Attached files
| file | filename |
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| EX-32 - EXHIBIT 32 - SCHAWK INC | exb32.htm |
| EX-31.2 - EXHIBIT 31.2 - SCHAWK INC | exb31-2.htm |
| EX-31.1 - EXHIBIT 31.1 - SCHAWK INC | exb31-1.htm |
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2010
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 001-09335
SCHAWK, INC.
(Exact name of Registrant as specified in its charter)
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Delaware
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66-0323724
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(State or other jurisdiction of
incorporation or organization)
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(I.R.S. Employer
Identification No.)
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1695 South River Road
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60018
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Des Plaines, Illinois
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(Zip Code)
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(Address of principal executive office)
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847-827-9494
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(Registrant’s telephone number, including area code)
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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 þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
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Large accelerated filer o
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Accelerated filer þ
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Non-accelerated filer o
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Smaller reporting company o
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(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Act).
Yes o No þ
The number of shares of the Registrant’s Common Stock outstanding as of October 29, 2010 was 25,669,433.
SCHAWK, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
September 30, 2010
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Page
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PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Schawk, Inc.
(In thousands, except share amounts)
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September 30,
2010
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December 31,
2009
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(unaudited)
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Assets
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Current assets:
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Cash and cash equivalents
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$ | 28,959 | $ | 12,167 | ||||
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Trade accounts receivable, less allowance for doubtful accounts
of $1,187 at September 30, 2010 and $1,619 at December 31, 2009
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86,802 | 88,822 | ||||||
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Inventories
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21,324 | 20,536 | ||||||
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Prepaid expenses and other current assets
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10,314 | 8,192 | ||||||
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Income tax receivable
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212 | 2,565 | ||||||
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Deferred income taxes
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3,544 | 992 | ||||||
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Total current assets
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151,155 | 133,274 | ||||||
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Property and equipment, less accumulated depreciation of $103,459 at September 30,
2010 and $96,440 at December 31, 2009
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46,215 | 50,247 | ||||||
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Goodwill
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188,641 | 187,664 | ||||||
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Other intangible assets, net
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34,534 | 37,605 | ||||||
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Deferred income taxes
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1,294 | 1,424 | ||||||
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Other assets
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6,919 | 6,005 | ||||||
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Total assets
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$ | 428,758 | $ | 416,219 | ||||
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Liabilities and stockholders’ equity
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Current liabilities:
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Trade accounts payable
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$ | 15,925 | $ | 16,957 | ||||
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Accrued expenses
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62,624 | 64,079 | ||||||
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Deferred income taxes
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5,510 | 205 | ||||||
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Income taxes payable
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4,976 | 14,600 | ||||||
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Current portion of long-term debt
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21,189 | 12,858 | ||||||
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Total current liabilities
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110,224 | 108,699 | ||||||
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Long-term liabilities:
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Long-term debt
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41,423 | 64,707 | ||||||
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Other liabilities
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15,988 | 15,920 | ||||||
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Deferred income taxes
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4,350 | 2,059 | ||||||
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Total long-term liabilities
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61,761 | 82,686 | ||||||
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Stockholders’ equity:
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Common stock, $0.008 par value, 40,000,000 shares authorized,
30,390,003 and 29,855,796 shares issued at September 30, 2010 and
December 31, 2009, respectively; 25,644,433 and 25,108,894
shares outstanding at September 30, 2010 and December 31, 2009,
respectively
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223 | 220 | ||||||
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Additional paid-in capital
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197,580 | 191,701 | ||||||
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Retained earnings
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108,996 | 85,953 | ||||||
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Accumulated comprehensive income, net
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10,795 | 7,804 | ||||||
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Treasury stock, at cost, 4,745,570 and 4,746,902 shares of common
stock at September 30, 2010 and December 31, 2009, respectively
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(60,821 | ) | (60,844 | ) | ||||
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Total stockholders’ equity
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256,773 | 224,834 | ||||||
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Total liabilities and stockholders’ equity
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$ | 428,758 | $ | 416,219 | ||||
The Notes to Consolidated Financial Statements are an integral part of these consolidated statements.
Schawk, Inc.
(Unaudited)
(In thousands, except per share amounts)
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Three Months Ended
September 30,
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Nine Months Ended
September 30,
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2010
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2009
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2010
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2009
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Net sales
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$ | 112,562 | $ | 113,463 | $ | 342,110 | $ | 330,540 | ||||||||
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Cost of sales
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68,768 | 67,957 | 209,617 | 209,006 | ||||||||||||
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Gross profit
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43,794 | 45,506 | 132,493 | 121,534 | ||||||||||||
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Selling, general and administrative expenses
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28,675 | 32,193 | 91,619 | 98,313 | ||||||||||||
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Foreign exchange (gain) loss
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694 | (644 | ) | 2,244 | (1,089 | ) | ||||||||||
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Indemnity settlement
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-- | (4,986 | ) | -- | (4,986 | ) | ||||||||||
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Acquisition integration and restructuring expenses
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371 | 1,328 | 1,386 | 3,646 | ||||||||||||
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Multiemployer pension withdrawal expense
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500 | -- | 500 | -- | ||||||||||||
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Impairment of long-lived assets
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-- | -- | 680 | 136 | ||||||||||||
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Operating income
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13,554 | 17,615 | 36,064 | 25,514 | ||||||||||||
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Other income (expense)
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Interest income
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15 | 124 | 31 | 224 | ||||||||||||
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Interest expense
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(1,642 | ) | (2,880 | ) | (5,401 | ) | (6,797 | ) | ||||||||
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Income before income taxes
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11,927 | 14,859 | 30,694 | 18,941 | ||||||||||||
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Income tax provision
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4,154 | 1,553 | 4,596 | 3,163 | ||||||||||||
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Net income
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$ | 7,773 | $ | 13,306 | $ | 26,098 | $ | 15,778 | ||||||||
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Earnings per share:
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Basic
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$ | 0.30 | $ | 0.53 | $ | 1.03 | $ | 0.63 | ||||||||
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Diluted
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$ | 0.30 | $ | 0.53 | $ | 1.01 | $ | 0.63 | ||||||||
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Weighted average number of common and common
equivalent shares outstanding:
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Basic
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25,577 | 24,955 | 25,387 | 24,937 | ||||||||||||
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Diluted
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25,923 | 25,040 | 25,794 | 24,949 | ||||||||||||
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Dividends per Class A common share
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$ | 0.0400 | $ | 0.0100 | $ | 0.1200 | $ | 0.0525 | ||||||||
The Notes to Consolidated Financial Statements are an integral part of these consolidated statements.
Schawk, Inc.
Nine Months Ended September 30, 2010 and 2009
(Unaudited)
(In thousands)
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2010
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2009
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Cash flows from operating activities
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Net income
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$ | 26,098 | $ | 15,778 | ||||
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Adjustments to reconcile net income to cash provided by operating activities:
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Depreciation
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9,889 | 10,715 | ||||||
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Amortization
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3,369 | 3,494 | ||||||
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Impairment of long-lived assets
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680 | 136 | ||||||
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Insurance settlement
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(1,539 | ) | -- | |||||
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Non-cash restructuring charge
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-- | 210 | ||||||
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Amortization of deferred financing fees
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527 | 626 | ||||||
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Share-based compensation expense
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1,414 | 1,290 | ||||||
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Loss realized on sale of property and equipment
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12 | 115 | ||||||
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Changes in operating assets and liabilities, net of acquisitions:
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Trade accounts receivable
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2,209 | 2,903 | ||||||
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Inventories
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(1,019 | ) | 1,195 | |||||
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Prepaid expenses and other current assets
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(2,516 | ) | 586 | |||||
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Trade accounts payable, accrued expenses and other liabilities
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(2,453 | ) | (4,207 | ) | ||||
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Income taxes refundable (payable)
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(1,967 | ) | 8,980 | |||||
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Net cash provided by operating activities
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34,704 | 41,821 | ||||||
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Cash flows from investing activities
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Proceeds from sales of property and equipment
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491 | 4,420 | ||||||
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Proceeds from insurance settlement
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1,539 | -- | ||||||
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Purchases of property and equipment
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(6,724 | ) | (3,886 | ) | ||||
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Acquisitions, net of cash acquired
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(895 | ) | (367 | ) | ||||
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Other
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11 | (18 | ) | |||||
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Net cash provided by (used in) investing activities
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(5,578 | ) | 149 | |||||
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Cash flows from financing activities
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Proceeds from issuance of long-term debt
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82,161 | 65,443 | ||||||
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Payments of long-term debt, including current maturities
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(97,114 | ) | (110,549 | ) | ||||
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Payment of deferred financing fees
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(1,017 | ) | (1,170 | ) | ||||
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Cash dividends
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(3,032 | ) | (1,293 | ) | ||||
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Purchase of common stock
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-- | (4,277 | ) | |||||
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Issuance of common stock
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4,468 | 837 | ||||||
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Net cash used in financing activities
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(14,534 | ) | (51,009 | ) | ||||
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Effect of foreign currency rate changes
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2,200 | (814 | ) | |||||
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Net increase (decrease) in cash and cash equivalents
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16,792 | (9,853 | ) | |||||
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Cash and cash equivalents at beginning of period
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12,167 | 20,205 | ||||||
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Cash and cash equivalents at end of period
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$ | 28,959 | $ | 10,352 | ||||
The Notes to Consolidated Financial Statements are an integral part of these consolidated statements.
Schawk, Inc.
Notes to Consolidated Financial Statements
(Unaudited)
(In thousands, except per share data)
Note 1 – Significant Accounting Policies
The Company’s significant accounting policies are included in Note 1 to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 (“2009 Form 10-K”). There have been no material changes in the Company’s significant accounting policies since December 31, 2009, except as follows:
Derivative Financial Instruments. In May 2010, the Company executed two “variable to fixed” interest rate swaps, designated as cash flow hedges, for the total notional amount of $15,000. The Company assesses hedge effectiveness quarterly by comparing the current terms of the swaps and the debt. The effective portion of the derivative fair value gains or losses from these cash flow hedges is deferred in Accumulated comprehensive income, net. The derivatives are recorded on the Consolidated Balance Sheets at fair value. See Note 14 – Derivative Financial Instruments for further discussion.
Interim Financial Statements
The unaudited consolidated interim financial statements of Schawk, Inc. (“Schawk” or the “Company”) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. Certain previously reported immaterial amounts have been reclassified to conform to the current-period presentation. In the opinion of management, all adjustments necessary for a fair presentation for the periods presented have been recorded.
These financial statements should be read in conjunction with, and have been prepared in conformity with, the accounting principles reflected in the Company’s consolidated financial statements and the notes thereto for the three years ended December 31, 2009, as filed with its 2009 Form 10-K. The results of operations for the three and nine months ended September 30, 2010 are not necessarily indicative of the results to be expected for the full fiscal year ending December 31, 2010.
Recent Accounting Pronouncements
In October 2009, the Financial Accounting Standards Board (“FASB”) amended the Accounting Standards Codification (“ASC” or “Codification”) as summarized in Accounting Standards Update (“ASU”) No. 2009-13, Revenue Recognition (Topic 605) – Multiple-Deliverable Revenue Arrangements, and ASU 2009-14, Software (Topic 985) – Certain Revenue Arrangements That Include Software Elements. As summarized in ASU 2009-13, ASC Topic 605 has been amended (1) to provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and the consideration allocated; (2) to require an entity to allocate revenue in an arrangement using estimated selling prices of deliverables if a vendor does not have vendor-specific objective evidence (“VSOE”) or third-party evidence of selling price; and (3) to eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method. As summarized in ASU 2009-14, ASC Topic 985 has been amended to remove from the scope of industry specific revenue accounting guidance for software and software related transactions, tangible products containing software components and non-software components that function together to deliver the product’s essential functionality. The accounting changes summarized in ASU 2009-14 and ASU 2009-13 are both effective for fiscal years beginning on or after June 15, 2010, with early adoption permitted. The Company is currently evaluating the impact that the adoption of ASU 2009-13 and ASU 2009-14 may have on the Company’s consolidated financial statements.
Note 2 – Inventories
The Company’s inventories consist primarily of raw materials and work in process inventories, as well as finished goods inventory related to the Company’s Los Angeles print operation. Raw materials are stated at the lower of cost or market. Work-in-process consists of primarily deferred labor and overhead costs.
The majority of the Company’s inventories are valued on the first-in, first-out (FIFO) basis. The remaining inventories are valued using the last-in, first-out (LIFO) method. The Company periodically evaluates the realizability of inventories and adjusts the carrying value as necessary.
Inventories consist of the following:
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September 30,
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December 31,
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2010
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2009
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Raw materials
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$ | 2,165 | $ | 2,736 | ||||
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Work in process
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19,582 | 16,969 | ||||||
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Finished Goods
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517 | 1,771 | ||||||
| 22,264 | 21,476 | |||||||
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Less: LIFO reserve
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(940 | ) | (940 | ) | ||||
| $ | 21,324 | $ | 20,536 | |||||
Note 3 – Earnings Per Share
Basic earnings per share and diluted earnings per share are shown on the Consolidated Statements of Operations. Basic earnings per share are computed by dividing net income by the weighted average shares outstanding for the period. Diluted earnings per share are computed by dividing net income by the weighted average number of common shares, including common stock equivalent shares (stock options) outstanding for the period. There were no reconciling items to net income to arrive at income available to common stockholders.
