other		(I.R.S. Employer Identification No.)
jurisdiction of incorporation or organization)

540 Western Maryland Parkway
Hagerstown, Maryland		21740
(Address of principal executive offices)		(Zip Code)

(301) 733-0018

Registrant’s telephone number, including area code

Securities registered pursuant to Section 12(b) of the Act
Not Applicable

Securities registered pursuant to Section 12(g) of the Act
Not Applicable

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_|

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |X|

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes |_| No |X|

As of June 30, 2004, Phoenix had no voting or non-voting common equity registered under the Securities Exchange Act of 1934, as amended. There is no trading market for the common equity of Phoenix.

As of March 15, 2005, there were 11,100 shares of Phoenix’s Class A Common Stock issued and outstanding and 7,794 of Phoenix’s Class B Common Stock issued and outstanding.

Documents Incorporated by Reference

None.

Table of Contents

Item No.		Name of Item	Page No.

Part I
	Item 1.	Business	2
	Item 2.	Properties	8
	Item 3.	Legal Proceedings	8
	Item 4.	Submission of Matters to a Vote of Security Holders	8

Part II
	Item 5.	Market for Registrant’s Common Equity and Related Stockholder Matters	8
	Item 6.	Selected Consolidated Financial Data	9
	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12
	Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	19
	Item 8.	Financial Statements and Supplementary Data	20
	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	20
	Item 9A	Controls and Procedures	20

Part III
	Item 10.	Directors and Executive Officers of the Registrant	21
	Item 11.	Executive Compensation	22
	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	26
	Item 13.	Certain Relationships and Related Transactions	28

	Item 14	Principal Accountant Fees and Services	28

Part IV
	Item 15	Exhibits, Financial Statement Schedules and Reports on Form 8-K	29

Forward Looking Statements

Some of the statements in this Annual Report on Form 10-K are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. These statements include our indications regarding our intent, beliefs or current expectations. In some cases, you can identify forward-looking statements by terminology such as “may,” “estimates,” “anticipates,” “intends,” “will,” “should,” “could,” “expects,” “believes,” “continues” or “predicts.” These statements involve a variety of known and unknown risks, uncertainties, and other factors that may cause our actual results to differ materially from intended or expected results. These factors include (i) the risk factors and other information presented in our Registration Statement filed with the Securities and Exchange Commission, File No. 333-50995, which became effective May 13, 1999, (ii) the sufficiency of funds to finance our current operations, remaining capital expenditures and internal growth for the year 2005, (iii) the realization of any revenue on the sale of any of our assets, (iv) future consolidation in the printing industry, (v) the ability to pass increased costs of materials on to our customers, (vi) the suitability and adequacy of our existing facilities for our current and short term future needs, without the necessity for major investment in plant and equipment, (vii) whether a resurgence in book publishing will occur, (viii) our ability to continue to reduce costs, (ix) the risks inherent in our interest rate swap agreement, including risk of early termination and (x) the outcome of any claims and lawsuits filed, threatened to be filed or pending against us. You should not place undue reliance on these forward-looking statements, which speak only as of the date hereof. We expressly decline any obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

PART I

ITEM 1. BUSINESS

Unless the context requires otherwise, “Phoenix,” “we,” “us,” and “our” refers to Phoenix Color Corp. and its subsidiaries.

Overview

We manufacture book components in Hagerstown, Maryland (the “Component Facilities”) and we manufacture heavily illustrated multicolor books at our book manufacturing facility in Rockaway, New Jersey (the “Rockaway Facility”). Through January 31, 2005, we manufactured one and two color hard cover and soft cover books at our book manufacturing facility in Hagerstown, Maryland (the “BTP Facility”). Book components include book jackets, paperback covers, pre-printed case covers for hardcover books, illustrations, endpapers and inserts. We generate revenues primarily through the sale of books and book components to book publishers. Book publishers generally design book components to enhance the sales appeal of the books. The production of book components requires specialized equipment, materials and finishes and often demands high-quality, intricate work. As a result, many leading publishers rely on specialty printers such as Phoenix to supply high quality book components.

In developing and growing our business, we have emphasized:

•

Technologically advanced prepress and manufacturing equipment and efficient production techniques;

	•	Computer managed information systems that link all of our facilities and customers and furnish real time operating data;

	•	Fast turnaround times made possible by our state-of-the-art manufacturing equipment, the strategic location of our three plants near major delivery points and the use of our own delivery trucks;

	•	Long-term relationships with suppliers of important raw materials such as paper, laminating film and ink; and

	•	Highly motivated and trained sales personnel.

