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| SGK > SEC Filings for SGK > Form 10-K on 11-Jun-2009 | All Recent SEC Filings |
11-Jun-2009
Annual Report
(Thousands of dollars, except per share amounts)
Cautionary Statement Regarding Forward-Looking Information
Certain statements contained herein and in "Item 1. Business" 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 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; 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 remedy known internal control deficiencies and weaknesses and the discovery of 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; 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.
Executive overview
Marketing, promotional and advertising spending by consumer products companies and retailers drives a majority of the Company's revenues. The markets served are primarily consumer products, pharmaceutical, entertainment and retail. The Company's business in this area involves producing graphic images for various applications. Generally, the Company or a third party creates an image and then the image is manipulated to enhance the color and to prepare it for print. The applications vary from consumer product packaging, including food and beverage packaging images, to retail advertisements in newspapers, including freestanding inserts (FSI's) and magazine ads. The graphics process is generally the same regardless of the application. The following steps in the graphics process must take place to produce a final image:
• Strategic Analysis
• Planning and Messaging
• Conceptual Design
• Content Creation
• File Building
• Retouching
• Art Production
• Pre-Media
The Company's involvement in a client project may involve many of the above steps or just one of the steps, depending on the client's needs. Each client assignment, or "job", is a custom job in that the image being produced is unique, even if it only involves a small change from an existing image, such as adding a "low fat" banner on a food package. Essentially, such changes equal new revenue for us. The Company is paid for its graphic imaging work regardless of the success or failure of the food product, the promotion or the ad campaign.
Historically, a substantial majority of the Company's revenues have been derived from providing graphic services for consumer product packaging applications. Packaging changes occur with regular frequency and lack of notice, and client turn-around requirements are so tight, that there is little backlog. There are regular promotions throughout the year that create revenue opportunities for us, for example: Valentine's Day, Easter, Fourth of July, Back-to-School, Halloween, Thanksgiving and Christmas. In addition, there are event-driven promotions that occur regularly, such as the Super Bowl, Grammy Awards, World Series, Indianapolis 500 and the Olympics. Additionally, changing regulatory requirements necessitate new packaging and a high degree of documentation. Lastly, there are a number of health related "banners" that are added to food and beverage packaging, such as "heart healthy," "low in carbohydrates," "enriched with essential vitamins," "low in saturated fat" and "caffeine free." All of these items require new product packaging designs or changes in existing designs, in each case creating additional opportunities for revenue. Graphic services for the consumer products packaging industry generally involve higher margins due to the substantial expertise necessary to meet consumer products companies' precise specifications and to quickly, consistently and efficiently bring their products to market, as well as due to the complexity and variety of packaging materials, shapes and sizes, custom colors and storage conditions.
As a result of recent acquisitions, the Company has increased the percentage of its revenue derived from providing graphics services to advertising and retail clients and added to its service offering graphic services to the entertainment market. These clients typically require high volume, commodity-oriented premedia graphic services.
Graphic services for these clients typically yield relatively lower margins due to the lower degree of complexity in providing such services, and the number and size of companies in the industry capable of providing such services.
In 2008, approximately 9 percent of the Company's total revenues came from its largest single client. While the Company seeks to build long-term client relationships, revenues from any particular client can fluctuate from period to period due to the client's purchasing patterns. Any termination of or significant reduction in the Company business relationship with any of its principal clients could have a material adverse effect on its business, financial condition and results of operations.
Recent Acquisitions
The Company has grown its business through a combination of internal growth and acquisitions. Schawk has completed approximately 57 acquisitions since 1965. The Company's recent acquisitions have significantly expanded its service offerings and its geographic presence, making us the only independent premedia firm with substantial operations in North America, Europe and Asia. As a result of these acquisitions, the Company is able to offer a broader range of services to its clients. Its expanded geographic presence also allows us to better serve its multinational clients' demands for global brand consistency. None of the acquisitions described below resulted in a new business segment.