The following table sets forth the number of common and common stock equivalent shares used in the computation of basic and diluted earnings per share:
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Three Months Ended
September 30,
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Nine Months Ended
September 30,
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2010
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2009
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2010
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2009
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Weighted average shares – Basic
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25,577
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24,955
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25,387
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24,937
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Effect of dilutive stock options
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346
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85
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407
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12
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Adjusted weighted average shares and assumed
conversions – Diluted
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25,923
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25,040
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25,794
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24,949
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The following table presents the potentially dilutive outstanding stock options excluded from the computation of diluted earnings per share for each period because they would be anti-dilutive:
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Three Months Ended
September 30,
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Nine Months Ended
September 30,
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|||||||||||||||
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2010
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2009
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2010
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2009
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Anti-dilutive options
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917 | 1,349 | 908 | 2,749 | ||||||||||||
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Exercise price range
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$ | 12.87 - $21.08 | $ | 7.16 - $21.08 | $ | 12.87 - $21.08 | $ | 6.94 - $21.08 | ||||||||
Note 4 – Comprehensive Income
The Company reports certain changes in equity during a period in accordance with the Comprehensive Income Topic of the Codification, ASC 220. Accumulated comprehensive income, net includes cumulative translation adjustments and changes in gains and losses on hedged transactions, net of tax. The components of comprehensive income (loss) for the three and nine month periods ended September 30, 2010 and 2009 are as follows:
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Three Months Ended
September 30,
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Nine Months Ended
September 30,
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|||||||||||||||
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2010
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2009
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2010
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2009
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Net income
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$ | 7,773 | $ | 13,306 | $ | 26,098 | $ | 15,778 | ||||||||
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Foreign currency translation adjustments
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4,489 | 1,588 | 3,132 | 5,163 | ||||||||||||
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Changes in unrealized loss on hedges (net of tax)
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(50 | ) | -- | (141 | ) | -- | ||||||||||
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Comprehensive income
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$ | 12,212 | $ | 14,894 | $ | 29,089 | $ | 20,941 | ||||||||
Note 5 – Stock Based Compensation
The Company accounts for share-based payments in accordance with the provisions of the Stock Compensation Topic of the Codification, ASC 718, based on the grant date fair value estimated in accordance with the provisions of ASC 718 and using the straight-line expense attribution method.
The Company records compensation expense for employee stock options based on the estimated fair value of the options on the date of grant using the Black-Scholes option-pricing model with the assumptions included in the table below. The Company uses historical data among other factors to estimate the expected price volatility, the expected term and the expected forfeiture rate. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for the estimated life of the option. The following assumptions were used to estimate the fair value of options granted during the nine-month periods ended September 30, 2010 and September 30, 2009, using the Black-Scholes option-pricing model.
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Nine Months Ended
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Nine Months Ended
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September 30, 2010
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September 30, 2009
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Expected dividend yield
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0.88%-1.24%
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1.34%-1.39%
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Expected stock price volatility
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47.75%-48.97%
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43.75%-43.8%
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Risk-free interest rate
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2.87%-3.26%
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2.79%-3.33%
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Weighted-average expected life of options
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6.53-7.40 years
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6.8-7.21 years
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Forfeiture rate
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1.0%-3.0%
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0.85%-1.00%
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No options or shares of restricted stock were granted during the three-month period ended September 30, 2010. The total fair value of options and restricted stock granted during the nine-month period ended September 30, 2010, was $1,688. The total fair value of options and restricted stock granted during the three and nine-month periods ended September 30, 2009, was $47 and $1,742, respectively. As of September 30, 2010, there was $2,390 of total unrecognized compensation cost related to nonvested options and restricted shares outstanding. That cost is expected to be recognized over a weighted average period of approximately two years. Expense recognized under ASC 718 for the three and nine-month periods ended September 30, 2010 was $373 and $1,414, respectively. Expense recognized under ASC 718 for the three and nine-month periods ended September 30, 2009, was $411 and $1,290, respectively.
Note 6 – Impairment of Long-lived Assets and Insurance Recoveries
During the first quarter of 2010, certain newly purchased and installed production equipment sustained water damage and became no longer operable. The Company recorded an impairment charge in the amount of $680, the net book value of the damaged equipment, which is included in Impairment of long-lived assets in the Consolidated Statements of Operations for the nine-month period ended September 30, 2010, and filed a claim with its insurance carrier for the loss incurred. The expense was recorded in the North America operating segment. In the nine-month period ended September 30, 2009, the Company recorded asset impairment charges of $136.
The Company maintains insurance coverage for property loss, business interruption, and directors and officers liability and records insurance recoveries in the period in which the insurance carrier validates the claim and confirms the amount of reimbursement to be paid. During the second quarter of 2010, the Company received an insurance settlement of $519 related to the damaged equipment for which impairment was recorded in the first quarter of 2010. In addition, during the second quarter of 2010, the Company received confirmation of a pending insurance settlement in the amount of $860 related to a flood loss at one of the Company’s North American operations during 2009. The Company recorded a receivable in the amount of $860 at June 30, 2010 for this pending settlement, which was received in July 2010. During the third quarter of 2010, the Company received an additional insurance settlement related to the equipment for which impairment was recorded in the first quarter of 2010 in the amount of $279; $160 related to property damage and $119 related to business interruption coverage. During the third quarter of 2010, the Company received a directors and officers liability insurance settlement in the amount of $1,196 representing reimbursement of certain expenses related to the Company’s ongoing SEC investigation. See Note 12 – Contingencies for further information related to the SEC investigation.
The table below summarizes where the insurance recoveries totaling $1,475 and $2,854 for the three and nine-month periods ended September 30, 2010 are reflected in the Consolidated Statements of Operations:
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Three Months Ended
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Nine Months Ended
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|||||||
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September 30, 2010
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September 30, 2010
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Cost of sales:
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Business interruption coverage
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$ | 119 | $ | 119 | ||||
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Total cost of sales
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119 | 119 | ||||||
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Selling, general and administrative expenses:
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Property coverage
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160 | 1,539 | ||||||
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Directors and officers liability coverage
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1,196 | 1,196 | ||||||
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Total selling, general and administrative expenses
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1,356 | 2,735 | ||||||
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Total insurance recoveries
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$ | 1,475 | $ | 2,854 | ||||
Note 7 – Acquisitions
Untitled London Limited
Effective September 17, 2010, the Company acquired the operating assets of Untitled London Limited, a United Kingdom-based agency that provides strategic, creative and technical services for digital marketing. The net assets and results of operations of Untitled London Limited are included in the Consolidated Financial Statements in the Europe operating segment, effective September 17, 2010. This business was acquired to expand the Company’s digital marketing capabilities in Europe.
The purchase price was approximately $860. The Company has recorded a preliminary purchase price allocation that will be adjusted upon completion of a fair value appraisal, which is in process. A summary of the preliminary fair values assigned to the acquired net assets is as follows:
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Accounts receivable
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$ | 79 | ||
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Inventory
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15 | |||
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Fixed assets
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80 | |||
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Goodwill
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343 | |||
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Customer relationships
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274 | |||
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Trade name
|
69 | |||
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Total cash paid at closing
|
$ | 860 |
Supplemental pro-forma information is not presented because the acquisition is considered immaterial to the Company’s consolidated financial statements.
Brandmark International Holding B.V.
Effective December 31, 2008, the Company acquired 100 percent of the outstanding stock of Brandmark International Holding B.V. (“Brandmark”), a Netherlands-based brand identity and creative design firm. Brandmark provides services to consumer products companies through its locations in Hilversum, The Netherlands and London, United Kingdom. The net assets and results of operations of Brandmark are included in the Consolidated Financial Statements in the Europe operating segment. This business was acquired to expand the Company’s creative design business in Europe, enhancing the Company’s ability to provide services for its multinational clients.
The purchase price of $10,456 consisted of $8,102 paid in cash to the seller at closing, $2,026 retained in an escrow account, less $245 received from the sellers for a Net Working Capital and Tangible Net Equity adjustment plus $573 paid for acquisition-related professional fees.
The Share Purchase Agreement provides that the purchase price may be increased by up to $703 if a specified target of earnings before interest and taxes was achieved for the fiscal year ended March 31, 2009. At December 31, 2009, $3 was recorded for an estimated purchase price adjustment based on the seller’s preliminary financial statements for the fiscal year ended March 31, 2009 and the additional purchase price was allocated to goodwill. During the first quarter of 2010, a final agreement was reached with the former owners to pay a total of $38 in additional purchase price. The incremental purchase price adjustment of $35 was recorded in the first quarter of 2010 and allocated to goodwill. The $38 total additional purchase price was paid to the former owners in April 2010.
Exit Reserves from Prior Acquisitions
The Company recorded exit reserves related to its acquisitions of Weir Holdings Limited and Seven Worldwide Holdings, Inc., which occurred in 2004 and 2005, respectively. The major expenses included in the exit reserves were employee severance and lease termination expenses. The exit reserve balances related to employee severance were paid in prior years. The exit reserves related to the facility closures are being paid over the term of the leases, with the longest lease expiring in 2015. The adjustments recorded during 2010 are principally due to a reduction in the reserve for a certain vacant facility which the Company re-occupied in September 2010. The remaining reserve balance of $970 is included in Accrued expenses and Other long-term liabilities on the Consolidated Balance Sheets as of September 30, 2010.
The following table summarizes the reserve activity from December 31, 2009 through September 30, 2010 for facility closure costs:
|
Beginning of
|
End of
|
|||||||||||||||
|
Period
|
Adjustments
|
Payments
|
Period
|
|||||||||||||
|
First quarter
|
$ | 2,431 | $ | (8 | ) | $ | (263 | ) | $ | 2,160 | ||||||
|
Second quarter
|
$ | 2,160 | $ | (754 | ) | $ | (238 | ) | $ | 1,168 | ||||||
|
Third quarter
|
$ | 1,168 | $ | 59 | $ | (257 | ) | $ | 970 | |||||||
Note 8 – Debt
In December 2003, the Company entered into a private placement of debt (the “2003 Private Placement”) to provide long-term financing. The terms of the Note Purchase Agreement relating to this transaction, as amended, provided for the issuance and sale by the Company of two series of notes: Tranche A, for $15,000, payable in annual installments of $2,143 from 2007 through 2013, and Tranche B, for $10,000, payable in annual installments of $1,429 from 2008 through 2014. The remaining aggregate balance of the Tranche A and Tranche B notes, $12,289, is included on the September 30, 2010 Consolidated Balance Sheets as follows: $3,072 is included in Current maturities of long-term debt
and $9,217 is included in Long-term debt.
In January 2005, the Company entered into a Note Purchase and Private Shelf Agreement (the “2005 Private Placement”) with Prudential Investment Management Inc., pursuant to which the Company sold $50,000 in a series of three Senior Notes, maturing in January 2010, January 2011, and January 2012, respectively. The remaining aggregate outstanding balance of the two remaining notes, $34,412, is included on the September 30, 2010 Consolidated Balance Sheets as follows: $17,206 is included in Current maturities of long-term debt and $17,206 is included in Long-term debt.
In December 2007, the Company’s Canadian subsidiary entered into a revolving demand credit facility with a Canadian bank to provide working capital needs up to $1,000 Canadian dollars. The credit line is guaranteed by the Company. There was no balance outstanding on this credit facility at September 30, 2010.
Effective January 12, 2010, the Company and certain subsidiary borrowers of the Company entered into an amended and restated credit agreement (the “Credit Agreement”) in order to refinance its prior revolving credit facility that was set to terminate in January 2010. The Credit Agreement provides for a two and one-half year secured, multicurrency revolving credit facility in the principal amount of $90,000, including a $10,000 swing-line loan subfacility and a $10,000 subfacility for letters of credit. The Company may, at its option and subject to certain conditions, increase the amount of the facility by up to $10,000 by obtaining one or more new commitments from new or existing lenders to fund such increase. Immediately following the closing of the facility, there was approximately $15,000 in outstanding borrowings. Loans under the facility generally bear interest at a rate of LIBOR plus a margin that varies with the Company’s cash flow leverage ratio, in addition to applicable commitment fees, with a maximum rate of LIBOR plus 350 basis points. Loans under the facility are not subject to a minimum LIBOR floor. At September 30, 2010, the applicable margin was 250 basis points, resulting in an interest rate of 2.76 percent on LIBOR-based borrowings under the revolving credit facility. In order to manage the risk of rising interest rates on the Company’s variable rate revolving debt, the Company executed two “variable to fixed” interest rate swaps for the total notional amount of $15,000 in May of 2010. See Note 14 – Derivative Financial Instruments for further discussion.
Borrowings under the facility will be used for general corporate purposes, such as working capital and capital expenditures. Additionally, together with anticipated cash generated from operations, the unutilized portion of the credit facility is expected to be available to provide financing flexibility and support in the funding of principal payments due in 2010 and succeeding years on the Company’s other long-term debt obligations. The total balance outstanding under the Company’s credit facility at September 30, 2010 was $15,000 and is included in Long-term debt on the September 30, 2010 Consolidated Balance Sheets.
Outstanding obligations due under the facility are secured through security interests in and liens on substantially all of the Company’s and its domestic subsidiaries’ current and future personal property and on 100 percent of the capital stock of the Company’s existing and future domestic subsidiaries and 65 percent of the capital stock of certain foreign subsidiaries.
The Credit Agreement contains certain customary affirmative and negative covenants and events of default. Under the terms of the Credit Agreement, permitted capital expenditures excluding acquisitions are restricted to not more than $18,500 per fiscal year, or $40,000 over the term of the credit facility, and dividends, stock repurchases and other restricted payments are limited to $5,000 per fiscal year. Other covenants include, among other things, restrictions on the Company’s and in certain cases its subsidiaries’ ability to incur additional indebtedness; dispose of assets; create or permit liens on assets; make loans, advances or other investments; incur certain guarantee obligations; engage in mergers, consolidations or acquisitions, other than those meeting the requirements of the Credit Agreement; engage in certain transactions with affiliates; engage in sale/leaseback transactions; and engage in certain hedging arrangements. The Credit Agreement also requires compliance with specified financial ratios and tests, including a minimum fixed charge coverage ratio, a maximum cash flow ratio and a minimum consolidated net worth requirement. The Company was in compliance with all covenants at September 30, 2010.
Concurrently with its entry into the Credit Agreement, the Company also amended the note purchase agreements underlying its outstanding senior notes in order to conform the financial and other covenants contained in the note purchase agreements to the covenants contained in the Credit Agreement described above.
In September 2010, the Company financed $911 of the business insurance premiums for the 2010 – 2011 policy term.
The premiums are due in three equal quarterly payments, ending in June 2011. The total balance of the financed insurance premiums is included in Current debt on the September 30, 2010 Consolidated Balance Sheets.
Deferred Financing Fees
In connection with the 2010 refinancing of the revolving credit facility, the Company capitalized $1,090 of legal fees as deferred financing fees during the nine month period ended September 30, 2010 and began amortizing them based on the term of the new credit agreement, which expires July 12, 2012. During the nine month period ended September 30, 2009, the Company capitalized $1,170 of deferred financing fees related to its June 2009 debt amendments. The total amortization during the three and nine month periods ended September 30, 2010 was $141 and $527, respectively, which is included in Interest expense on the September 30, 2010 Consolidated Statements of Operations. The total amortization during the three and nine month periods ended September 30, 2009 was $401 and $626, respectively. At September 30, 2010, the Company had $954 of unamortized deferred financing fees.