History

Phoenix was founded in 1979 by a group of fifteen printing industry veterans, including Louis LaSorsa, our Chairman, President and Chief Executive Officer. Initially, we focused on supplying book components for the higher education and professional reference markets but in subsequent years expanded into other markets within the publishing industry. In 1998, we began manufacturing heavily illustrated multicolor books, and in 1999, one and two color hard and soft cover books. We originally conducted our operations in a single production facility in Long Island City, New York. In 1993, we moved the major portion of our business to Hagerstown, Maryland. On December 29, 2004, we sold the manufacturing assets of our BTP Facility and ceased operations at that facility effective January 31, 2005. We currently operate a total of three plants (after cessation of book manufacturing at our BTP Facility) in the States of Maryland and New Jersey and maintain a sales office in New York.

We were incorporated in the State of New York in 1979 and reincorporated by merger in the State of Delaware in 1996. Our headquarters is at 540 Western Maryland Parkway, Hagerstown, Maryland 21740 and our telephone number is (301) 733-0018.

Sale of Assets and Discontinued Operations

On December 29, 2004, we completed the sale to R.R. Donnelley & Sons Company (“R.R. Donnelley”) of the binding line and press equipment located at the BTP Facility. Pursuant to an Asset Purchase Agreement dated December 29, 2004, R. R. Donnelley acquired substantially all of the binding line and press equipment and other tangible personal property used at the BTP Facility for an aggregate purchase price of $16,831,514, which equaled the buyout price for the equipment subject to various equipment leases terminated at the transaction’s closing. In connection with the transaction, we agreed not to engage in the business of printing one or two color, soft or hard cover books in the United States for a period of five (5) years. We and R.R. Donnelley have reached an agreement through which the Component Facilities will produce components for a number of R.R. Donnelley book plants. This agreement does not contain any volume requirements. We have not reached any final conclusions regarding the use or disposition of the real property and improvements we own and which historically have been utilized by the BTP Facility, the operations of which have been terminated. The results of our BTP division have been presented as a discontinued operation in accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”).

Manufacturing Operations and Technology

Order Processing.

Our customers transmit orders to our various plant locations by physical delivery or electronic file transfer. After entering a customer order into our order processing system, we monitor the order on a real-time basis throughout the entire manufacturing process. Our management allocates work orders among our plants through our data network to maximize plant efficiency and minimize operating cost.

To limit the costs associated with maintaining inventory, many of our customers have instituted inventory controls to limit the amount of inventory held by them. As a result, we and other specialty printers are under increasing pressure to process orders quickly and efficiently. We have been able to meet the demands of our customers by investing in modern printing and finishing equipment, and digital communications and information network, as well as operating our facilities on a 24-hour basis, seven days a week. As an additional service, we provide real-time job status and plant capacity information to our customers over the Internet.

Digital Prepress Services.

We provide a complete range of prepress services, including color separations, high speed imaging, assembly, electronic retouching, archiving, digital file transfer, color-accurate digital proofing and computer generated platemaking. We offer prepress services at each of our manufacturing facilities. Our prepress services are linked through a high speed telecommunications network. We do not rely on any subcontractors for our prepress needs.

Printing and Finishing Services.

We manufacture book components by using 19 modern high-speed, sheet-feed offset lithographic printing presses capable of printing up to eight colors in a single pass, some of which can print both sides of the sheet at the same time, and most with inline coaters. We protect the manufactured book components by applying an ultraviolet liquid coating or laminating different types of film such as polypropelene and mylar. We also offer a plethora of in-house services, including foil stamping, selected and overall embossing, selected and overall liquid coatings and die cutting.

We produce heavily illustrated multicolor books in our Rockaway Facility, which has three presses capable of printing up to eight or ten colors on a single side or four or five colors on each side during a single pass. These presses employ roll stand technology, which sheets the paper as it enters the press, (thereby eliminating the need to sheet paper off line) and continually add paper to the feeder system of the press. We offer several varieties of binding styles including smythe sewn, side sewn and thread seal for hard cover books in addition to gluing for both hard cover and soft cover books.

Through January 31, 2005, we printed one and two color hard and soft cover books at our BTP Facility. In connection with the manufacture of books, we offered perfect binding, saddle wire binding and hard cover casing-in. On December 29, 2004 we sold the manufacturing assets of this facility.

Distribution and Logistics.

We operate our own tractor-trailers to deliver a majority of our products. This enables us to reduce transportation costs and to save one or more days of delivery time in fulfilling customer requirements. The tractor-trailers are also used to distribute raw materials among our manufacturing plants.