Brandmark International Holding B.V. Effective December 31, 2008, the Company acquired 100 percent of the outstanding stock of Brandmark International Holding B.V., 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 of Brandmark are included in the Consolidated Financial Statements as of December 31, 2008, in the Other operating segment. The purchase price was $10.3 million and may be increased by $0.7 million if a specified target of earnings before interest and taxes is achieved for the fiscal year ending March 31, 2009.
Marque Brand Consultants Pty Ltd. Effective May 31, 2008, the Company acquired 100 percent of the outstanding stock of Marque Brand Consultants Pty Ltd, an Australia-based brand strategy and creative design firm that provides services to consumer products companies. The net assets and results of operations of Marque are included in the Consolidated Financial Statements in the Other operating segment beginning June 1, 2008. The purchase price was $2.6 million and may be increased if certain thresholds of net sales and earnings before interest and taxes are exceeded for calendar year 2009.
Protopak Innovations, Inc. On September 1, 2007, the Company acquired Protopak Innovations, Inc., a Toronto, Canada-based company that produces prototypes and samples for the packaging industry. The acquisition price was $12.1 million. The price may be increased if certain thresholds of earnings before interest and taxes are achieved for the fiscal years ending September 30, 2008, 2009 and 2010. Because the earnings threshold was exceeded for the fiscal year ended September 30, 2008, the Company accrued $0.6 million for a purchase price adjustment at September 30, 2008 and allocated the additional purchase price to goodwill. The Company currently believes that future earn-out amounts, if any, will be immaterial to its balance sheet and cash flow. The net assets and results of operations are included in the consolidated financial statements beginning September, 1 2007 and are included in the Other operating segment.
Perks Design Partners Pty Ltd. On August 1, 2007, the Company acquired Perks Design Partners Pty Ltd., an Australia-based brand strategy and creative design firm that provides services to consumer products companies. The acquisition price was $3.3 million. The net assets and results of operations are included in the Consolidated Financial Statements beginning August 1, 2007 and are included in the Other operating segment.
Benchmark Marketing Services, LLC. On May 31, 2007, the Company acquired the operating assets of Benchmark Marketing Services, LLC, a Cincinnati, Ohio-based creative design agency that provides services to consumer product companies. The acquisition price was $5.8 million and the price may be increased if certain thresholds of sales are achieved for the fiscal years ending May 31, 2008 and 2009. No purchase price adjustment was recorded for the fiscal year ended May 31, 2008 because the sales target was not achieved. In addition, the Company has recorded a reserve of $0.4 million for the estimated expenses associated with vacating the leased premises that Benchmark formerly occupied. Based on an integration plan formulated at the time of the acquisition,
it was determined that the Benchmark operations would be merged with the Company's existing Anthem Cincinnati operations. The Anthem Cincinnati facility was expanded and upgraded to accommodate the combined operations and Benchmark relocated to the Anthem Cincinnati facility in the fourth quarter of 2008. The net assets and results of operations are included in the Consolidated Financial Statements beginning June 1, 2007 and are included in the Other operating segment.
Schawk India, Ltd. On August 1, 2007, the Company acquired the remaining 10 percent of the outstanding stock of Schawk India, Ltd from the minority shareholders for $0.5 million. The Company had previously acquired 50 percent of a company currently known as Schawk India, Ltd. in February 2005 as part of its acquisition of Seven Worldwide, Inc. On July 1, 2006, the Company increased its ownership of Schawk India, Ltd. to 90 percent. Schawk India, Ltd. provides artwork management, premedia and print management services.
WBK, Inc. On July 1, 2006, the Company acquired the operating assets of WBK, Inc., a Cincinnati, Ohio-based design agency that provides services to retailers and consumer products companies. This operating unit is now known as Anthem Cincinnati. The acquisition price was $4.9 million and may increase if certain thresholds of sales and earnings before interest, taxes, depreciation and amortization are achieved for years 2007 through 2009. In the first quarter of 2008, the Company paid $0.9 million to the former owner of WBK as a result of achieving the earnings thresholds in 2007. The additional purchase price was allocated to goodwill. No earn-out is due for the year 2008 because the sales and earnings thresholds were not achieved. The Company currently believes that future earn-out amounts, if any, will be immaterial to its balance sheet and cash flow.