Note 9 – Goodwill and Intangible Assets
The Company’s intangible assets not subject to amortization consist entirely of goodwill. The Company accounts for goodwill in accordance with the Intangibles – Goodwill and Other Topic of the Codification, ASC 350. Under ASC 350, the Company’s goodwill is not amortized throughout the period, but is subject to an annual impairment test. The Company performs an impairment test annually on October 1, or more frequently if events or changes in business circumstances indicate that the carrying value may not be recoverable. Effective September 30, 2010, the Company sold certain operating assets of its Canadian large format operation, known as Cactus. The Company determined that approximately $50 of its North America segment goodwill should be allocated to the Cactus operation and recorded a charge for this amount in the third quarter of 2010. See Note 13 – Acquisition Integration and Restructuring for further information regarding the asset sale.
The changes in the carrying amount of goodwill by reportable segment during the three and nine-month periods ended September 30, 2010, were as follows:
|
North
|
Asia
|
|||||||||||||||
|
America
|
Europe
|
Pacific
|
Total
|
|||||||||||||
|
Balance at January 1, 2010
|
$ | 172,484 | $ | 7,853 | $ | 7,327 | $ | 187,664 | ||||||||
|
Additional purchase accounting adjustments
|
-- | 35 | -- | 35 | ||||||||||||
|
Foreign currency translation
|
481 | (449 | ) | 278 | 310 | |||||||||||
|
Balance at March 31, 2010
|
172,965 | 7,439 | 7,605 | 188,009 | ||||||||||||
|
Foreign currency translation
|
(464 | ) | (356 | ) | (258 | ) | (1,078 | ) | ||||||||
|
Balance at June 30, 2010
|
$ | 172,501 | $ | 7,083 | $ | 7,347 | $ | 186,931 | ||||||||
|
Acquisitions
|
-- | 343 | -- | 343 | ||||||||||||
|
Goodwill allocated to operations sold
|
(50 | ) | -- | -- | (50 | ) | ||||||||||
|
Foreign currency translation
|
299 | 580 | 538 | 1,417 | ||||||||||||
|
Balance at September 30, 2010
|
$ | 172,750 | $ | 8,006 | $ | 7,885 | $ | 188,641 | ||||||||
The Company’s other intangible assets subject to amortization are as follows:
|
September 30, 2010
|
|||||||||||||
|
Weighted Average Life
|
Cost
|
Accumulated
Amortization
|
Net
|
||||||||||
|
Customer relationships
|
14.3 years
|
$ | 51,888 | $ | (18,228 | ) | $ | 33,660 | |||||
|
Digital images
|
5.0 years
|
450 | (450 | ) | -- | ||||||||
|
Developed technologies
|
3.0 years
|
712 | (712 | ) | -- | ||||||||
|
Non-compete agreements
|
3.6 years
|
764 | (734 | ) | 30 | ||||||||
|
Trade names
|
2.6 years
|
811 | (709 | ) | 102 | ||||||||
|
Contract acquisition cost
|
3.0 years
|
1,220 | (478 | ) | 742 | ||||||||
|
13.6 years
|
$ | 55,845 | $ | (21,311 | ) | $ | 34,534 | ||||||
|
December 31, 2009
|
|||||||||||||
|
Weighted Average Life
|
Cost
|
Accumulated
Amortization
|
Net
|
||||||||||
|
Customer relationships
|
14.3 years
|
$ | 51,647 | $ | (15,326 | ) | $ | 36,321 | |||||
|
Digital images
|
5.0 years
|
450 | (420 | ) | 30 | ||||||||
|
Developed technologies
|
3.0 years
|
712 | (712 | ) | -- | ||||||||
|
Non-compete agreements
|
3.6 years
|
744 | (588 | ) | 156 | ||||||||
|
Trade names
|
2.7 years
|
732 | (681 | ) | 51 | ||||||||
|
Contract acquisition cost
|
3.0 years
|
1,220 | (173 | ) | 1,047 | ||||||||
|
13.3 years
|
$ | 55,505 | $ | (17,900 | ) | $ | 37,605 | ||||||
Other intangible assets were recorded at fair market value as of the dates of the acquisitions based upon independent third party appraisals. The fair values and useful lives assigned to customer relationship assets are based on the period over which these relationships are expected to contribute directly or indirectly to the future cash flows of the Company. The acquired companies typically have had key long-term relationships with Fortune 500 companies lasting 15 years or more. Because of the custom nature of the work that the Company does, it has been the Company’s experience that clients are reluctant to change suppliers. Amortization expense related to the other intangible assets totaled $1,096 and $3,369 for the three and nine-month periods ended September 30, 2010, respectively. Amortization expense related to the other intangible assets totaled $1,236 and $3,494 for the three and nine-month periods ended September 30, 2009, respectively. Amortization expense for each of the next five twelve month periods beginning October 1, 2010, is expected to be approximately $4,349 for 2011, $4,153 for 2012, $3,804 for 2013, $3,799 for 2014, and $3,179 for 2015.
Note 10 – Income Taxes
The Company’s interim period tax provision is determined as follows:
|
|
·
|
At the end of each quarter, the Company estimates the tax that will be provided for the fiscal year.
|
|
|
·
|
The forecasted annual effective tax rate is applied to the year-to-date ordinary income at the end of each quarter to compute the year-to-date tax applicable to ordinary income. The term ordinary income refers to income from continuing operations before income taxes, excluding significant, unusual or infrequently occurring items. The tax expense or benefit related to ordinary income in each quarter is the difference between the most recent year-to-date and the prior quarter-to-date computations.
|
|
|
·
|
The tax effects of significant or infrequently occurring items are recognized as discrete items in the interim periods in which the events occur. The impact of changes in tax laws or rates on deferred tax amounts, the effects of changes in judgment about valuation allowances established in prior years, and changes in tax reserves resulting from the finalization of tax audits or reviews are examples of significant, unusual or infrequently occurring items which are recognized as discrete items in the interim period in which the event occurs.
|
The determination of the forecasted annual effective tax rate is based upon a number of significant estimates and judgments, including the forecasted annual pretax income of the corporation in each tax jurisdiction in which it operates and the development of tax planning strategies during the year. In addition, the Company’s tax expense can be impacted by changes in tax rates or laws, the finalization of tax audits and reviews, as well as other factors that cannot be predicted with certainty. As such, there can be significant volatility in interim tax provisions.
The Company’s forecasted annual effective tax rate for the third quarter of 2010 was approximately 28 percent and remained consistent with the 2010 second quarter forecasted annual effective tax rate of 28 percent.
The following table sets out the tax expense and the effective tax rates of the Company:
|
Three Months Ended September 30,
|
Nine Months Ended September 30,
|
|||||||||||||||
|
(in thousands)
|
2010
|
2009
|
2010
|
2009
|
||||||||||||
|
Pretax income (loss)
|
$ | 11,927 | $ | 14,859 | $ | 30,694 | $ | 18,941 | ||||||||
|
Income tax expense
|
$ | 4,154 | $ | 1,553 | $ | 4,596 | $ | 3,163 | ||||||||
|
Effective tax rate
|
34.8 | % | 10.5 | % | 15.0 | % | 16.7 | % | ||||||||
In the third quarter of 2010, the Company recognized tax expense of $4,154 on pretax income of $11,927, or an effective tax rate of 34.8 percent. There were no significant discrete period items reported in the third quarter 2010. In the third quarter of 2009, the Company recognized tax expense of $1,553 on pretax income of $14,859, or an effective tax rate of 10.5 percent. The tax rate was affected by the discrete period tax benefits related to the nontaxable indemnity settlement of $1,986 and the related benefit of amended tax return adjustments of $1,373.
For the first nine months of 2010, the Company recognized tax expense of $4,596 on pretax income of $30,694, or an effective tax rate of 15.0 percent. Since no other significant items were reported in the third quarter of 2010, the decrease in the effective tax rate for the first nine months of 2010 is principally due to a discrete period tax benefit related to the release of uncertain tax positions, net of federal and state benefits of $6,346, of which $5,630 resulted from the receipt of approval from the Joint Committee on Taxation related to a U.S. federal audit and $716 resulted from other favorable state and international tax settlements and statute closures. For the first nine months of 2009, the Company recognized tax expense of $3,163 on pretax income of $18,941, or an effective tax rate of 16.7 percent. No other significant items were reported outside of the third quarter 2009.
The Company has unrecognized tax benefits, exclusive of interest and penalties of $4,329 and $16,259 at September 30, 2010 and December 31, 2009, respectively. The reserve for uncertain tax positions decreased by $137 in the third quarter of 2010. The reserve for uncertain tax positions decreased in the second quarter by $6,462, primarily the result of the following; $5,775 due to the Joint Committee on Taxation approval of the U.S. federal audit and other favorable state and international tax settlements, and $687 from statute of limitation closures, which was recorded as an increase in deferred tax liabilities. The significant decrease in the reserve during the first quarter of 2010 was primarily due to the receipt of approval of a change in tax accounting method and was recorded primarily as an increase in deferred tax liabilities of $5,368.
Note 11 – Segment Reporting
The Company organizes and manages its operations primarily by geographic area and measures profit and loss of its segments based on operating income (loss). The accounting policies used to measure operating income of the segments are the same as those used to prepare the consolidated financial statements.
Segment Reporting Topic of the Codification, ASC 280, requires that a public business enterprise report financial information about its reportable operating segments. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker (“CODM”) in deciding how to allocate resources and in assessing performance.
The Company’s North America reportable segment includes all of the Company’s operations located in North America,
including its Canadian and Mexican operations, its U.S. branding and design capabilities and its U.S. digital solutions business. The Company’s Europe reportable segment includes all operations located in Europe, including its European branding and design capabilities and its digital solutions business. The Company’s Asia Pacific reportable segment includes all operations in Asia and Australia, including its Asia Pacific branding and design capabilities. These reporting segments meet the quantitative thresholds for separate disclosure in accordance with the relevant provisions of ASC 280.
Corporate consists of unallocated general and administrative activities and associated expenses, including executive, legal, finance, information technology, human resources and certain facility costs. In addition, certain costs and employee benefit plans are included in corporate and not allocated to operating segments.
The Company has disclosed operating income (loss) as the primary measure of segment earnings (loss). This is the measure of profitability used by the Company’s CODM and is most consistent with the presentation of profitability reported within the consolidated financial statements.
Segment information relating to results of operations is as follows:
|
Three Months Ended September 30,
|
Nine Months Ended September 30,
|
|||||||||||||||
|
2010
|
2009
|
2010
|
2009
|
|||||||||||||
|
Sales to external clients:
|
||||||||||||||||
|
North America
|
$ | 97,360 | $ | 98,493 | $ | 297,996 | $ | 285,722 | ||||||||
|
Europe
|
16,724 | 16,978 | 49,099 | 48,872 | ||||||||||||
|
Asia Pacific
|
7,547 | 7,668 | 22,609 | 20,690 | ||||||||||||
|
Intercompany sales elimination
|
(9,069 | ) | (9,676 | ) | (27,594 | ) | (24,744 | ) | ||||||||
|
Total
|
$ | 112,562 | $ | 113,463 | $ | 342,110 | $ | 330,540 | ||||||||
|
Operating segment income
(loss):
|
||||||||||||||||
|
North America
|
$ | 17,627 | $ | 18,164 | $ | 50,906 | $ | 38,765 | ||||||||
|
Europe
|
1,490 | 1,022 | 2,853 | 2,180 | ||||||||||||
|
Asia Pacific
|
982 | 2,192 | 3,637 | 5,287 | ||||||||||||
|
Corporate
|
(6,545 | ) | (3,763 | ) | (21,332 | ) | (20,718 | ) | ||||||||
|
Operating income
|
13,554 | 17,615 | 36,064 | 25,514 | ||||||||||||
|
Interest expense, net
|
(1,627 | ) | (2,756 | ) | (5,370 | ) | (6,573 | ) | ||||||||
|
Income before income taxes
|
$ | 11,927 | $ | 14,859 | $ | 30,694 | $ | 18,941 | ||||||||
Note 12 – Contingencies
United States Securities and Exchange Commission
The United States Securities and Exchange Commission (“SEC”) has been conducting a fact-finding investigation to determine whether there have been violations of certain provisions of the federal securities laws in connection with the Company’s restatement of its financial results for the years ended December 31, 2005 and 2006 and for the first three quarters of 2007. On March 5, 2009, the SEC notified the Company that it had issued a Formal Order of Investigation. The Company has been cooperating fully with the SEC and is committed to continue to cooperate fully until the SEC completes its investigation. The Company has incurred professional fees and other costs in responding to the SEC’s previously informal inquiry and expects to continue to incur professional fees and other costs in responding to the SEC’s ongoing formal investigation, which may be significant, until resolved.
Note 13 – Acquisition Integration and Restructuring
Actions Initiated in 2008
In 2008, the Company initiated a cost reduction and restructuring plan involving a consolidation and realignment of its
workforce and incurred costs for employee terminations, obligations for future lease payments, fixed asset impairments, and other associated costs. The costs associated with these actions are covered under the Exit or Disposal Cost Obligations Topic of the Codification, ASC 420, and the Compensation – Nonretirement Postemployment Benefits Topic, ASC 712.
The following table summarizes the accruals recorded, adjustments, and the cash payments during the nine-month period ended September 30, 2010, related to cost reduction and restructuring actions initiated during 2008. The adjustments are comprised of reversals of previously recorded expense accruals and foreign currency translation adjustments. The remaining reserve balance of $3,346 is included in Accrued expenses and Other long-term liabilities on the Consolidated Balance Sheets at September 30, 2010.
|
Employee
|
Lease
|
|||||||||||
|
Terminations
|
Obligations
|
Total
|
||||||||||
|
Liability balance at December 31, 2009
|
$ | 288 | $ | 3,924 | $ | 4,212 | ||||||
|
New accruals
|
1 | 66 | 67 | |||||||||
|
Adjustments
|
(31 | ) | (7 | ) | (38 | ) | ||||||
|
Cash payments
|
(21 | ) | (612 | ) | (633 | ) | ||||||
|
Liability balance at March 31, 2010
|
237 | 3,371 | 3,608 | |||||||||
|
New accruals
|
-- | 58 | 58 | |||||||||
|
Adjustments
|
(2 | ) | (7 | ) | (9 | ) | ||||||
|
Cash payments
|
(1 | ) | (124 | ) | (125 | ) | ||||||
|
Liability balance at June 30, 2010
|
234 | 3,298 | 3,532 | |||||||||
|
New accruals
|
-- | 51 | 51 | |||||||||
|
Adjustments
|
(94 | ) | (6 | ) | (100 | ) | ||||||
|
Cash payments
|
(1 | ) | (136 | ) | (137 | ) | ||||||
|
Liability balance at September 30, 2010
|
$ | 139 | $ | 3,207 | $ | 3,346 | ||||||
Actions Initiated in 2009
During 2009, the Company continued its cost reduction efforts and incurred additional costs for facility closings and employee termination expenses.