Technology.

We continue to invest in new technology to ensure modern highly efficient production capabilities. We archive negative film and digital files to facilitate reorders. We also have state of the art printing presses, foil stamping presses, finishing equipment and binding equipment.

Before printing, we provide customers with color accurate digital proofs of their jobs, which our customers must approve. We can transfer digital files within our facilities and to our customers who have been provided with the appropriate equipment. We may also receive or transmit files from or to our customers through the Internet in various formats, including PDF and HTML, among others.

Raw Materials, Purchasing and Inventory

We use substantial quantities of paper, ink, laminating film, foil and other materials in our operations. We generally favor “single sourcing” of our various raw materials purchases. We believe that establishing strong commercial relationships with a relatively small number of suppliers enables us to negotiate favorable prices and to maintain reliable supplies of such materials. Nevertheless, we are not party to any long-term supply agreements, are not dependent on any single source for our raw materials and believe we could replace any individual supplier without disruption to our business. We maintain minimal inventories of our supplies. A change in suppliers could cause a delay in manufacturing, and a possible loss of sales, which could adversely affect operating results.

We generally obtain annual pricing commitments from our suppliers, but such commitments are not legally binding. Nevertheless, our vendors have historically complied with commitments made to us. We generally pass through material costs to our customers and believe that in the event of material price increases by vendors, we could pass such increases through to our customers.

We use centralized purchasing and storage for book component inventory at the Component Facilities in order to control raw material costs. Further, we purchase paper in large rolls and convert the paper, using our own computerized sheeters, into sheets in the sizes required by our presses. By converting in excess of 30 million pounds of paper in-house annually, we are able to reduce paper costs, avoid delays in obtaining properly sized sheets and minimize the need to maintain an inventory of specific sheet paper sizes.

Trademarks

Phoenix owns trademarks that are used in the conduct of its business. These trademarks are valuable assets, the most important of which are “Phoenix Color,” and “Phoenix Colornet.”

Markets

We sell book components and heavily illustrated multicolor books, and through January 31, 2005, we sold one and two color hard and soft cover books to all major book publishing markets. Various book publishing markets may respond to different economic and other factors, and declines in one or more markets in a given year may be offset by improvements in other markets. Accordingly, we view our sales to a broad range of book publishing markets as a competitive strength.

Sales of book components represented 77.1%, 77.4% and 78.5% of our net sales in the years ended December 31, 2004, 2003 and 2002, respectively. Sales of book components for use in general interest books accounted for 48.3% of our net book component sales for the year 2004, 52.1% for 2003 and 47.8%

for 2002. Sales of book components to publishers of educational materials accounted for 26.3% of net book component sales in 2004 and 24.9% in each of the years 2003 and 2002. Sales to publishers of business-related books accounted for 7.1%, 6.9% and 9.4% of net book component sales in 2004, 2003 and 2002, respectively. Sales of book components to all other book publishers accounted for 18.3%, 16.1% and 17.9% of net book component sales in 2004, 2003 and 2002, respectively.

We began selling heavily illustrated multicolor books to publishers of juvenile books in the fourth quarter of 1998. We are continuing to expand our customer base of both juvenile and non-juvenile illustrated multicolor book customers. Sales of heavily illustrated multicolor books represented 22.9%, 22.6% and 21.5% of our net sales for the years ended December 31, 2004, 2003, and 2002, respectively.

Customers

We have a base of over 400 active customers, including many of the leading publishing companies in the world. Among our largest customers are HarperCollins, Pearson Publishing, Simon & Schuster, Random House, Holtzbrinck Publishers, McGraw-Hill, Time Warner, Thomson Learning, Thomas Nelson, Oxford University Press, and W.W. Norton, many of which have been our customers since our inception in 1979. Many of these customers have decentralized operations in which purchasing decisions are made by various divisions. HarperCollins Publishers and Pearson Publishing accounted for 21.1% and 19.5%, respectively, of our net sales in 2004 and 19.3% and 19.1%, respectively, of our net sales in 2003. Our ten largest customers accounted for approximately 85.2% and 82.6% of net sales in 2004 and 2003, respectively. The loss of any one or more of our ten largest customers would be detrimental to our operating results.

Because we derive all of our revenues from customers in the book publishing and book printing industries, our business, financial condition and results of operations could be adversely affected by changes which have a negative impact on these industries.