Anthem York. In January 2006, the Company acquired certain operating assets of the internal design agency operation of Nestle UK and entered into a design services agreement with this client. This operation is known as Anthem York. The acquisition price was $2.2 million.
Seven Worldwide, Inc. On January 31, 2005, the Company acquired Seven Worldwide, Inc. (formerly Applied Graphics Technologies, Inc.), a graphic services company with operations in 40 locations in the United States, Europe, Australia and India. The purchase price of $210.6 million consisted of $135.6 million paid in cash at closing, $4.5 million of acquisition-related professional fees and the issuance of four million shares of common stock with a value of $70.5 million. Seven Worldwide Inc.'s results of operations are included in the consolidated financial statements beginning January 31, 2005.
The stock purchase agreement entered into by the Company with Kohlberg & Company, L. L. C. ("Kohlberg") to acquire Seven Worldwide, Inc. ("Seven") provided for a payment of $10.0 million into an escrow account. The escrow was established to insure that funds were available to pay Schawk, Inc. any indemnity claims it may have under the stock purchase agreement. During 2006, Kohlberg filed a Declaratory Judgment Complaint in the state of New York seeking the release of the $10.0 million held in escrow. The Company has filed a counter-motion for summary judgment asserting that Schawk, Inc. has valid claims against the amounts held in escrow and that as a result, such funds should not be released but rather paid out to the Company. Kohlberg has denied that it has any indemnity obligations to the Company. At December 31, 2008, the Company had recorded a receivable from Kohlberg on its Consolidated Balance Sheet in the amount of $3.8 million, for a Seven Delaware unclaimed property liability settlement and certain other tax settlements paid by the Company for pre-acquisition tax liabilities and related professional fees. In addition, in February 2008, the Company paid $6.0 million in settlement of Internal Revenue Service audits of Seven, that had been accrued as of the acquisition date, for the pre-acquisition years of 1996 to 2003. The Company believes it is entitled to indemnification for both amounts under the terms of the stock purchase agreement and that recoverability is probable. In addition, there are other tax matters for which the Company has established reserves related to years prior to the Company's acquisition of Seven. Subsequent to the Company's adoption of Statement of Financial Accounting Standards No. 141(R), "Business Combinations" ("SFAS No. 141R"), on January 1, 2009, all adjustments to pre-acquisition tax reserves will be adjustments to tax expense, regardless of whether the final determination exceeds or is less than the original liability.
Winnetts. On December 31, 2004, the Company acquired certain assets and the business of Weir Holdings, Ltd., known as "Winnetts", a UK based graphic services company with operations in six locations in the UK, Belgium and Spain. The acquisition price was $23.3 million. Winnetts was the Company's first operation in Europe. The two largest graphics business acquisitions in the Company's history were Seven and Winnetts. The principal objective in acquiring Winnetts and Seven was to expand the Company's geographic presence and its service
offering. This expansion enabled it to provide a more comprehensive level of customer service, to build a broader platform from which to grow its business and continue to pursue greater operating efficiencies.
The Company began work on a consolidation plan before the acquisition of Seven was finalized, recording an exit reserve of approximately $2.5 million based on the plan. The major expenses included in the exit reserve were severance pay for employees of acquired facilities that were merged with existing Schawk operations and lease termination expenses. The Company made payments of approximately $0.9 million in 2008 for lease termination expenses and anticipates making future payments of approximately $1.9 million. (See Note 3 to the Consolidated Financial Statements for further discussion). The Company realized significant synergies and reduced operating costs from the closing of nine US and UK operating facilities and the downsizing of several other operating facilities in 2005 and early 2006 and the elimination of the Seven corporate headquarters in New York City. In addition, the Company recorded acquisition integration and restructuring expenses which are shown as a separate line in the operating expense section of the Consolidated Statement of Operations of $3.9 million for the year ended December 31, 2006. The major items included in this expense were severance pay for employees at legacy Schawk, Inc. facilities that had been merged with operations of the acquired businesses, retention pay for key employees whose services were necessary during a transition period, travel expenses related to the planning and execution of facility consolidations, and professional fees for accounting, human resource, and integration planning advice.