The following table summarizes the accruals recorded, adjustments, and the cash payments during the nine-month period ended September 30, 2010, related to cost reduction and restructuring actions initiated during 2009. The remaining reserve balance of $288 is included in Accrued expenses and Other long-term liabilities on the Consolidated Balance Sheets at September 30, 2010.
|
Employee
|
Lease
|
|||||||||||
|
Terminations
|
Obligations
|
Total
|
||||||||||
|
Liability balance at December 31, 2009
|
$ | 925 | $ | 108 | $ | 1,033 | ||||||
|
New accruals
|
3 | 2 | 5 | |||||||||
|
Adjustments
|
(79 | ) | (27 | ) | (106 | ) | ||||||
|
Cash payments
|
(493 | ) | -- | (493 | ) | |||||||
|
Liability balance at March 31, 2010
|
356 | 83 | 439 | |||||||||
|
New accruals
|
-- | 28 | 28 | |||||||||
|
Adjustments
|
(2 | ) | (28 | ) | (30 | ) | ||||||
|
Cash payments
|
(100 | ) | -- | (100 | ) | |||||||
|
Liability balance at June 30, 2010
|
254 | 83 | 337 | |||||||||
|
New accruals
|
8 | 1 | 9 | |||||||||
|
Adjustments
|
(4 | ) | (24 | ) | (28 | ) | ||||||
|
Cash payments
|
(19 | ) | (11 | ) | (30 | ) | ||||||
|
Liability balance at September 30, 2010
|
$ | 239 | $ | 49 | $ | 288 | ||||||
Actions Initiated in 2010
The following table summarizes the accruals recorded, adjustments, and the cash payments during the nine-month period ended September 30, 2010, related to cost reduction and restructuring actions initiated during 2010. The remaining reserve balance of $72 is included in Accrued expenses and Other long-term liabilities on the Consolidated Balance Sheets at September 30, 2010.
|
Employee
|
Lease
|
|||||||||||
|
Terminations
|
Obligations
|
Total
|
||||||||||
|
Liability balance at December 31, 2009
|
$ | -- | $ | -- | $ | -- | ||||||
|
New accruals
|
294 | -- | 294 | |||||||||
|
Adjustments
|
(3 | ) | -- | (3 | ) | |||||||
|
Cash payments
|
(67 | ) | -- | (67 | ) | |||||||
|
Liability balance at March 31, 2010
|
224 | -- | 224 | |||||||||
|
New accruals
|
456 | -- | 456 | |||||||||
|
Adjustments
|
(1 | ) | -- | (1 | ) | |||||||
|
Cash payments
|
(426 | ) | -- | (426 | ) | |||||||
|
Liability balance at June 30, 2010
|
253 | -- | 253 | |||||||||
|
New accruals
|
104 | -- | 104 | |||||||||
|
Adjustments
|
(13 | ) | -- | (13 | ) | |||||||
|
Cash payments
|
(272 | ) | -- | (272 | ) | |||||||
|
Liability balance at September 30, 2010
|
$ | 72 | $ | -- | $ | 72 | ||||||
The combined expenses for the cost reduction and restructuring actions initiated in 2008, 2009, and 2010, shown above, were $22 and $743 for the three and nine months ended September 30, 2010, respectively. In addition, the Company recorded $349 and $643 for consulting and legal fees related to the Company’s restructuring during the three and nine months ended September 30, 2010, respectively. The total expenses for the three and nine months ended September 30, 2010 were $371 and $1,386, respectively, and are presented as Acquisition integration and restructuring expense in the Consolidated Statements of Operations.
The expenses for the nine month periods ended September 30, 2010 and September 30, 2009 and the cumulative expense since the cost reduction program’s inception were recorded in the following segments:
|
North
|
Asia
|
|||||||||||||||||||
|
America
|
Europe
|
Pacific
|
Corporate
|
Total
|
||||||||||||||||
|
Nine months ended September 30, 2010
|
$ | 661 | $ | 91 | $ | (23 | ) | $ | 657 | $ | 1,386 | |||||||||
|
Nine months ended September 30, 2009
|
$ | 1,568 | $ | 1,221 | $ | 652 | $ | 205 | $ | 3,646 | ||||||||||
|
Cumulative since program inception
|
$ | 9,976 | $ | 5,043 | $ | 1,217 | $ | 1,999 | $ | 18,235 | ||||||||||
Sale of Cactus assets
Effective September 30, 2010, the Company sold certain operating assets of its Canadian large format operation, known as Cactus. The assets were sold because the Company is focusing on strategy, creative design and premedia services in the Canadian region. The selling price was approximately $462 and resulted in a pretax gain of approximately $22, which included a write-off for goodwill allocated to the Cactus business. The Company determined that approximately $50 of its North America segment goodwill should be allocated to the Cactus operation and recorded a charge for this amount in the third quarter of 2010. The following table is a summary of the asset sale:
|
Net cash received from buyer
|
$ | 462 | ||
|
Book value of assets sold
|
(362 | ) | ||
|
Expenses of sale
|
(28 | ) | ||
|
Goodwill write-off
|
(50 | ) | ||
|
Pretax gain on sale of assets
|
$ | 22 |
The pretax gain on sale of assets is recorded in Selling, general and administrative expenses in the Consolidated Statement of Operations for the three and nine-month periods ended September 30, 2010. The operating results of the Cactus operation are not reported as discontinued operations because the impact on the Company’s consolidated financial statements is immaterial.
Note 14 – Derivative Financial Instruments
Interest Rate Swaps
In order to manage the risk of rising interest rates on a portion of the Company’s variable rate revolving debt, the Company entered into two “variable to fixed” interest rate swaps with financial institution counterparties for the total notional amount of $15,000 in May of 2010. The swaps, which expire in June 2012, have been designated as cash flow hedges. Under the Derivatives and Hedging Topic of the FASB Codification, ASC 815, the effective portion of the derivative fair value gains or losses from these cash flow hedges is deferred in Accumulated comprehensive income, net. The company assesses hedge effectiveness quarterly by comparing the critical terms of the swaps and the debt. Since the Company assessed the hedge to be fully effective, the derivative fair value gains or losses have been deferred in Accumulated comprehensive income, net on the Consolidated Balance Sheets at September 30, 2010.
The interest rate swaps are measured at fair value on a recurring basis. Monthly LIBOR rates, observable at commonly quoted intervals for the full term of the swaps and classified as Level 2 input (see Note 15 – Fair Value Measurements), provide basis for valuation of these swaps. An income approach, using the present value of projected future cash payments based on monthly LIBOR rates, is the valuation technique used in assessing the swaps’ fair value.
As of September 30, 2010, the fair value of the derivative instruments was:
|
Derivative Assets
|
Derivative Liabilities
|
||||||||||
|
Instrument
|
Balance Sheet Location
|
Fair Value
|
Balance Sheet Location
|
Fair Value
|
|||||||
|
Interest rate swaps
|
Other assets
|
$ | -- |
Other long-term liabilities
|
$ | 234 | |||||
The effect of derivative instruments on the Consolidated Statements of Operations for the three months ended September 30, 2010, was:
|
Instrument
|
Amount of gain/(loss) recognized on derivatives in Accumulated comprehensive income, net
|
Amount of gain/(loss) reclassified from Accumulated comprehensive income, net into earnings*
|
||||||
|
Interest rate swaps
|
$ | (50 | ) | $ | -- | |||
The effect of derivative instruments on the Consolidated Statements of Operations for the nine months ended September 30, 2010, was:
|
Instrument
|
Amount of gain/(loss) recognized on derivatives in Accumulated comprehensive income, net
|
Amount of gain/(loss) reclassified from Accumulated comprehensive income, net into earnings*
|
||||||
|
Interest rate swaps
|
$ | (141 | ) | $ | -- | |||
* ASC 815 does not require that the amount in Accumulated comprehensive income, net be amortized to earnings unless the swaps are terminated. At the maturity of the swaps, their fair value will be zero – just as it was at inception – and each of the swap market value changes over its term will have been recorded as adjustments to both the swap asset or liability and Accumulated comprehensive income, net.
Note 15 – Fair Value Measurements
Fair value is defined under the Fair Value Measurements and Disclosures Topic of the Codification, ASC 820, as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value under ASC 820 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard established a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable.
|
|
·
|
Level 1 – Quoted prices in active markets for identical assets or liabilities. These are typically obtained from real-time quotes for transactions in active exchange markets involving identical assets.
|
|
|
·
|
Level 2 – Inputs, other than quoted prices included within Level 1, which are observable for the asset or liability, either directly or indirectly. These are typically obtained from readily-available pricing sources for comparable instruments.
|
|
|
·
|
Level 3 – Unobservable inputs, where there is little or no market activity for the asset or liability. These inputs reflect the reporting entity’s own assumptions of the data that market participants would use in pricing the asset or liability, based on the best information available in the circumstances.
|
For purposes of financial reporting, the Company has determined that the fair value of such financial instruments as cash and cash equivalents, accounts receivable, accounts payable and long-term debt approximates carrying value at September 30, 2010. Interest rate swaps are measured at fair value on a recurring basis and the following table summarizes the derivative financial instruments measured at fair value as of September 30, 2010:
|
Level 1
|
Level 2
|
Level 3
|
Total
|
|||||||||||||
|
Other long-term liabilities:
|
||||||||||||||||
|
Interest rate swaps
|
$ | -- | $ | 234 | $ | -- | $ | 234 | ||||||||
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Cautionary Statement Regarding Forward-Looking Information
Certain statements contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this report that relate to the Company’s beliefs or expectations as to future events are not statements of historical fact and are forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. The Company intends any such statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Although the Company believes that the assumptions upon which such forward-looking statements are based are reasonable within the bounds of its knowledge of its industry, business and operations, it can give no assurance the assumptions will prove to have been correct and undue reliance should not be placed on such statements. Important factors that could cause actual results to differ materially and adversely from the Company’s expectations and beliefs include, among other things, the strength of the United States economy in general and specifically market conditions for the consumer products industry; the level of demand for the Company’s services; unfavorable foreign exchange fluctuations; changes in or weak consumer confidence and consumer spending; loss of key management and operational personnel; the ability of the Company to implement its business strategy and plans; the ability of the Company to comply with the financial covenants contained in its debt agreements and obtain waivers or amendments in the event of non-compliance; the ability of the Company to maintain an effective system of disclosure and internal controls and the discovery of any future control deficiencies or weaknesses, which may require substantial costs and resources to rectify; the stability of state, federal and foreign tax laws; the ability of the Company to identify and capitalize on industry trends and technological advances in the imaging industry; higher than expected costs associated with compliance with legal and regulatory requirements; higher than expected costs or unanticipated difficulties associated with integrating acquired operations; the stability of political conditions in foreign countries in which the Company has production capabilities; terrorist attacks and the U.S. response to such attacks; as well as other factors detailed in the Company’s filings with the Securities and Exchange Commission. The Company assumes no obligation to update publicly any of these statements in light of future events.
Business Overview
Schawk, Inc., and its subsidiaries (“Schawk” or the “Company”) provide strategic, creative and executional graphic services and solutions to clients in the consumer products packaging, retail, pharmaceutical and advertising markets. The Company, headquartered in Des Plaines, Illinois, has been in operation since 1953 and is incorporated under the laws of the State of Delaware.
The Company is one of the world’s largest independent business service providers in the graphics industry. The Company currently delivers these services through more than 150 locations in 14 countries across North America, Europe, Asia and Australia. By leveraging its global comprehensive portfolio of strategic, creative and executional capabilities, the Company believes it helps companies of all sizes create compelling and consistent brand experiences that strengthen consumers’ affinity for these brands. The Company does this by helping its clients “activate” their brands worldwide.
The Company believes that it is positioned to deliver its offering in a category that is unique to its competition. This category, brand point management, reflects Schawk’s ability to provide integrated strategic, creative and executional services globally across the four primary points in which its clients’ brands touch consumers: at home, on the go, at the store and on the shelf. “At Home” includes brand touchpoints such as direct mail, catalogs, advertising, circulars, and the internet. “On the Go” includes brand touchpoints such as outdoor advertising, mobile/cellular and the internet. “In the Store” includes brand touchpoints such as point-of-sale displays, in-store merchandising and interactive displays. “On the Shelf” focuses on packaging as a key brand touchpoint.
The Company’s strategic services are delivered primarily through its branding and design capabilities, performed under its Anthem Worldwide (“Anthem”) brand. These services include brand analysis and articulation, design strategy and design. These services help clients revitalize existing brands and bring new products to market that respond to changing consumer desires and trends. Anthem’s services also help retailers optimize their brand portfolios, helping them create fewer, smarter and potentially more profitable brands. The impact of changes to design and brand strategy can potentially exert a significant impact on a company’s brand, category, market share, equity and sales. Strategic services also represent some of Schawk’s highest value, highest margin services.
The Company’s creative services are delivered through Anthem and through various sub-specialty capabilities whose services include digital photography, 3D imaging, creative retouching, CGI (Computer Generated Images), packaging mock-ups/sales samples, brand compliance, retail marketing (catalogs, circulars, point-of-sale displays), interactive media, and large-format printing. These services support the creation, adaptation and maintenance of brand imagery used across brand touchpoints – including packaging, advertising, marketing and sales promotion materials – offline in printed materials and online in visual media such as the internet, mobile/cellular, interactive displays and television. The Company believes that creative services, since they often represent the creation of client’s original intellectual property, present a high-margin growth opportunity for Schawk.
The Company’s executional services are delivered primarily through its legacy premedia business, which at this time continues to account for the most significant portion of its revenues. Premedia products such as color proofs, production artwork, digital files and flexographic, lithographic and gravure image carriers are supported by color management and print management services that the Company believes provides a vital interface between the creative design and production processes. The Company believes this ensures the production of consistent, high quality brand/graphic images on a global scale at the speed required by clients to remain competitive in today’s markets on global, regional and local scales. Increasingly, the Company has been offering executional services in the growing digital space, in order to meet growing client demand to market their brands on the internet and via mobile and interactive technologies. Additionally, the Company’s graphic lifecycle content management software and services facilitates the organization, management, application and re-use of proprietary brand assets. The Company believes that products such as BLUE™ confer the benefits of brand consistency, accuracy and speed to market for its clients.
