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| SR > SEC Filings for SR > Form 10-K on 6-Mar-2009 | All Recent SEC Filings |
6-Mar-2009
Annual Report
This Management's Discussion and Analysis provides material historical and
prospective disclosures intended to enable investors and other users to assess
our financial condition and results of operations. Statements that are not
historical are forward-looking and involve risks and uncertainties, including
those discussed under the caption "Risk Factors" in Item 1A of this Annual
Report on Form 10-K and elsewhere in this report. These risks could cause our
actual results to differ materially from any future performance suggested below.
This Management's Discussion and Analysis includes the following sections:
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Overview - An overall discussion of our Company, the business challenges and opportunities we believe are key to our financial success, and our plans for facing these challenges and capitalizing upon the opportunities before us.
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Critical Accounting Polices and Estimates - A discussion of the accounting policies that require our most critical judgments and estimates. This discussion provides insight into the level of subjectivity, quality, and variability involved in these judgments and estimates. This section also provides a summary of recently adopted and recently issued accounting pronouncements that have or may materially affect our business.
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Results of Operations - An analysis of our consolidated results of operations and segment results for the three years presented in our consolidated financial statements. This analysis discusses material trends within our business and provides important information necessary for an understanding of our operating results.
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Liquidity and Capital Resources - An analysis of cash flows and discussion of our financial condition, and contractual obligations. This section provides information necessary to evaluate our ability to generate cash and to meet existing and known future cash requirements over both the short and long term.
References to 2008, 2007, and 2006 refer to the 52-week periods ended December 28, 2008, December 30, 2007, and December 31, 2006.
OVERVIEW
The Company - We are a leading document services provider that partners with our customers to manage, control, and source their document and print-related spending. We primarily serve the healthcare, industrial, and commercial markets.
We are trusted by our customers to manage business-critical documents. Managing
these documents not only includes providing printed documents but also includes
helping companies migrate from paper-based to digital processes by providing
innovative tools to manage the entire lifecycle of their documents from concept
to delivery. To accomplish this, we provide products and services including:
printed products, pressure-sensitive labels, print-on-demand services, document
automation, document design, outsourcing, warehouse and distribution services,
and professional services.
We make a measurable difference for our customers by helping them achieve their desired business outcomes by assisting them with reducing costs, transitioning to more efficient processes, effectively managing their risks and meeting their regulatory and industry requirements, and driving their business growth.
Our operations include five reportable segments: Document Management, Label Solutions, POD Services, Document Systems, and PathForward.
Our Business Challenges - We are engaged in an industry undergoing fundamental changes due to advancements in and proliferation of digital technologies. These changes, in addition to the current economic conditions, create business challenges for us. We believe our Company is facing the following key challenges:
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Declines in demand for traditional custom-printed documents
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Excess production capacity and price competition within our industry
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Future pension funding requirements and amortization of actuarial gains and losses
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Current economic conditions and disruption in credit markets.
The following is a discussion of these business challenges and our strategy for managing their effect upon our business.
We plan to continue to invest in new and existing technologies and services that provide innovative, valuable solutions for our customers' document needs. We believe our extensive expertise within our markets combined with increased focus on targeted solutions for those markets will differentiate us from our competitors and produce growth opportunities outside of traditional printed documents.
Excess production capacity and price competition within our industry - Paper mill operating rates for uncoated freesheet have declined somewhat but still remained high at the end of 2008. Faced with higher energy and transportation costs, paper mills are expected to continue to manage production capacity through downtime and closures in an attempt to maintain or increase paper prices.
Despite a competitive marketplace, we have generally been able to pass through increased paper cost, although it often takes several quarters due to the custom nature of our products and our contractual relationships with many of our customers. We expect this trend to continue; however, current economic conditions may limit our success at recovering all of our increased costs, resulting in lower margins on products we sell.
To remain competitive, in 2007, we initiated restructuring actions to reduce our annual operating costs by $40 million. We eliminated approximately 250 positions, primarily in management and overhead, representing $22 million annually in compensation and related costs. We also consolidated our manufacturing and warehousing operations to save approximately $5 million annually. Other initiatives that targeted purchasing costs and other non-compensation expenditures lowered costs by approximately $13 million annually.
Future pension funding and loss amortization - During 2001, 2002, and most recently in 2008, our qualified pension plan became underfunded due to weak stock market returns. The amortization of these asset losses plus other actuarial losses has resulted in significant pension loss amortization in recent years - equivalent to $0.42 per share in 2008, $0.55 per share in 2007, and $0.54 per share in 2006. Pension loss amortization is expected to be $20.4 million in 2009, equivalent to $0.43 per share. As a result of the 2008 losses and possible future losses from a continued weak economy in 2009, we expect pension loss amortization to trend higher in future years.