Sales

In 2004 we had a direct sales force consisting of 21 sales representatives located throughout the U.S. Due to the termination of operations at our BTP Facility, we reduced our sales force in 2005 by 7 people. We train our sales personnel in techniques of selling and technical training in the manufacturing process and train them to provide superior service to customers. We have established a marketing department, which works with our sales department to promote our services, including participating in publishing industry trade shows.

Backlog

We do not operate with any backlog at our book component and heavily illustrated multicolor books facilities. Both we and our customers share the same goal: processing orders on demand in the shortest possible time frame.

Competition

The printing industry in general, and the printing and manufacturing of books in particular, are extremely competitive. Over the past several years, there has been significant consolidation in the publishing industry, such that fewer publishers control a greater share of the market. Although there are still many small, independent publishers, they do not wield the leverage held by major publishing houses. In addition, many of the larger publishers have become part of much larger media companies with in-house production capabilities, and are driven to maximize profits. Over the past four years, the printing

industry has experienced a reduction in demand for books and book components and is currently experiencing excess capacity. These factors have combined to cause pricing pressures for book and book component manufacturers. Management believes that this environment will lead to more consolidation within the commercial print industry as companies seek economies of scale, broader customer relationships, geographic coverage and product breadth to overcome or offset industry excess capacity and pricing pressures.

We compete in the printing and manufacturing of books with dominant printers in the industry, consisting of R.R. Donnelley, Quebecor/World and Banta Corporation, as well as smaller companies such as Worzalla Publishers and Lake Book. All of the dominant printers have significantly more revenue and assets than us. Our Rockaway Facility also competes in the multicolor highly illustrated book market with Asian printers that create pricing pressure for these type of books. We also compete with book component printers, such as Coral Graphics, which offer services similar to ours to the publishing industry.

Competitive factors in the printing of book components and the manufacture of complete books include price, quality, speed of production and delivery, use of technology and the ability to service specialized customer needs on a consistent basis. Many of the largest publishers also have contracts with book printers to insure that the publishers’ products are printed on a preferred basis in the event manufacturing availability becomes limited. The cost of moving film or digital files from one printer to another is a disincentive for publishers to order reprints from a printer other than the printer that completed the original print job. In both the printing and manufacturing of books and book components, we believe that we compete by offering a high level of service that many customers, particularly medium sized publishers, are unaccustomed to receiving from our competitors. We also compete with our book component competitors by being able to perform in-house all services required by publishers.

Employees

As of December 31, 2004, we had 690 employees, of whom 8 were engaged in management, 37 in finance, administration and billing, 64 in sales, sales support and customer service, 10 in information systems and technological development, 15 in transportation and 556 in manufacturing. None of our employees are represented by unions, and we believe we have satisfactory relations with our workforce. Due to the cessation of operations at the BTP Facility, we eliminated approximately 180 positions in January 2005.

Working Capital

Through careful management, and not withstanding the decline in revenues, we have increased our working capital to $6.2 million at December 31, 2004 compared to $1.9 million at December 31, 2003 and a negative $1.1 million at December 31, 2002. We maintain inventories at the lowest levels possible while still fulfilling customer orders, relying on our vendors to provide adequate inventory for delivery within 24 hours. We supply all of the materials for our Component Facilities and Rockaway Facility, whereas certain large publishers provided paper at our the BTP Facility. We provide terms consistent with norms in the industry for payment of invoices from customers. Smaller publishers generally request more favorable payment terms, which we sometimes grant in accordance with the publishers’ respective financial stability, but never in excess of 90 days and with limits on overall credit advanced. We make no sales on consignment.

Seasonality

There is generally no seasonality in our sales due to various markets in publishing industry producing books at various times during the year.

ITEM 2. PROPERTIES

Our corporate and administrative offices are located in one of the two adjacent manufacturing facilities comprising the Component Facilities. We lease various manufacturing and regional sales offices. A summary of the location, size and nature of the principal facilities appears below:

Location	Use	Leased/Owned; Expiration Date	Square Footage

Hagerstown, MD	Corporate offices; printing, prepress and finishing for book components	Owned	114,000
Hagerstown, MD	Printing, prepress and finishing for book components	Owned	86,000
New York City, NY	Sales	Leased; 10/31/09	11,000
Rockaway, NJ	Printing, prepress and finishing for complete books	Leased; 3/31/08	90,000
Hagerstown, MD (1)	Printing, prepress and binding for complete books	Owned	170,000

(1) The BTP Facility ceased operations in January 2005 following the sale of all of its book manufacturing assets other than the land and building located at the BTP Facility. We are evaluating the options with respect to all of our real estate located in Hagerstown, Maryland.