As a global supplier of integrated strategic, creative and executional graphics capabilities, Schawk helps clients meet their growing need for consistency across brand touchpoints from a single coordinated contact. A high level of consistency can impact clients’ businesses in potentially significant ways such as the retention and growth of the equity in their brands and improved consumer recognition, familiarity and affinity. The latter has the potential to help clients improve sales and market share of their brands. Additionally, through its global systems, the Company provides processes that reduce opportunities for third parties to counterfeit its clients’ brands, which is an issue in both mature and
developing regions. The Company also believes that its integrated and comprehensive capabilities provide clients with the potential for long-term cost-reductions across their graphic workflows.
Organization
Effective July 1, 2009, the Company restructured its operations to report its operations on a geographic basis, in three reportable segments: North America, Europe and Asia Pacific. This organization reflects the current management reporting structure. The Company’s North America segment includes all of the Company’s operations located in North America, including its Canadian and Mexican operations, its U.S. branding and design capabilities and its U.S. digital solutions business. The Company’s Europe segment includes all operations located in Europe, including its European branding and design capabilities and its digital solutions business in London. The Company’s Asia Pacific segment includes all operations in Asia and Australia, including its Asia Pacific branding and design capabilities.
Financial Overview
Net sales decreased $0.9 million or 0.8 percent in the third quarter of 2010 to $112.6 million from $113.5 million in the third quarter of 2009. The quarter-over-quarter sales decline reflects a slower than expected rate of new product introductions and packaging changes from the Company’s consumer packaged goods accounts as economic uncertainties continue, a reduction in promotional activity from the Company’s entertainment accounts and the loss of a lower margin non-core retail client. For the third quarter of 2010, net income was $7.8 million or $0.30 per fully diluted share, as compared to net income of $13.3 million or $0.53 per fully diluted share for the third quarter of 2009. In the third quarter of 2010 compared to the third quarter of 2009, sales decreased in the North America operating segment by 1.2 percent, in the Europe operating segment by 1.5 percent and in the Asia Pacific operating segment by 1.6 percent.
Gross profit decreased by $1.7 million or 3.8 percent in the third quarter of 2010 to $43.8 million from $45.5 million in the third quarter of 2009. The gross profit decreased in the North America and Asia Pacific operating segments, partially offset by an increase in gross profit in the Europe operating segment. The gross profit in the North America operating segment decreased by $1.5 million or 4.1 percent. The gross profit in the Asia Pacific operating segment decreased by $0.5 million or 11.4 percent. The gross profit in the Europe operating segment increased by $0.2 million or 3.9 percent.
Operating income decreased by $4.1 million or 23.1% in the third quarter of 2010 to $13.6 million from $17.6 million in the third quarter of 2009. The decline in operating income, quarter-over-quarter, is principally due to a $5.0 million indemnity settlement related to the Company’s 2005 acquisition of Seven Worldwide Holdings, Inc. recorded as income in the third quarter of 2009, which did not recur in the third quarter of 2010. Other factors which affected the operating profit, quarter-over-quarter, are as follows: Selling, general and administrative expenses decreased $3.5 million, or 10.9 percent, in the third quarter of 2010 to $28.7 million from $32.2 million in the third quarter of 2009. During the third quarter of 2010, the Company recorded two insurance recoveries, totaling $1.5 million, of which $1.4 million was recorded as a reduction of selling, general and administrative expense and $0.1 million was recorded as a reduction of cost of sales. The first recovery, in the amount of $0.3 million, related to production equipment damaged during the first quarter of 2010 at one of the Company’s North American facilities, for which a $0.7 million asset impairment charge was recorded in the first quarter of 2010. The second recovery, in the amount of $1.2 million, resulted from a directors’ and officers’ liability insurance settlement for certain expenses related to the Company’s ongoing SEC investigation. The Company also had reduced restructuring expenses associated with the Company’s cost reduction activities of $0.4 million in the third quarter of 2010 compared to $1.3 million in the third quarter of 2009. The Company recorded a net loss on foreign exchange exposures of $0.7 million in the third quarter of 2010 as compared to a net gain of $0.6 million in the third quarter of 2009. The net loss on foreign exchange exposures in the third quarter of 2010 included unrealized losses of $0.3 million compared to unrealized gains on foreign exchange exposures of $0.7 million in the third quarter of 2009. The unrealized foreign exchange gains and losses related primarily to unhedged currency exposure from intercompany debt obligations of the Company’s foreign subsidiaries. In addition, the Company recorded a $0.5 million expense in the third quarter of 2010 to adjust the estimated liability related to its 2008 decision to terminate participation in a certain union pension plan, which the Company expects to settle in the fourth quarter of 2010.
Cost Reduction and Capacity Utilization Actions
Beginning in 2008, continuing in 2009 and in the first nine months of 2010, the Company incurred restructuring costs for employee terminations, obligations for future lease payments, fixed asset impairments, and other associated costs as part of its previously announced plan to reduce costs through a consolidation and realignment of its work force and facilities. The total expense recorded for the three and nine-month periods of 2010 was $0.4 million and $1.4 million, respectively,
and is presented as Acquisition integration and restructuring expense in the Consolidated Statements of Operations. See Note 13 – Acquisition Integration and Restructuring in Part I, Item 1 for additional information.
The expense for each of the years 2008 and 2009 and for the first nine months of 2010, and the cumulative expense since the cost reduction program’s inception, was recorded in the following operating segments:
|
North
|
Asia
|
|||||||||||||||||||
|
(in millions)
|
America
|
Europe
|
Pacific
|
Corporate
|
Total
|
|||||||||||||||
|
Nine months ended September 30, 2010
|
$ | 0.7 | $ | 0.1 | $ | -- | $ | 0.6 | $ | 1.4 | ||||||||||
|
Year ended December 31, 2009
|
3.6 | 1.4 | 1.0 | 0.5 | 6.5 | |||||||||||||||
|
Year ended December 31, 2008
|
5.7 | 3.6 | 0.2 | 0.9 | 10.4 | |||||||||||||||
|
Cumulative since program inception
|
$ | 10.0 | $ | 5.1 | $ | 1.2 | $ | 2.0 | $ | 18.3 | ||||||||||
It is estimated that cost savings resulting from cost reduction actions initiated in the first nine months of 2010 will be approximately $4.5 million for 2010 and recurring pre-tax savings are expected to increase over the subsequent two-year period to approximately $8 million annually. It is estimated that cost savings resulting from the 2009 cost reduction actions was approximately $8.9 million for 2009 and recurring pre-tax savings are expected to increase over the subsequent two-year period to approximately $16 million annually. Cost savings resulting from the 2008 cost reduction actions is estimated to have been approximately $7.4 million during 2008 and recurring pre-tax savings are estimated to have increased over the subsequent two-year period to approximately $22 million annually.
Results of Operations
Consolidated
The following table sets forth certain amounts, ratios and relationships calculated from the Consolidated Statements of Operations for the three months ended:
|
Three Months Ended
September 30,
|
2010 vs. 2009
Increase (Decrease)
|
|||||||||
|
(in thousands)
|
2010
|
2009
|
$
|
%
|
||||||
|
Net sales
|
$
|
112,562
|
$
|
113,463
|
$
|
$(901)
|
(0.8)%
|
|||
|
Cost of sales
|
68,768
|
67,957
|
811
|
1.2%
|
||||||
|
Gross profit
|
43,794
|
45,506
|
(1,712)
|
(3.8)%
|
||||||
|
Selling, general and administrative expenses
|
28,675
|
32,193
|
(3,518)
|
(10.9)%
|
||||||
|
Foreign exchange (gain) loss
|
694
|
(644)
|
1,338
|
nm
|
||||||
|
Indemnity settlement
|
--
|
(4,986)
|
4,986
|
nm
|
||||||
|
Acquisition integration and restructuring expenses
|
371
|
1,328
|
(957)
|
(72.1)%
|
||||||
|
Multiemployer pension withdrawal expense
|
500
|
--
|
500
|
nm
|
||||||
|
Operating income
|
13,554
|
17,615
|
(4,061)
|
(23.1)%
|
||||||
|
Other income (expense):
|
||||||||||
|
Interest income
|
15
|
124
|
(109)
|
(87.9)%
|
||||||
|
Interest expense
|
(1,642)
|
(2,880)
|
1,238
|
(43.0)%
|
||||||
|
Income before income taxes
|
11,927
|
14,859
|
(2,932)
|
(19.7)%
|
||||||
|
Income tax provision (benefit)
|
4,154
|
1,553
|
2,601
|
nm
|
||||||
|
Net income
|
$
|
7,773
|
$
|
13,306
|
$
|
(5,533)
|
(41.6)%
|
|||
|
Effective income tax rate
|
34.8%
|
10.5 %
|
||||||||
Expressed as a percentage of Net Sales:
|
Gross margin
|
38.9%
|
40.1%
|
(120) bpts
|
|
|
Selling, general and administrative expense
|
25.5%
|
28.4%
|
(290) bpts
|
|
|
Foreign exchange (gain) loss
|
0.6%
|
(0.6)%
|
120 bpts
|
|
|
Indemnity settlement
|
--
|
(4.4)%
|
440 bpts
|
|
|
Acquisition integration and restructuring expenses
|
0.3%
|
1.2%
|
(90) bpts
|
|
|
Multiemployer pension withdrawal expense
|
0.4%
|
--
|
40 bpts
|
|
|
Operating margin
|
12.0%
|
15.5%
|
(350) bpts
|
bpts = basis points
nm = not meaningful
Net sales in the third quarter of 2010 were $112.6 million compared to $113.5 million in the same period of the prior year, a decrease of $0.9 million, or 0.8 percent. The quarter-over-quarter sales decline reflects a slower than expected rate of new product introductions and packaging changes from the Company’s consumer packaged goods accounts as economic uncertainties continue, a reduction in promotional activity from the Company’s entertainment accounts and the loss of a lower margin non-core retail client. Net sales decreased, quarter-over-quarter, in the North America segment by $1.1 million, or 1.2 percent, in the Asia Pacific segment by $0.1 million, or 1.6 percent, and in the Europe segment by 0.3 million or 1.5 percent. While sales for the third quarter of 2010, as compared to the third quarter of 2009, were impacted by changes in foreign currency translation rates on a country-by-country basis, the overall impact on sales for the third quarter was minimal.
Consumer products packaging accounts sales in the third quarter of 2010 were $82.1 million, or 72.9 percent of total sales, as compared to $80.2 million, or 70.7 percent, in the same period of last year, representing an increase of 2.3 percent. Advertising and retail accounts sales of $20.1 million in the third quarter of 2010, or 17.9 percent of total sales, decreased 8.8 percent from $22.1 million in the third quarter of 2009. Entertainment account sales of $7.1 million in the third quarter of 2010, or 6.3 percent of total sales, decreased 15.6 percent from $8.5 million in the third quarter of 2009. During the third quarter, the Company continued to see measured progress year-over-year with its largest client segment, consumer packaged goods accounts, with their continued product and brand innovation activity in the areas of strategy and design. However, new product introductions and packaging changes were slower than anticipated for the quarter as consumer packaged goods clients have become more cautious based on economic uncertainties that continue to exist. The quarter-over-quarter increase in sales for consumer products packaged goods accounts was offset by a reduction in promotional activity from the Company’s entertainment accounts and the loss of a lower margin non-core retail client, as previously discussed.
Gross profit was $43.8 million, or 38.9 percent, of sales in the third quarter of 2010, a decrease of $1.7 million, or 3.8 percent, from $45.5 million, or 40.1 percent of sales, in the third quarter of 2009. The decrease in gross profit is attributable to the decrease in revenue quarter-over-quarter as well as restoration of compensation and benefit reductions implemented during 2009 as part of the Company’s cost reduction initiatives.
Operating income decreased by $4.1 million, to $13.6 million in the third quarter of 2010 from $17.6 million in the third quarter of 2009. The decline in operating income, quarter-over-quarter, is principally due to a $5.0 million indemnity settlement related to the Company’s 2005 acquisition of Seven Worldwide Holdings, Inc. recorded as income in the third quarter of 2009, which did not recur in the third quarter of 2010. The operating income percentage was 12.0 percent for the third quarter of 2010, compared to 15.5 percent in the third quarter of 2009. Other factors which affected the operating profit, quarter-over-quarter, are discussed below.
Selling, general and administrative expenses decreased by $3.5 million over the prior period, reflecting a $0.7 million decrease in professional and consulting fees related to the Company’s internal control remediation and related matters and lower operating expenses resulting from the Company’s cost reduction initiatives, partially offset by restoration of certain temporary cost reduction actions that the Company implemented for 2009. In addition, as previously discussed, during the third quarter of 2010, the Company recorded several insurance recoveries, totaling $1.5 million, principally as a reduction of selling, general and administrative expense. In the third quarter of 2010, the Company recorded $0.4 million of acquisition integration and restructuring expenses compared to $1.3 million in the third quarter of 2009. These expenses were recorded in connection with previously announced plans to consolidate, reduce and re-align the Company’s work force and operations and represent costs for employee terminations, obligations for future lease payments, and other associated costs. The Company recorded a $0.7 million loss on foreign exchange exposures in the third quarter of 2010, of which $0.3 million related to unrealized currency remeasurements, compared to a gain on
foreign exchange exposures of $0.6 million in the comparable 2009 period. The Company’s foreign exchange gains or losses relate primarily to unhedged currency exposure from intercompany debt obligations of the Company’s foreign subsidiaries. In addition, the Company recorded a $0.5 million expense in the third quarter of 2010 to adjust the estimated liability related to its 2008 decision to terminate participation in a certain union pension plan, which the Company expects to settle in the fourth quarter of 2010.
Interest expense in the third quarter of 2010 was $1.6 million compared to $2.9 million in the third quarter of 2009, a decrease of $1.2 million, or 43.0 percent. The reduction in interest expense is primarily due to the decrease in average debt outstanding period-over-period. As previously discussed, in order to manage the risk of rising interest rates on a portion of its variable rate revolving debt, the Company executed two “variable to fixed” interest rate swaps for the total notional amount of $15.0 million in May of 2010.
The Company recorded income tax expense of $4.2 million for the third quarter of 2010 compared to income tax expense of $1.6 million in the third quarter of 2009. The income tax expense effective tax rate was 34.8 percent and 10.5 percent for the third quarters of 2010 and 2009 respectively. The increase in the effective rate for 2010 compared to 2009 is primarily due to discrete period tax adjustments related to the nontaxable indemnity settlement and amended tax return adjustments in 2009.