The Pension Protection Act of 2006 became effective in 2008 and increases the minimum funding requirements for our qualified pension plan. Although we do not know the exact amount required for our minimum funding at this time, we estimate our funding will be $20 to $25 million in 2009, which is more than the expected required funding. Based upon the new requirements and the recent decline in the value of our pension assets, it is likely that we will be required to increase our level of contributions in 2010 and beyond.
In response to these challenges, we modified our qualified and nonqualified defined benefit pension plans for employees still accruing benefits under the plans. Effective June 30, 2008, these participants ceased accruing pension benefits and the final pension amounts were based upon pay and service through June 29, 2008. The Company match in the 401(k) savings plan was increased for the affected employees from 10% to 75% on the first six percent of eligible compensation deferred. Excluding pension loss amortization, we expect to realize annualized savings of approximately $4.4 million in service costs as a result of these changes.
Current economic conditions and disruption in credit markets - Recent market and economic conditions have been volatile and challenging resulting in decreased demand and significant price competition in an already price-competitive environment. These factors had a significant impact upon our revenues during the year. Although we cannot predict the duration and severity of the current disruption in financial markets and adverse economic conditions going forward, we expect to continue to see similar challenges in 2009.
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We initiated plans to integrate several of our POD Services print centers and Document Management distribution warehouses in order to improve efficiency and reduce cost. We closed two print centers and one distribution center and integrated two other print centers with warehouses. We expect to realize approximately $3.0 million in annualized cost savings as a result of these actions.
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We also implemented a plan to redesign our sales support infrastructure to more of a centralized model by the end of March 2009. Customer transactional and administrative functions are being transitioned from our field sales offices to one of three client support centers, one of which is new. This action is expected to result in approximately $5.6 million in annualized cost savings.
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In November, we reduced our workforce by 5%, eliminating approximately 175 positions throughout the Company. Annualized savings are expected to total approximately $11.0 million.
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Late in the year, we renegotiated various contracts to enable us to lower raw material costs, outbound freight charges, and professional service fees. In addition, we re-evaluated production schedules at our manufacturing facilities to substantially reduce over-time expenses. We expect to realize approximately $9.0 million in annualized savings as a result of these changes.
Our Focus - Our sales focus during 2008 and in previous years was primarily
product driven. Given our substantial experience and expertise within our
vertical markets, we are shifting our focus from products to our vertical
markets and the challenges and solutions needed in these particular markets.
Additionally, we are creating operational efficiencies to reduce costs, improve
customer satisfaction, and generate positive cash flow. In 2009, we will be
focusing on:
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Increased coverage and improved client satisfaction within our vertical markets
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Relentless pursuit of cost reduction
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Generating positive cash flow.
Increased coverage and improved client satisfaction within our vertical markets
- We believe focusing our efforts on markets where we are trusted industry
leaders and have an extensive understanding of the document-related issues will
enable us to provide valuable solutions specific to these markets in a very
timely and highly responsive manner.
One of our main objectives is to expand our sales in these vertical markets by focusing our in-depth knowledge on providing a full range of innovative, valuable document and print-related solutions for these customers. Key to this objective is offering products and services that are driven by anticipated needs and solutions specific to these customers. We are also investing in alternative sales channels that will further strengthen our position as a leader in these markets and are aligning our sales infrastructure to enable a higher level of customer service and increased opportunities to present our comprehensive solutions to new and existing customers.
We intend to continue to bring our customers products and services that improve their ability to capture, manage, and move information in their business processes. We offer a portfolio of Standard Register managed services that help our customers reduce costs and improve their business processes, allowing them to concentrate on their core competencies. We expect that our ability to provide for digital print-on-demand output, including color and variable print, and services that provide the customer with added convenience, design capability, and control over the process to be a strong differentiator among our competitors.
Relentless pursuit of cost reduction/Generating positive cash flow - We will continue to critically evaluate costs and improve productivity in order to stay cost competitive and most importantly, generate positive cash flow. We expect these measures to allow us to weather the current downturn in the economy and position us for growth as the economy strengthens.
In preparing our financial statements and accounting for the underlying transactions and balances, we applied the accounting policies disclosed in the Notes to the Consolidated Financial Statements. Preparation of our financial statements requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Although we believe our estimates and assumptions are reasonable, they are based on information presently available, and actual results may differ significantly from those estimates.
We consider the estimates discussed below as critical to an understanding of our
financial statements because they place the most significant demands on
management's judgment about the effect of matters that are inherently uncertain,
and the impact of different estimates or assumptions is material to our
financial condition or results of operations. The impact and any associated
risks related to these estimates are discussed throughout this discussion and
analysis where such estimates affect reported and expected financial results.