All owned real property collateralizes our senior credit facility pursuant to our Amended and Restated Credit Agreement with Wachovia Bank, N.A. dated September 30, 2003 (the “Senior Credit Facility”).

We believe that our existing facilities are suitable and adequate for our current and short term future needs, without the necessity of major investment in plant or equipment. The Component Facilities and the Rockaway Facility operate at approximately 75% of capacity.

ITEM 3. LEGAL PROCEEDINGS

We are not a party to any legal proceedings, other than claims and lawsuits arising in the normal course of our business. Although the outcome of claims and lawsuits against us can not be accurately predicted, we do not believe that any of the claims and lawsuits will have a material adverse effect on our business, financial condition, results of operations and cash flows for any quarterly or annual period.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS

No established public trading market exists for our Class A Common Stock or Class B Common Stock. As of March 15, 2005 there were eleven holders of record of our Class A Common Stock and two holders of record of our Class B Common Stock.

We did not declare or pay any dividends on our capital stock in the past three years. We expect to retain future earnings, if any, to finance the growth and development of our business. Thus, we do not intend to declare or pay dividends on our capital stock for the foreseeable future. Further, our Senior Credit Facility prohibits, and the indenture governing our 10-3/8% Senior Subordinated Notes (the “Indenture”) restricts, the payment of dividends. Under the terms of the Indenture, we may not pay dividends unless we are not in default under the Indenture and we would, after giving effect to the dividend, be in compliance with certain financial criteria, as set forth in the Indenture.

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The selected consolidated financial data of the Company for the years ended December 31, 2004, 2003, 2002, 2001 and 2000 have been derived from our Audited Consolidated Financial Statements. Prior period amounts have been restated to reflect the sale of the manufacturing assets of the BTP Facility and the presentation of the BTP asset group as a discontinued operation in accordance with SFAS No. 144. This information should be read in conjunction with the 2004, 2003 and 2002 Consolidated Financial Statements and the related Notes thereto appearing as Item 8 of this Annual Report on Form 10-K and Management’s Discussion and Analysis of Financial Condition and Results of Operations.

	Years Ended December 31,

	2000			2001			2002			2003			2004

	(dollars in thousands)
Statement of Operations Data:
Sales	$	137,545		$	109,342		$	111,123		$	106,159		$	98,577
Cost of sales		102,622			79,757			76,552			73,662			71,998
Gross profit		34,923			29,585			34,571			32,497			26,579
Operating expenses:
Selling and marketing expenses		5,560			6,619			6,110			5,042			5,007
General and administrative		16,103			14,060			10,571			11,814			9,775
(Gain) loss on sale of assets (1)		2,630			122			(323	)		589			694
Restructuring charge (credit) (2)		11,425			(304	)		—			(2,181	)		—
Impairment charge (3)		—			—			744			—			—
Lease termination charge (4)		—			—			1,760			—			—
Total operating expenses		35,718			20,497			18,862			15,264			15,476
Income (loss) from operations		(795	)		9,088			15,709			17,233			11,103
Interest expense		(12,943	)		(12,374	)		(12,675	)		(12,066	)		(12,166	)
Other income (expense)		116			254			(345	)		(2	)		181
Income (loss) from continuing operations before income taxes		(13,622	)		(3,032	)		2,689			5,165			(882	)

Income tax (benefit) provision		(3,732	)		4,400			(3,269	)		—			(440	)
(Loss) income from continuing operations		(9,890	)		(7,432	)		5,958			5,165			(442	)
Discontinued operations (5):
Loss from operations of the discontinued BTP division (including loss on disposal of $5.6 million in 2004)		(8,595	)		(7,577	)		(7,599	)		(7,995	)		(12,719	)
Income tax benefit		3,323			—			—			—			—
Loss on discontinued operations		(5,272	)		(7,577	)		(7,599	)		(7,995	)		(12,719	)
Net loss	$	(15,162	)	$	(15,009	)	$	(1,641	)	$	(2,830	)	$	(13,161	)
Balance Sheet Data (at year end):
Cash and cash equivalents	$	368		$	122		$	109		$	64		$	39
Total assets		133,072			122,402			119,044			111,780			91,665
Total debt (including capital lease obligations)		114,180			117,902			119,626			116,101			109,795

Total stockholders’ (deficit)		(2,653	)		(17,624	)		(19,233	)		(22,049	)		(35,195	)
Other Financial Data:
Depreciation and amortization expense	$	15,436		$	13,955		$	10,330		$	10,631		$	10,979

Capital expenditures (6)		7,431			5,254	&