In the third quarter of 2010, the Company recorded net income of $7.8 million, as compared to $13.3 million for the same period of 2009.
Other Information
Depreciation and amortization expense was $4.4 million for the third quarter of 2010 as compared to $4.7 million in the third quarter of 2009.
Capital expenditures in the third quarter of 2010 were $1.8 million compared to $1.5 million in the same period of 2009.
The following table sets forth certain amounts, ratios and relationships calculated from the Consolidated Statements of Operations for the nine months ended:
|
Nine Months Ended
September 30,
|
2010 vs. 2009
Increase (Decrease)
|
|||||||||
|
(in thousands)
|
2010
|
2009
|
$
|
%
|
||||||
|
Net sales
|
$
|
342,110
|
$
|
330,540
|
$
|
11,570
|
3.5%
|
|||
|
Cost of sales
|
209,617
|
209,006
|
611
|
0.3%
|
||||||
|
Gross profit
|
132,493
|
121,534
|
10,959
|
9.0%
|
||||||
|
Selling, general and administrative expenses
|
91,619
|
98,313
|
(6,694)
|
(6.8)%
|
||||||
|
Foreign exchange (gain) loss
|
2,244
|
(1,089)
|
3,333
|
nm
|
||||||
|
Indemnity settlement
|
--
|
(4,986)
|
4,986
|
nm
|
||||||
|
Acquisition integration and restructuring expenses
|
1,386
|
3,646
|
(2,260)
|
(62.0)%
|
||||||
|
Multiemployer pension withdrawal expense
|
500
|
--
|
500
|
nm
|
||||||
|
Impairment of long-lived assets
|
680
|
136
|
544
|
nm
|
||||||
|
Operating income
|
36,064
|
25,514
|
10,550
|
41.3%
|
||||||
|
Other income (expense):
|
||||||||||
|
Interest income
|
31
|
224
|
(193)
|
(86.2)%
|
||||||
|
Interest expense
|
(5,401)
|
(6,797)
|
1,396
|
(20.5)%
|
||||||
|
Income before income taxes
|
30,694
|
18,941
|
11,753
|
62.1%
|
||||||
|
Income tax provision (benefit)
|
4,596
|
3,163
|
1,433
|
45.3%
|
||||||
|
Net income
|
$
|
26,098
|
$
|
15,778
|
$
|
10,320
|
65.4%
|
|||
|
Effective income tax rate
|
15.0%
|
16.7%
|
||||||||
24
Expressed as a percentage of Net Sales:
|
Gross margin
|
38.7%
|
36.8%
|
190 bpts
|
|
|
Selling, general and administrative expense
|
26.8%
|
29.7%
|
(290)bpts
|
|
|
Foreign exchange (gain) loss
|
0.7%
|
(0.3)%
|
100 bpts
|
|
|
Indemnity settlement
|
--
|
(1.5)%
|
150 bpts
|
|
|
Acquisition integration and restructuring expenses
|
0.4%
|
1.1%
|
(70) bpts
|
|
|
Multiemployer pension withdrawal expense
|
0.1%
|
--
|
10 bpts
|
|
|
Impairment of long-lived assets
|
0.2%
|
--
|
20 bpts
|
|
|
Operating margin
|
10.5%
|
7.7%
|
280 bpts
|
bpts = basis points
nm = not meaningful
Net sales in the first nine months of 2010 were $342.1 million compared to $330.5 million in the same period of the prior year, an increase of $11.6 million, or 3.5 percent. Net sales increased, period-over-period, in all operating segments: the North America segment increased by $12.3 million, or 4.3 percent; the Europe segment increased by $0.2 million, or 0.5 percent; and the Asia Pacific segment increased by $1.9 million, or 9.3 percent. Approximately $4.4 million of the sales increase, period-over-period, was the result of changes in foreign currency translation rates, as the U.S. dollar decreased in value relative to certain of the local currencies of the Company’s foreign subsidiaries. The period-over-period increase in sales primarily reflects an overall improvement in the global economy, which started in the latter half of 2009 and continued into 2010, although the Company’s entertainment account sales declined period-over-period. Many of the Company’s clients have increased brand innovation and introduction activities, including the frequency of packaging redesigns and sales promotion projects, resulting in higher revenue for the Company.
Consumer products packaging accounts sales in the first nine months of 2010 were $245.4 million, or 71.7 percent of total, as compared to $233.2 million, or 70.6 percent, in the same period of last year, representing an increase of 5.2 percent. As market and economic conditions improved, many of the Company’s consumer products packaging clients increased their frequency of package redesigns, sales promotions and new product introductions, as compared to the prior year period. Advertising and retail accounts sales of $64.4 million in the first nine months of 2010, or 18.8 percent of total sales, increased 0.1 percent from $64.3 million in the first nine months of 2009. Entertainment account sales of $21.6 million in the first nine months of 2010, or 6.3 percent of total sales, declined 11.7 percent from $24.5 million in the first nine months of 2009.
Gross profit was $132.5 million, or 38.7 percent, of sales in the first nine months of 2010, an increase of $11.0 million, or 9.0 percent, from $121.5 million, or 36.8 percent of sales, in the first nine months of 2009. The increase in gross profit is largely attributable to the increase in revenue period-over-period and cost savings related to the Company’s restructuring initiatives.
Operating income increased by $10.6 million, to $36.1 million in the first nine months of 2010 from $25.5 million in the first nine months of 2009. The operating income percentage for the first nine months of 2010 was 10.5 percent, compared to an operating income percentage of 7.7 percent in the first nine months of 2009. The increase in operating income in the first nine months of 2010 compared to the first nine months of 2009 is principally due to the increase in revenue period-over-period, lower operating expenses resulting from the Company’s cost reduction initiatives, and the net effect of the items discussed below.
The decrease in selling, general and administrative expenses over the prior period reflects a $4.0 million decrease in professional and consulting fees related to the Company’s internal control remediation and related matters, partially offset by restoration of certain temporary cost reduction actions that the Company implemented for 2009. In addition, as previously discussed, during the first nine months of 2010, the Company recorded several insurance recoveries, totaling $2.9 million, principally as a reduction of selling, general and administrative expense. In the first nine months of 2010, the Company recorded $1.4 million of acquisition integration and restructuring expenses compared to $3.6 million in the first nine months of 2009. These expenses were recorded in connection with previously announced plans to consolidate, reduce and re-align the Company’s work force and operations and represent costs for employee terminations, obligations for future lease payments, and other associated costs. The Company recorded a $2.2 million loss on foreign exchange exposures in the first nine months of 2010, of which $1.5 million related to unrealized currency remeasurements,
compared to a gain on foreign exchange exposures of $1.1 million in the comparable 2009 period. The unrealized currency losses in the first nine months of 2010 were principally due to the deterioration of the value of the Euro during the period. The Company’s foreign exchange gains or losses relate primarily to unhedged currency exposure from intercompany debt obligations of the Company’s foreign subsidiaries. During the first nine months of 2009, the Company recorded $5.0 million of income for an indemnity settlement related to the 2005 acquisition of Seven Worldwide Holdings, Inc. In addition, the Company recorded a $0.7 million asset impairment charge in the first nine months of 2010 for equipment damaged at one of its North American facilities, compared to a $0.1 million asset impairment charge recorded in the first nine months of 2009. Additionally, the Company recorded a $0.5 million expense in the first nine months of 2010 to adjust the estimated liability related to its 2008 decision to terminate participation in a certain union pension plan, which the Company expects to settle in the fourth quarter of 2010.
Interest expense in the first nine months of 2010 was $5.4 million compared to $6.8 million in the first nine months of 2009, a decrease of $1.4 million, or 20.5 percent. The reduction in interest expense is primarily due to the decrease in average debt outstanding period-over-period. As previously discussed, in order to manage the risk of rising interest rates on a portion of its variable rate revolving debt, the Company executed two “variable to fixed” interest rate swaps for the total notional amount of $15.0 million in May of 2010.
The Company recorded income tax expense of $4.6 million for the first nine months of 2010, compared to income tax expense of $3.2 million in the first nine months of 2009. The income tax expense effective tax rate was 15.0 percent and 16.7 percent for the first nine months of 2010 and 2009 respectively. The decrease in the effective tax rate for the 2010 period compared to the prior year is primarily due to an increase in the amount of discrete period tax benefits from the release of uncertain tax positions during the first nine months of 2010 of $7.1 million compared to the nontaxable indemnity settlement and amended tax return adjustments of $3.4 million reflected in 2009.
In the first nine months of 2010, the Company recorded net income of $26.1 million, as compared to a net income of $15.8 million for the same period of 2009.
Other Information
Depreciation and amortization expense was $13.3 million for the first nine months of 2010 as compared to $14.2 million in the first nine months of 2009.
Capital expenditures in the first nine months of 2010 were $6.7 million compared to $3.9 million in the same period of 2009.
Segment Information
North America
|
Three months ended September 30,
|
2010 vs. 2009
Increase (Decrease)
|
|||||||||
|
(in thousands)
|
2010
|
2009
|
$
|
%
|
||||||
|
Net sales
|
$
|
97,360
|
$
|
98,493
|
$
|
(1,133)
|
(1.2)%
|
|||
|
Acquisition integration and
restructuring expenses
|
$
|
117
|
$
|
566
|
$
|
(449)
|
(79.3)%
|
|||
|
Foreign exchange (gain) loss
|
$
|
(23)
|
$
|
38
|
$
|
(61)
|
nm
|
|||
|
Depreciation and amortization
|
$
|
2,734
|
$
|
2,807
|
$
|
(73)
|
(2.6)%
|
|||
|
Operating income
|
$
|
17,627
|
$
|
18,164
|
$
|
(537)
|
(3.0)%
|
|||
|
Operating margin
|
18.1%
|
18.4%
|
(30)bpts
|
|||||||
|
Capital expenditures
|
$
|
1,063
|
$
|
1,215
|
$
|
(152)
|
(12.5)%
|
|||
|
Total assets
|
$
|
343,816
|
$
|
319,722
|
$
|
24,094
|
7.5%
|
|||
nm = not meaningful
bpts = basis points
Net sales in the third quarter of 2010 for the North America segment were $97.4 million compared to $98.5 million in the same period of the prior year, a decrease of $1.1 million or 1.2 percent. Sales for the third quarter of 2010, as compared to the third quarter of 2009, benefited from an increase of $0.7 million resulting from changes in foreign currency translation rates, as the U.S. dollar decreased in value relative to certain of the local currencies of the Company’s foreign subsidiaries. While sales for the nine-month period ended September 30, 2010 increased relative to sales for the nine-month period ended September 30, 2009, sales for the third quarter of 2010 were lower compared to sales for the third quarter of 2009, reflecting a slower than expected rate of new product introductions and packaging changes from the Company’s consumer packaged goods accounts as economic uncertainties continue, a reduction in promotional activity from the Company’s entertainment accounts and the loss of a lower margin non-core retail client.
Operating income was $17.6 million or 18.1 percent of sales, in the third quarter of 2010 compared to $18.2 million, or 18.4 percent of sales, in the second quarter of 2009, a decrease of $0.5 million. The decrease in operating income is principally due to the decrease in revenue quarter-over-quarter.
|
Nine months ended September 30,
|
2010 vs. 2009
Increase (Decrease)
|
|||||||||
|
(in thousands)
|
2010
|
2009
|
$
|
%
|
||||||
|
Net sales
|
$
|
297,996
|
$
|
285,722
|
$
|
12,274
|
4.3%
|
|||
|
Acquisition integration and
restructuring expenses
|
$
|
661
|
$
|
1,568
|
$
|
(907)
|
(57.9)%
|
|||
|
Foreign exchange (gain) loss
|
$
|
(58)
|
$
|
71
|
$
|
(129)
|
nm
|
|||
|
Impairment of long-lived assets
|
$
|
680
|
$
|
61
|
$
|
619
|
nm
|
|||
|
Depreciation and amortization
|
$
|
8,273
|
$
|
8,833
|
$
|
(560)
|
(6.3)%
|
|||
|
Operating income
|
$
|
50,906
|
$
|
38,765
|
$
|
12,141
|
31.3%
|
|||
|
Operating margin
|
17.1%
|
13.6%
|
350bpts
|
|||||||
|
Capital expenditures
|
$
|
4,619
|
$
|
2,976
|
$
|
1,643
|
55.2%
|
|||
|
Total assets
|
$
|
343,816
|
$
|
319,722
|
$
|
24,094
|
7.5%
|
|||
nm = not meaningful
bpts = basis points
Net sales in the first nine months of 2010 for the North America segment were $298.0 million compared to $285.7 million in the same period of the prior year, an increase of $12.3 million or 4.3 percent. Approximately $3.6 million of the period-over-period sales increase was the result of changes in foreign currency translation rates, as the U.S. dollar decreased in value relative to the local currencies of certain of the Company’s foreign subsidiaries. The period-over
period increase in sales reflects an improvement in the North American economy, which started in the latter half of 2009 and continued into 2010. In response to improving economic conditions, many of the Company’s consumer products clients have increased their levels of marketing and new product introductions and have increased the frequency of packaging redesigns and sales promotion projects, resulting in higher revenue for the Company. As previously mentioned, sales in the third quarter of 2010 declined slightly in comparison to the third quarter of 2009, reflecting a slower than expected rate of new product introductions and packaging changes from the Company’s consumer packaged goods accounts as economic uncertainties continue, a reduction in promotional activity from the Company’s entertainment accounts and the loss of a lower margin non-core retail client.
Operating income was $50.9 million or 17.1 percent of sales, in the first nine months of 2010 compared to $38.8 million, or 13.6 percent of sales, in the first nine months of 2009, an increase of $12.1 million. The increase in operating income is principally due to the increase in revenue period-over-period and the Company’s cost reduction initiatives, which began in the second half of 2008 and continued into the third quarter of 2010.