The impact of changes in the estimates and assumptions discussed below for the
pension plan, deferred taxes, and inventories generally do not affect segment
results. However, changes in revenue recognition, fair value measurements, and
share-based compensation expense (through an allocation of corporate expenses)
could impact individual segment results.
For a detailed discussion of the application of these and other accounting policies, see "Summary of Significant Accounting Policies" in the Notes to the Consolidated Financial Statements. Management has discussed the development and selection of the critical accounting policies and the related disclosure included herein with the Audit Committee of the Board of Directors.
Pension Benefit Plan Assumptions
Included in our financial statements are significant pension obligations and benefit costs which are measured using actuarial valuations. The use of actuarial models requires us to make certain assumptions concerning future events that will determine the amount and timing of the benefit payments. Such assumptions include the discount rate and the expected long-term rate of return on plan assets. In addition, the actuarial calculation includes subjective factors, such as withdrawal and mortality rates, to estimate the projected benefit obligation. The actuarial assumptions used may differ materially from actual results due to changing market and economic conditions, higher or lower withdrawal rates, or longer or shorter life spans of participants. These differences may have a significant impact on the amount of pension obligations and benefit expense recorded in future periods.
Discount rate - One of the principal components of calculating the projected benefit obligation and certain components of pension benefit costs is the assumed discount rate. The discount rate is the assumed rate at which future pension benefits could be effectively settled. The discount rate established at year-end for the benefit obligations is also used in the calculation of the interest component of benefit cost for the following year. Discount rates are established based on prevailing market rates for high-quality, fixed-income instruments with maturities equal to the future cash flows to pay the benefit obligations when due.
Expected long-term rate of return on plan assets - One of the principal components of the net periodic pension cost calculation is the expected long-term rate of return on plan assets. The required use of an expected long-term rate of return on plan assets may result in recognized pension income that is greater or less than the actual returns of those plan assets in any given year. Over time, however, the expected long-term returns are designed to approximate the actual long-term returns and therefore result in a pattern of income and expense recognition that more closely matches the pattern of the services provided by our employees. Our qualified defined benefit pension plan's assets are invested in a broadly- diversified portfolio consisting primarily of publicly-traded common stocks and fixed-income securities. We use long-term historical actual return experience and estimates of future long-term investment return, with consideration to the expected investment mix of the plan's assets, to develop our expected rate of return assumption used in the net periodic pension cost calculation. Differences between actual and expected returns are recognized in the pension cost calculation over five years using a five-year, market-related asset value method of amortization. The amortization of these differences has, and will continue to have, a significant effect on net periodic pension cost.
Our nonqualified pension benefit plans are unfunded plans and have no plan assets. Therefore, the expected long-term rate of return on plan assets is not a factor in accounting for these benefit plans.
We review the assumptions used to account for our pension obligations and benefit cost each fiscal year-end.
Weighted-Average Assumptions
Projected benefit obligation 2008 2007 Discount rate used for pension obligations 5.75% 6.00%
Holding all other assumptions constant:
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A 1% increase in the discount rate would decrease the pension obligation recorded by approximately $41 million.
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A 1% decrease in the discount rate would increase the pension obligation recorded by approximately $48 million.
Net periodic pension benefit cost 2008 2007 2006 Discount rate 5.75% 5.75% 5.75% Expected long-term rate of return on plan assets 8.75% 8.75% 8.75%
Holding all other assumptions constant:
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A 1% increase in the discount rate would decrease pension cost by approximately $3.2 million. A 1% decrease in the discount rate would increase pension cost by approximately $3.5 million.
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A 1% increase or decrease in the expected long-term rate of return on plan assets would decrease or increase pension benefit cost by $3.3 million.
Amortization of differences between the expected and actual returns on the plan assets impacts our pension cost. The actual return on plan assets in 2008 was a loss of approximately 28%. The difference between this loss and the gain expected based upon the long-term rate of return created an actuarial loss of approximately $76.4 million, on an after-tax basis, that was charged directly to shareholders' equity. This actuarial loss will be amortized to expense in future years.
Changes in discount rates used to value pension liabilities can also impact our
pension cost through the amortization of the actuarial gains and losses created.
The change in discount rate from 6.0% to 5.75% created an actuarial loss of
$11.5 million, on an after-tax basis, which also was charged directly to
shareholders' equity.
While we previously expected that amortization expense would continue to trend lower in 2009, the significant asset and liability losses in 2008 will cause amortization expense to be approximately $20.4 million in 2009 and trend higher in subsequent years. We currently have approximately $184.7 million of actuarial losses related to our pension plans that will be amortized to expense in future years.
The long-term rate of return on plan assets that we expect to use to determine fiscal 2009 net periodic pension cost is 8.75%, the same as 2008.