In connection with Schawk's financing of the Seven acquisition, the Company entered into a credit agreement dated January 28, 2005 with JPMorgan Chase Bank, N.A. Also on January 28, 2005, the Company entered into a Note Purchase and Private Shelf Agreement with Prudential Investment Management Inc, pursuant to which the Company sold $50.0 million in a series of three Senior Notes. See "Liquidity and Capital Resources" for a discussion of 2009 amendments to the terms of the credit agreement and Senior Notes. As of December 31, 2008 there was $135.9 million of debt outstanding, of which $132.0 million was considered long-term.
Financial Results Overview
Net sales declined $50.2 million or 9.2 percent for the year ended December 31, 2008 to $494.2 million from $544.4 million in 2007. For the twelve months ended December 31, 2008, the net loss was $60.0 million or $2.24 per fully diluted share, as compared to net income of $30.6 million or $1.10 per fully diluted share for 2007. The Company experienced a 22.9 percent net sales decline in the fourth quarter of 2008 as compared to same period in 2007. Through the nine months ended September 30, 2008 the company had experienced a 4.5 percent decline in net sales as compared to the comparable prior year period. The 2008 net sales decline occurred in the United States and Mexico operating segment (82.5 percent), the Europe operating segment (15.4 percent) and the Other operating segment (2.1 percent).
Gross profit declined by $28.0 million or 14.6 percent in 2008 to $164.4 million from $192.4 million in 2007. Of this decline, 61 percent is attributable to the lower volume of sales and 39 percent is attributable to a 2.0 percent decline in the gross profit percentage. The decline in the gross profit percentage occurred in all reportable segments.
Selling, general and administrative expenses (excluding impairment of goodwill, restructuring expenses, pension withdrawal expense and impairment of long-lived assets) increased $17.6 million or 13.4 percent in 2008 to $148.6 million from $131.0 million in 2007. The Company also incurred expenses in 2008 for which similar expenses were not recorded in 2007 as follows: impairment of goodwill of $48.0 million; restructuring expenses associated with the Company's cost reductions activities of $10.4 million; pension withdrawal expenses of $7.3 million; and an increase over the prior year in impairment of long lived assets of $5.4 million. In addition, the Company incurred $6.8 million of professional fees, included in Selling, general and administrative expenses, related to its internal control remediation and related matters. The increase in these operating expenses resulted in an operating loss of $56.6 million in 2008 as compared to operating income of $60.2 million in 2007.
Goodwill impairment During 2008, the Company changed its annual goodwill testing date from calendar year-end to October 1 and performed the 2008 test as of that date. Goodwill is assigned to multiple reporting units, mainly on a geographic basis at a level below the operating segments. Using projections of operating cash flow for each reporting unit, the Company prepared a step one assessment of the fair value of each reporting unit as compared to the carrying value of each reporting unit. The step one impairment analysis indicated an impairment of
the goodwill assigned to the Company's European and Anthem reporting units. The Company then prepared a step two valuation of the European and Anthem reporting units and concluded, after assigning fair values to all assets and liabilities of these reporting units in a manner similar to a purchase price allocation, that goodwill for the European and Anthem reporting units was impaired by $30.7 million and $17.3 million, respectively, which was recorded in the fourth quarter of 2008. The goodwill impairment reflects the decline in global economic conditions and general reduction in consumer and business confidence experienced during the fourth quarter of 2008.
In the first quarter of 2009, the Company's market capitalization decreased due to a decline in the trading price of its common stock. Accordingly, the Company has commenced a review for potential impairment, which could result in additional goodwill impairment charges in 2009.