Europe
|
Three months ended September 30,
|
2010 vs. 2009
Increase (Decrease)
|
|||||||||
|
(in thousands)
|
2010
|
2009
|
$
|
%
|
||||||
|
Net sales
|
$
|
16,724
|
$
|
16,978
|
$
|
(254)
|
(1.5)%
|
|||
|
Acquisition integration and
restructuring expenses
|
$
|
(81)
|
$
|
214
|
$
|
(295)
|
nm
|
|||
|
Foreign exchange (gain) loss
|
$
|
(186)
|
$
|
(287)
|
$
|
101
|
35.2%
|
|||
|
Depreciation and amortization
|
$
|
592
|
$
|
900
|
$
|
(308)
|
(34.2)%
|
|||
|
Operating income
|
$
|
1,490
|
$
|
1,022
|
$
|
468
|
45.8%
|
|||
|
Operating margin
|
8.9%
|
6.0%
|
290bpts
|
|||||||
|
Capital expenditures
|
$
|
341
|
$
|
124
|
$
|
217
|
nm
|
|||
|
Total assets
|
$
|
45,979
|
$
|
45,081
|
$
|
898
|
2.0%
|
|||
nm = not meaningful
bpts = basis points
Net sales in the Europe segment in the third quarter of 2010 were $16.7 million compared to $17.0 million in the same period of the prior year, a decrease of $0.3 million, as weakness in the European economy continued. Sales for the third quarter of 2010, as compared to the third quarter of 2009, reflect a decrease of $1.1 million resulting from changes in foreign currency translation rates, as the U.S. dollar increased in value relative to certain of the local currencies of the Company’s foreign subsidiaries.
Operating income was $1.5 million, or 8.9 percent of sales, in the third quarter of 2010 compared to $1.0 million or 6.0 percent of sales in the third quarter of 2009, a increase of $0.5 million. The increase in operating income, quarter-over-quarter, reflects the Company’s cost reduction initiatives.
|
Nine months ended September 30,
|
2010 vs. 2009
Increase (Decrease)
|
|||||||||
|
(in thousands)
|
2010
|
2009
|
$
|
%
|
||||||
|
Net sales
|
$
|
49,099
|
$
|
48,872
|
$
|
227
|
0.5%
|
|||
|
Acquisition integration and
restructuring expenses
|
$
|
90
|
$
|
1,221
|
$
|
(1,131)
|
(92.6)%
|
|||
|
Foreign exchange (gain) loss
|
$
|
98
|
$
|
218
|
$
|
(120)
|
(55.0)%
|
|||
|
Impairment of long-lived assets
|
$
|
--
|
$
|
75
|
$
|
(75)
|
(100.0)%
|
|||
|
Depreciation and amortization
|
$
|
2045
|
$
|
2,316
|
$
|
(271)
|
(11.7)%
|
|||
|
Operating income
|
$
|
2,853
|
$
|
2,180
|
$
|
673
|
30.9%
|
|||
|
Operating margin
|
5.8%
|
4.5%
|
130bpts
|
|||||||
|
Capital expenditures
|
$
|
724
|
$
|
438
|
$
|
286
|
65.3%
|
|||
|
Total assets
|
$
|
45,979
|
$
|
45,081
|
$
|
898
|
2.0%
|
|||
nm = not meaningful
bpts = basis points
Net sales in the Europe segment in the first nine months of 2010 were $49.1 million compared to $48.9 million in the same period of the prior year, an increase of $0.2 million or 0.5 percent. Sales for the first nine months of 2010, as compared to the first nine months of 2009, reflect a decrease of $0.6 million resulting from changes in foreign currency translation rates, as the U.S. dollar increased in value relative to certain of the local currencies of the Company’s foreign subsidiaries.
Operating income was $2.9 million, or 5.8 percent of sales, in the first nine months of 2010 compared to $2.2 million or 4.5 percent of sales in the first nine months of 2009, an increase of $0.7 million or 30.9 percent. The increase in operating income, period-over-period, reflects the Company’s cost reduction initiatives.
Asia Pacific
|
Three months ended September 30,
|
2010 vs. 2009
Increase (Decrease)
|
|||||||||
|
(in thousands)
|
2010
|
2009
|
$
|
%
|
||||||
|
Net sales
|
$
|
7,547
|
$
|
7,668
|
$
|
(121)
|
(1.6)%
|
|||
|
Acquisition integration and
restructuring expenses
|
$
|
(18)
|
$
|
312
|
$
|
(330)
|
nm
|
|||
|
Foreign exchange (gain) loss
|
$
|
222
|
$
|
(449)
|
$
|
671
|
nm
|
|||
|
Depreciation and amortization
|
$
|
283
|
$
|
264
|
$
|
19
|
7.2%
|
|||
|
Operating income
|
$
|
982
|
$
|
2,192
|
$
|
(1,290)
|
(55.2)%
|
|||
|
Operating margin
|
13.0%
|
28.6%
|
(1,560)bpts
|
|||||||
|
Capital expenditures
|
$
|
395
|
$
|
150
|
$
|
245
|
nm
|
|||
|
Total assets
|
$
|
23,374
|
$
|
20,832
|
$
|
2,542
|
12.2%
|
|||
nm = not meaningful
bpts = basis points
Net sales in the Asia Pacific segment in the third quarter of 2010 were $7.5 million compared to $7.7 million in the same period of the prior year, a decrease of $0.1 million or 1.6 percent. Sales for the third quarter of 2010, as compared to the third quarter of 2009, benefited from an increase of $0.4 million resulting from changes in foreign currency translation rates, as the U.S. dollar decreased in value relative to certain of the local currencies of the Company’s foreign subsidiaries.
Operating income was $1.0 million in the third quarter of 2010, or 13.0 percent of sales, as compared to $2.2 million, or 28.6 percent of sales, in the third quarter of 2009, a decrease of $1.2 million, or 55.2 percent. The decrease in operating income was due in part to the impact of the Company’s efforts to enhance global production efficiencies, resulting in revised pricing for work done for other Schawk locations. In addition, the Asia Pacific segment recorded a foreign exchange loss in the 2010 period, compared to a foreign exchange gain in the 2009 period.
|
Nine months ended September 30,
|
2010 vs. 2009
Increase (Decrease)
|
|||||||||
|
(in thousands)
|
2010
|
2009
|
$
|
%
|
||||||
|
Net sales
|
$
|
22,609
|
$
|
20,690
|
$
|
1,919
|
9.3%
|
|||
|
Acquisition integration and
restructuring expenses
|
$
|
(23)
|
$
|
652
|
$
|
(675)
|
nm
|
|||
|
Foreign exchange (gain) loss
|
$
|
383
|
$
|
(1,429)
|
$
|
1,812
|
nm
|
|||
|
Depreciation and amortization
|
$
|
893
|
$
|
747
|
$
|
146
|
19.5%
|
|||
|
Operating income
|
$
|
3,637
|
$
|
5,287
|
$
|
(1,650)
|
(31.2)%
|
|||
|
Operating margin
|
16.1%
|
25.6%
|
(950)bpts
|
|||||||
|
Capital expenditures
|
$
|
1,042
|
$
|
408
|
$
|
634
|
nm
|
|||
|
Total assets
|
$
|
23,374
|
$
|
20,832
|
$
|
2,542
|
12.2%
|
|||
nm = not meaningful
bpts = basis points
Net sales in the Asia Pacific segment in the first nine months of 2010 were $22.6 million compared to $20.7 million in the same period of the prior year, an increase of $1.9 million or 9.3 percent. Approximately $1.4 million of the period-over-period sales increase was the result of changes in foreign currency translation rates, as the U.S. dollar decreased in value relative to the local currencies of certain of the Company’s foreign subsidiaries.
Operating income was $3.6 million in the first nine months of 2010, or 16.1 percent of sales, as compared to $5.3 million, or 25.6 percent of sales, in the first nine months of 2009, a decrease of 31.2 percent. The decrease in operating income was due in part to the impact of the Company’s efforts to enhance global production efficiencies, resulting in revised pricing for work done for other Schawk locations. In addition, the Asia Pacific segment recorded a foreign exchange loss in the 2010 period, compared to a foreign exchange gain in the 2009 period.
Liquidity and Capital Resources
The Company’s primary liquidity needs are to fund capital expenditures, support working capital requirements and service indebtedness. The Company’s principal sources of liquidity are cash generated from its operating activities and borrowings under its credit agreement. The Company’s total debt outstanding at September 30, 2010 was $62.6 million. As noted below, the Company entered into an amended and restated credit agreement in January 2010.
As of September 30, 2010, the Company had $29.0 million in consolidated cash and cash equivalents, compared to $12.2 million at December 31, 2009. The Company expects to use part of its September 30, 2010 cash and cash equivalents to fund an expected settlement of its pension withdrawal liability in the fourth quarter of 2010 and required debt repayments in the first quarter of 2011.
Cash provided by operating activities. Cash provided by operating activities was $34.7 million in the first nine months of 2010 compared to $41.8 million in the first nine months of 2009. The period-over-period decrease in cash provided from operations reflects the improvement in net income to $26.1 million for the first nine months of 2010 compared to net income of $15.8 million for the first nine months of 2009, partially offset by unfavorable changes in non-cash current assets and current liabilities in the 2010 period as compared to the 2009 period. The change in working capital accounts in the 2009 period reflects a $7.5 million income tax refund received in the second quarter of 2009.
Depreciation and intangible asset amortization expense in the first nine months of 2010 was $9.9 million and $3.4 million, respectively, as compared to $10.7 million and $3.5 million, respectively, in the first nine months of the prior year.
Cash provided by (used in) investing activities. Cash used in investing activities was $5.6 million in the first nine months of 2010 compared to $0.1 million of cash provided by investing activities during the comparable 2009 period. The cash used in investing activities in the 2010 period includes proceeds of $1.5 million from property loss insurance settlements and $0.5 million from the sale of assets. The cash provided by investing activities in the 2009 period reflects proceeds of $4.4 million from the sale of property and equipment, mainly from the sale of land and buildings that had been classified as “held for sale” at year-end 2008. The cash used in investing activities in the 2010 period also includes an expenditure of $0.9 million for the operating assets of Untitled London Limited. Capital expenditures were $6.7 million in the first nine months of 2010 compared to $3.9 million in the first nine months of 2009. Over the next five years, assuming no significant business acquisitions, capital expenditures are expected to be in the range of $10.0 to $18.5 million annually. During the next three years, the Company expects to incur capital investment and related costs in information technology systems to improve customer service, business effectiveness and internal controls, as well as to reduce operating costs.
Cash used in financing activities. Cash used in financing activities in the first nine months of 2010 was $14.5 million compared to cash used in financing activities of $51.0 million during the first nine months of 2009. The cash used in financing activities in the first nine months of 2010 reflects $15.0 million of net payments of debt compared to $45.1 million of net payments of debt during the first nine months of 2009. The debt payments in the 2009 period include $20.0 million of prepayments made by the Company to its lenders in June 2009 pursuant to its June 11, 2009 debt amendments. The Company used $4.3 million to purchase shares of its common stock during the first nine months of 2009. No shares were repurchased by the Company during the first nine months of 2010. In addition, the Company received proceeds of $4.5 million from the issuance of common stock during the first nine months of 2010 compared to
$0.8 million in the first nine months of 2009. The issuance of common stock in both periods is attributable to stock option exercises and issuance of shares pursuant to the Company’s employee stock purchase plan. Dividend payments on common stock were $3.0 million and $1.3 million for the first nine months ended September 30, 2010 and 2009, respectively. The dividends paid during the first nine months of 2010 reflect an increase to $0.04 per share, or approximately $1.0 million per quarter, and, subject to declarations at the discretion of the Board of Directors, the Company expects quarterly dividends at this rate to continue throughout 2010.
Revolving Credit Facility, Note Purchase Agreements and Other Debt Arrangements.
In December 2003, the Company entered into a private placement of debt (the “2003 Private Placement”) to provide long-term financing. The terms of the Note Purchase Agreement relating to this transaction, as amended, provided for the issuance and sale by the Company of two series of notes: Tranche A, for $15.0 million, payable in annual installments of $2.1 million from 2007 through 2013, and Tranche B, for $10.0 million, payable in annual installments of $1.4 million from 2008 through 2014. The remaining aggregate balance of the Tranche A and Tranche B notes, $12.3 million, is included on the September 30, 2010 Consolidated Balance Sheets as follows: $3.1 million is included in Current maturities of long-term debt and $9.2 million is included in Long-term debt.
In January 2005, the Company entered into a Note Purchase and Private Shelf Agreement (the “2005 Private Placement”) with Prudential Investment Management Inc, pursuant to which the Company sold $50.0 million in a series of three Senior Notes, maturing in January 2010, January 2011, and January 2012, respectively. The remaining aggregate outstanding balance of the two remaining notes, $34.4 million, is included on the September 30, 2010 Consolidated Balance Sheets as follows: $17.2 million is included in Current maturities of long-term debt and $17.2 million is included in Long-term debt.
In December, 2007, the Company’s Canadian subsidiary entered into a revolving demand credit facility with a Canadian bank to provide working capital needs up to $1.0 million Canadian dollars. The credit line is guaranteed by the Company. There was no balance outstanding on this credit facility at September 30, 2010.
Effective January 12, 2010, the Company and certain subsidiary borrowers of the Company entered into an amended and restated credit agreement (the “Credit Agreement”) in order to refinance its prior revolving credit facility that was set to terminate in January 2010. The Credit Agreement provides for a two and one-half year secured, multicurrency revolving credit facility in the principal amount of $90.0 million, including a $10.0 million swing-line loan subfacility and a $10.0 million subfacility for letters of credit. The Company may, at its option and subject to certain conditions, increase the amount of the facility by up to $10.0 million by obtaining one or more new commitments from new or existing lenders to fund such increase. Immediately following the closing of the facility, there was approximately $15.0 million in outstanding borrowings. Loans under the facility generally bear interest at a rate of LIBOR plus a margin that varies with the Company’s cash flow leverage ratio, in addition to applicable commitment fees, with a maximum rate of LIBOR plus 350 basis points. Loans under the facility are not subject to a minimum LIBOR floor. At September 30, 2010, the applicable margin was 250 basis points, resulting in an interest rate of 2.76 percent on LIBOR-based borrowings under the revolving credit facility. In order to manage the risk of rising interest rates on the Company’s variable rate revolving debt, the Company executed two “variable to fixed” interest rate swaps for the total notional amount of $15.0 million in May of 2010. See Note 14 – Derivative Financial Instruments in Part I, Item 1, and Item 3, Quantitative and Qualitative Disclosures About Market Risk, for further discussion.
Borrowings under the facility will be used for general corporate purposes, such as working capital and capital expenditures. Additionally, together with anticipated cash generated from operations, the unutilized portion of the credit facility is expected to be available to provide financing flexibility and support in the funding of principal payments due in 2010 and succeeding years on the Company’s other debt obligations. The total balance outstanding under the Company’s credit facility at September 30, 2010 was $15.0 million and is included in Long-term debt on the September 30, 2010 Consolidated Balance Sheets.