During the second quarter of 2007, we performed the annual impairment test for goodwill. The test was performed at the reporting unit level using a fair-value-based test that compares the fair value of the asset to its carrying value of $6.5 million. Based upon the test results, we determined that the discounted sum of the expected future cash flows from the assets exceeded the carrying value of those assets; therefore, no impairment of goodwill was recognized. During the second quarter of 2008, we elected to carry forward the 2007 test based upon our judgment of the following factors:
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The assets and liabilities that make up the reporting unit used to determine the fair value had not changed significantly from 2007
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The 2007 valuation resulted in an amount that exceeded the carrying amount of the reporting unit by a substantial margin
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Based upon an analysis of events that have occurred and circumstances that have changed since the 2007 valuation, the likelihood that the current fair value determination would be less than the current carrying amount of the reporting unit is remote.
As a result, no impairment of goodwill was recognized in 2008. The fair-value test performed in our analysis in 2007 used significant estimates and assumptions, which included projected future cash flows, discount rates that reflect the risk inherent in the future cash flows, growth rates, and determination of appropriate market values. The most critical estimates used in determining the expected cash flows were the revenue and cost assumptions and the terminal value assumed. If our estimate of expected future cash flows had been 10% lower, or if either of these two assumptions changed by 10%, the expected future cash flows would still have exceeded the carrying value of the assets, including goodwill, for both 2007 and 2008.
Deferred Taxes
We record income taxes under the asset and liability method. Significant management judgment is required in determining our deferred tax assets and liabilities, any valuation allowance recorded against our deferred tax assets, and our provision for income taxes, including tax positions taken or to be taken in our tax returns.
At December 28, 2008, we had net deferred tax assets of $126.7 million attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and to operating loss and tax credit carryforwards. We base our estimate of deferred tax assets and liabilities on current tax laws and rates and, in certain cases, business plans, tax planning strategies, and other expectations about future outcomes. Since the effect of a change in tax rates is recognized in earnings in the period when the changes are enacted, changes in existing tax laws or rates could affect actual tax results, and future business results may affect the amount of deferred tax liabilities or the valuation of deferred tax assets over time.
Valuation Allowances - Our ability to realize deferred tax assets is primarily dependent on the future taxable income of the taxable entity to which the deferred tax asset relates. We evaluate all available evidence to determine whether it is more likely than not that some portion, or all, of the deferred income tax asset will not be realized.
The decision to record a valuation allowance requires varying degrees of judgment based upon the nature of the item giving rise to the deferred tax asset. We have established valuation allowances for U.S. and Canadian capital loss carryforwards of approximately $80.6 million ($14.2 million in deferred tax assets) because we believe it is more likely than not that they will not be utilized before the expiration period. Should future taxable income be materially different from our estimates, changes in the valuation allowance could occur that would impact our tax expense in the future.
Under the dollar value LIFO method, similar items of inventory are aggregated to
form inventory "pools." Increases and decreases in a pool are identified and
measured in terms of the total dollar value of inventory in the pool. The use
of indices is an integral part of the dollar value LIFO method. Using the
link-chain technique, a cumulative index is used to convert (deflate) year-end
inventories priced at current cost to base-year cost and to convert (inflate) an
increment stated at base-year cost back to LIFO cost. Under both techniques,
indices are developed by pricing all inventory items twice. In other words,
inventory quantities on hand at the end of the current year are priced at
current year current costs and at prior year current costs. This ratio of costs
is then used to adjust the cumulative index at the end of the preceding year to
a new cumulative index. The total current cost of current year-end inventories
is next converted to total base-year cost by means of the new cumulative index.
The net change in inventory is then determined by comparing the total inventory
at base-year cost at the beginning and the end of the current year. LIFO values
are determined, by layer, by applying the applicable cumulative index to the
increments stated at base-year cost.
We evaluate the LIFO calculation each quarter and record an adjustment, if necessary, for the expected annual effect of inflation, and these estimates are adjusted to actual results determined at year-end. We determine the LIFO cost on an interim basis by estimating annual inflation trends, annual purchases and ending inventory levels for the fiscal year. We apply internally-developed indices that we believe more consistently measure inflation or deflation in the components of our inventories and product mix and our merchandise mix. We believe the internally-developed indices more accurately reflect inflation or deflation in our own prices than the U.S. Bureau of Labor Statistics producer price indices or other published indices. Should actual annual inflation rates and inventory balances at the end of any fiscal year differ materially from our interim estimates, changes could occur that would materially affect our Consolidated Statement of Income for that year.
At December 28, 2008, a 10% increase in our 2008 cumulative index would have increased our LIFO expense approximately $0.9 million or approximately $0.6 million after tax. Conversely, a 10% decrease in our 2008 cumulative index would have decreased our LIFO expense by approximately $1.1 million or approximately $0.7 million after tax.
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