Cost reduction actions Beginning in the second quarter of 2008, 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 2008 was $10.4 million. The costs associated with these actions are covered under Statement of Financial Accounting Standards No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS No. 146") and Statement of Financial Accounting Standards No. 112, "Employers' Accounting for Postemployment Benefits" ("SFAS No. 112").
The total expense of $10.4 million is presented as Acquisition integration and restructuring expense in the Consolidated Statement of Operations; $4.8 million of these expenses were recorded in the United States and Mexico segment, $3.4 million in the Europe segment, $1.3 million in the Other operating segment and $0.9 million of these expenses were recorded in Corporate. See Note 6 - Acquisition Integration and Restructuring for additional information.
Costs savings in 2008 associated with these cost reduction activities were approximately $7.4 million with full year 2009 savings expected to be between $20.0 million and $22.0 million.
Pension withdrawal expense As more fully described in Note 16 - Employee Benefit Plans, in the fourth quarter of 2008 the Company decided to terminate participation in the Supplemental Retirement and Disability Fund for employees of their Minneapolis, MN facility and notified the board of trustees of the union's pension fund that they would no longer be making contributions for this facility to the union's plan. Accordingly, the Company's decision triggers the assumption of a partial termination withdrawal liability. The Company recorded a liability as of December 31, 2008, net of discount, for $7.3 million to reflect this obligation, which is included in Other long-term liabilities on the Consolidated Balance Sheets.
Impairment of long lived assets During 2008, the Company made a decision to sell land and buildings at three locations and engaged independent appraisers to assess their fair values. Based on the appraisal reports, the Company determined that the carrying values of the properties could not be supported by their estimated fair values. The combined carrying value of $10.0 million was written down by $3.5 million, based on the properties' estimated fair values of $6.5 million.
Also, during 2008, software that had been capitalized by the Company in accordance with the AICPA Statement of Position No. 98-1 "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP No. 98-1") was reviewed for impairment due to changes in circumstances which indicated that the carrying amount of these assets might not be recoverable. As a result of these circumstances, the Company has written down the capitalized costs of the software to fair value. The amount of the write-down recorded in 2008 was $2.3 million.
The Company also recorded a $0.5 million impairment charge to write-down the net assets of its large format print operation to fair value. See "Discontinued Operations" below and Note 4 - Discontinued Operations for more information.
Also, included in the Impairment of long-lived assets in the Consolidated Statement of Operations is $0.4 million of additional impairment charges for leasehold improvements and customer relationship intangible assets. See Notes 2 - Significant Accounting Policies and 22 - Impairment of Long-lived Assets for additional information.
Discontinued Operations
During the third quarter of 2008, the Company made a decision to sell its large format printing operation located in Toronto, Canada and began actively marketing the business to potential buyers. At September 30, 2008, the Company had received an offer from a qualified buyer and expected to complete a sale of the business during the fourth quarter of 2008. In accordance with Statement of Financial Accounting Standards No. "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"), the assets and liabilities of the business for sale were disaggregated as assets and liabilities of discontinued operations in the Consolidated Balance Sheet in the Form 10-Q filed for the quarter ended September 30, 2008. The results of operation of the business for sale were also classified as discontinued operations in the Consolidated Statement of Operations in the Form 10-Q filed for the quarter ended September 30, 2008.
The Company recorded an impairment loss of $0.5 million to write-down the net assets of the business to fair value. This charge is included in Impairment of long-lived assets in the Consolidated Statement of Operations for the year-ended December 31, 2008.
The anticipated sale did not close during the fourth quarter as the Company had expected and, in December 2008, the Company reassessed the likelihood of completing the sale of the business within a one year time period and determined that it could no longer meet the requirements of SFAS No. 144 for classifying the business as held for sale and therefore as a discontinued operation. Accordingly, in this Form 10-K, the large format printing operation has been included in continuing operations. The assets and liabilities of the business, which had been disaggregated as assets and liabilities of discontinued operations in the Form 10-Q filed for the quarter ended September 30, 2008 have . . .
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