Outstanding obligations due under the facility are secured through security interests in and liens on substantially all of the Company’s and its domestic subsidiaries’ current and future personal property and on 100 percent of the capital stock of the Company’s existing and future domestic subsidiaries and 65 percent of the capital stock of certain foreign subsidiaries.
The Credit Agreement contains certain customary affirmative and negative covenants and events of default. Under the
terms of the Credit Agreement, permitted capital expenditures excluding acquisitions are restricted to not more than $18.5 million per fiscal year, or $40.0 million over the term of the credit facility, and dividends, stock repurchases and other restricted payments are limited to $5.0 million per fiscal year. Other covenants include, among other things, restrictions on the Company’s and in certain cases its subsidiaries’ ability to incur additional indebtedness; dispose of assets; create or permit liens on assets; make loans, advances or other investments; incur certain guarantee obligations; engage in mergers, consolidations or acquisitions, other than those meeting the requirements of the Credit Agreement; engage in certain transactions with affiliates; engage in sale/leaseback transactions; and engage in certain hedging arrangements. The Credit Agreement also requires compliance with specified financial ratios and tests, including a minimum fixed charge coverage ratio, a maximum cash flow ratio and a minimum consolidated net worth requirement. The Company was in compliance with all covenants at September 30, 2010.
Concurrently with its entry into the Credit Agreement, the Company also amended the note purchase agreements underlying its outstanding senior notes in order to conform the financial and other covenants contained in the note purchase agreements to the covenants contained in the Credit Agreement described above.
Off-balance sheet arrangements and contractual obligations
The Company does not have any material off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on its financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources.
There have been no material changes in the Company’s minimum debt, lease and other material noncancelable commitments from those reported in the Company’s Form 10-K for the year ended December 31, 2009, except as follows:
As of September 30, 2010, the Company’s total liability for uncertain tax positions was $4.8 million, including $0.5 million of accrued interest and penalties. Of this total, it is estimated that $0.5 million will be settled in one year or less and $4.3 million will be settled in one to three years. The increase in the Company’s liability for uncertain tax positions during the third quarter of 2010 was primarily due to fluctuations in foreign exchange rates.
As of December 31, 2009, the Company’s total liability for uncertain tax positions was $18.1 million, including $1.9 million of accrued interest and penalties. Due to the high degree of uncertainty regarding the timing of potential future cash flows associated with these liabilities, the Company was unable to make a reasonably reliable estimate of the amount and period in which these liabilities might be paid.
Recent Accounting Pronouncements
See Note 1 – Significant Accounting Policies to the Consolidated Financial Statements, included in Part I, Item 1, for information on recent accounting pronouncements.
Critical accounting policies and estimates
The discussion and analysis of the Company’s financial condition and results of operations are based upon its consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of its financial statements. Actual results may differ from these estimates under different assumptions or conditions. Critical accounting estimates are defined as those that are reflective of significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions. The following expanded disclosures regarding the Company’s sensitivity to changes in its material assumptions and estimates related to the nine-month period ended September 30, 2010 should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in the Company’s Form 10-K for the year ended December 31, 2009.
Accounts Receivable:
The Company’s clients are primarily consumer product manufacturers, advertising agencies; retailers, both grocery and non-grocery, and entertainment companies. Accounts receivable consist primarily of amounts due to Schawk from its
normal business activities. The Company’s allowance for doubtful accounts is determined using assumptions of minimum reserve requirement percentages applied to the aging of the Company’s trade accounts receivable, along with specific reserves for known collection issues. For example, the aging-based portion of our reserve is determined by applying a 25% reserve to amounts overdue by more than 120 days, a 60% reserve to amounts overdue by more than 180 days and a 100% reserve for amounts overdue by more than 360 days. In our experience, this policy as supplemented by specific reserves for known collection issues, broadly captures the credit risk in our receivables. Based on the Company’s estimates and assumptions, an allowance for doubtful accounts and credit memos of $1.2 million was established at September 30, 2010, compared to an allowance of $1.6 million at December 31, 2009.
Impairment of Long-Lived Assets:
The Company records impairment losses on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired. Events that may indicate that certain long-lived assets might be impaired might include a significant downturn in the economy or the consumer packaging industry in particular, a loss of a major customer or several customers, a significant decrease in the market value of an asset, a significant adverse change in the manner in which an asset is used or an adverse change in the physical condition of an asset. The Company tests long-lived assets for impairment when facts and circumstances have changed and a potential impairment trigger is indicated. Impairment is evaluated by a comparison of the carrying value of an asset to the estimated future net undiscounted cash flows expected to be generated by the asset. If this comparison indicates that an asset is impaired, the loss recognized is the amount by which the carrying value exceeds the estimated fair value. The Company’s impairment losses in regard to long-lived assets have in recent years primarily related to surplus properties resulting from restructuring (i.e., facility consolidation) actions. For significant losses, the Company estimates fair value based on market valuation studies performed by qualified third-party valuation experts. Assumptions used in estimating cash flows include among other things those assumptions concerning periods of operation and projections of revenues and costs of revenues, industry trends and market interest rates. There are inherent uncertainties associated with the judgments and estimates used in assessing asset impairment and it is possible that impairment charges recognized in a given period would differ if the assessment was made in a different period. During the nine-month period ended September 30, 2010, the Company recorded an impairment charge of $0.7 million for certain production equipment which became inoperable due to water damage and reflected this expense as Impairment of long-lived assets in the Consolidated Statements of Operations at September 30, 2010.
Goodwill and Other Acquired Intangible Assets:
The Company has made acquisitions in the past that included a significant amount of goodwill, customer relationships and, to a lesser extent, other intangible assets. Goodwill is not amortized but is subject to an annual (or under certain circumstances more frequent) impairment test based on its estimated fair value. Customer relationships and other acquired intangible assets are amortized over their useful lives and are tested for impairment when facts and circumstances have changed and a potential impairment trigger is indicated. Events that may indicate potential impairment include a loss of, or a significant decrease in volume from, a major customer, a change in the expected useful life of an asset, a change in the market value of an asset, a significant adverse change in legal factors or business climate, unanticipated competition relative to a major customer or the loss of key personnel relative to a major customer. Impairment is evaluated by a comparison of the carrying value of an asset to the future net undiscounted cash flows expected to be generated by the asset. If this comparison indicates that an acquired intangible asset is impaired, the loss recognized is the amount by which the carrying value exceeds the estimated fair value.
The Company performs a goodwill impairment test annually, or when events or changes in business circumstances indicate that the carrying value may not be recoverable. The Company will perform its 2010 goodwill impairment test as of October 1, 2010.
In evaluating the recoverability of goodwill, it is necessary to estimate the fair value of the reporting units. In making this assessment, the Company’s management relies on a number of factors to discount anticipated future cash flows, including operating results, business plans and present value techniques. There are inherent uncertainties in the assumptions and estimates used in developing future cash flows and management’s judgment is required in applying these assumptions and estimates to the analysis of goodwill impairment, including projecting revenues and profits, interest rates, cost of capital, tax rates, the corporation’s stock price and the allocation of shared or corporate items. Many of the factors used in assessing fair value are outside the control of management and it is reasonably likely that assumptions and estimates will change from period to period. These changes may result in future impairments. For example, the Company’s revenue growth rate could be lower than projected due to economic, industry or competitive
factors or the discount rate used in the Company’s cash flow model could increase due to a change in market interest rates. Additionally, future goodwill impairment charges may be necessary if the Company’s market capitalization decreases due to a decline in the trading price of the Company’s common stock.
Income Taxes:
Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using tax rates in effect for the year in which the differences are expected to reverse. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets arising from temporary differences and net operating losses will not be realized. Federal, state and foreign tax authorities regularly audit Schawk, like other multi-national companies, and tax assessments may arise several years after tax returns have been filed. Effective January 1, 2007, the Company adopted the provisions of Income Taxes Topic of the Codification, ASC 740, that contains a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50 percent likely of being realized upon ultimate settlement. The Company considers many factors when evaluating and estimating its tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes, which could result in a change in reported income tax expense for a particular period. For example, the Company’s effective tax rates could be adversely affected by earnings being lower than anticipated in countries which have lower statutory rates and higher than anticipated in countries which have higher statutory rates, by changes in the valuation of deferred tax assets and liabilities, or by changes in the relevant tax, accounting or other laws, regulations, principles and interpretations. The Company is subject to audit in various jurisdictions, and such jurisdictions may assess additional income tax against it. Although the Company believes its tax estimates are reasonable, the final determination of tax audits and any related litigation could be materially different from its historical income tax provisions and accruals. The results of an audit or litigation could have a material effect on the Company’s operating results or cash flows in the period or periods for which that determination is made. See Note 10 - Income Taxes to the Consolidated Financial Statements for further discussion.
The Company has provided valuation allowances against deferred tax assets, primarily arising from the acquisition of Seven in 2005, due to the dormancy of the companies generating the tax assets or due to income tax rules limiting the availability of the losses to offset future taxable income.
Exit Reserves:
The Company records reserves for the consolidation of workforce and facilities of acquired companies. The exit plans are approved by company management prior to, or shortly after, the acquisition date. The exit plans provide for severance pay, lease abandonment costs and other related expenses. A change in any of the assumptions used to estimate the exit reserves that result in a decrease to the reserve would result in a decrease to goodwill for acquisitions completed prior to December 31, 2008. Any change in assumptions that result in an increase to the exit reserves would result in a charge to income. At September 30, 2010, the Company had exit reserves of approximately $1.0 million that were included in Accrued expenses and Other liabilities on the Consolidated Balance Sheets, for exit activities completed in 2005 and 2006, primarily for facility closure costs. Future increases or decreases in these reserves are possible, as the Company continues to assess changes in circumstance that would alter the future cost assumptions used in the calculation of the reserves. Exit reserves are adjusted when facts regarding a particular reserve have changed, indicating that the original reserve assumptions are no longer valid. For example, the sublease assumptions originally used in computing a reserve for a vacant leased property could become invalid because of a change in circumstances of a sublease tenant, requiring a recalculation of the correct reserve balance. However, the Company believes that, because the current exit reserves are diminishing, any further changes to the exit reserves would be immaterial to its consolidated financial statements. See Note 7 - Acquisitions to the Consolidated Financial Statements for further discussion.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
A discussion regarding market risk is included in the Company’s Form 10-K for the year ended December 31, 2009. Other than as described below, there have been no material changes in information regarding market risk relating to the Company’s business on a consolidated basis since December 31, 2009.
The Company had $15.0 million of variable rate debt outstanding at September 30, 2010 and expects to use its variable rate revolving credit facility during 2010 and beyond to fund cash flow needs and, to the extent opportunities arise, acquisitions. Under this debt, the Company is exposed to interest-rate volatility, primarily changes in the LIBOR rate. As discussed in Note 14 -Derivative Financial Instruments to its unaudited consolidated financials statements included in this report, in May 2010 the Company entered into two “variable to fixed” interest rate swaps for a total notional amount of $15.0 million. Prior to that time, the Company historically had not actively managed interest rate exposure on variable rate debt or hedged its interest rate exposures. The swaps expire in June 2012 and the Company’s revolving credit facility terminates in July 2012.
The Company entered into the interest rate swaps in order to hedge its exposure to interest rate changes and reduce the volatility of its financing costs on a portion of its revolving variable rate debt through its maturity date. The Company does not use swaps or other derivative instruments for trading or speculative purposes. However, disruptions in the credit markets could impact the effectiveness of its hedging strategies and increase credit risks. Our credit risk on our swaps relates to our exposure to potential nonperformance of the swap counterparty upon settlement of the swaps. We mitigate this credit risk by dealing with highly rated bank counterparties.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
We have established disclosure controls and procedures to ensure that the information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and that such information is accumulated and made known to the officers who certify the Company’s financial reports and to other members of senior management and the Board of Directors as appropriate to allow timely decisions regarding required disclosure.
Based on their evaluation as of September 30, 2010, the principal executive officer and principal financial officer of the Company have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) were effective.
(b) Changes in Internal Control Over Financial Reporting
There have been no changes in our internal controls over financial reporting during the third quarter of fiscal 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II – OTHER INFORMATION
Item 1A. Risk Factors
The Company has included in Part I, Item 1A of its Annual Report on Form 10-K for the year ended December 31, 2009 descriptions of certain risks and uncertainties that could affect the Company’s business, future performance or financial condition. The risk factors described in the Annual Report (collectively, the “Risk Factors”) could materially adversely affect our business, financial condition, future results or trading price of the Company’s common stock. In addition to the other information contained in the reports the Company files with the SEC, investors should consider these Risk Factors prior to making an investment decision with respect to the Company’s stock. The risks described in the Risk Factors, however, are not the only risks facing the Company. Additional risks and uncertainties not currently known to the Company or those that are currently considered to be immaterial also may materially adversely affect the Company’s business, financial condition and/or operating results.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Purchases of Equity Securities by the Company
The Company did not repurchase any shares of its common stock during the nine-month period ended September 30, 2010. During the first nine months of 2009, the Company repurchased 488,700 shares of its common stock, pursuant to an authorization from its Board of Directors in December 2008. The share repurchase program was discontinued in March, 2009. In addition, shares of common stock are occasionally tendered to the Company by certain employee and director stockholders in payment of stock options exercised. During the nine-month period ended September 30, 2010, 2,415 shares of Schawk, Inc. common stock had been tendered to the Company in connection with stock option exercises. No shares were tendered during the nine-month period ended September 30, 2009. The Company records the receipt of common stock in payment for stock options exercised as a reduction of common stock issued and outstanding.
Item 6. Exhibits
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3.1
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Certificate of Incorporation of Schawk, Inc., as amended. Incorporated herein by reference to Exhibit 4.2 to Registration Statement No. 333-39113.
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3.3
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By-Laws of Schawk, Inc., as amended. Incorporated herein by reference to Exhibit 3.2 to Form 8-K filed with the SEC on December 18, 2007.
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4.1
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Specimen Class A Common Stock Certificate. Incorporated herein by reference to Exhibit 4.1 to Registration Statement No. 33-85152.
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31.1
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Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended. *
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31.2
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Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended. *
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Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *
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* Filed herewith
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 3rd day of November, 2010.
Schawk, Inc.
(Registrant)
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By:
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/s/ John B. Toher
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John B. Toher
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Vice President and
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Corporate Controller
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