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CVO > SEC Filings for CVO > Form 10-Q on 7-May-2014All Recent SEC Filings

Show all filings for CENVEO, INC

Form 10-Q for CENVEO, INC


7-May-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This Management's Discussion and Analysis of Financial Condition and Results of Operations, which we refer to as MD&A, of Cenveo, Inc. and its subsidiaries, which we refer to as Cenveo, should be read in conjunction with the accompanying condensed consolidated financial statements and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year ended December 28, 2013, which we refer to as our 2013 Form 10-K. Item 7 of our 2013 Form 10-K describes the application of our critical accounting policies, for which there have been no significant changes as of March 29, 2014.

Forward-Looking Statements

Certain statements in this report may constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements generally can be identified by the use of terminology such as "may," "expect," "intend," "estimate," "anticipate," "plan," "foresee," "believe" or "continue" and similar expressions, or as other statements which do not relate solely to historical facts. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that could cause actual results to differ materially from what is expressed or forecasted in these forward-looking statements. In view of such uncertainties, investors should not place undue reliance on our forward-looking statements. Such statements speak only as of the date they were made, and we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Factors which could cause actual results to differ materially from management's expectations include, without limitation: (i) recent United States and global economic conditions have adversely affected us and could continue to do so; (ii) our substantial level of indebtedness could impair our financial condition and prevent us from fulfilling our business obligations; (iii) our ability to service or refinance our debt; (iv) the terms of our indebtedness imposing significant restrictions on our operating and financial flexibility; (v) additional borrowings available to us which could further exacerbate our risk exposure from debt; (vi) our ability to successfully integrate acquired businesses with our business; (vii) a decline in our consolidated profitability or profitability within one of our individual reporting units could result in the impairment of our assets, including goodwill and other long-lived assets;
(viii) the industries in which we operate our business are highly competitive and extremely fragmented; (ix) a general absence of long-term customer agreements in our industries, subjecting our business to quarterly and cyclical fluctuations; (x) factors affecting the United States postal services impacting demand for our products; (xi) the availability of the Internet and other electronic media adversely affecting our business; (xii) increases in paper costs and decreases in the availability of raw materials; (xiii) our labor relations; (xiv) our compliance with environmental laws; (xv) our dependence on key management personnel; and (xvi) any failure, interruption or security lapse of our information technology systems. This list of factors is not exhaustive, and new factors may emerge or changes to the foregoing factors may occur that would impact our business. Additional information regarding these and other factors can be found elsewhere in this report, and in our other filings with the Securities and Exchange Commission, which we refer to as the SEC.

Business Overview

We are a diversified manufacturing company focused on print-related products. Our broad portfolio of products includes envelope converting, commercial printing, label manufacturing and specialty packaging. We operate a global network of strategically located manufacturing facilities, serving a diverse base of over 100,000 customers.
Our business strategy has been, and continues to be, focused on improving sales performance, pursuing and integrating strategic acquisitions, improving our cost and capital structure, and maintaining reasonable levels of financial flexibility. We believe this strategy has allowed us to diversify our revenue base, maintain our low cost structure and deliver quality product offerings to our customers.

We operate our business in three complementary reportable segments: the envelope segment, the print segment and the label and packaging segment. During the fourth quarter of 2013, we completed a realignment of our segments as a result of a change in management reporting and strategy. Previously, we reported our segments as the print and envelope segment and the label and packaging segment.

Envelope. We are the largest envelope manufacturer in North America. On September 16, 2013, we enhanced our manufacturing capabilities and reduced capacity in the envelope industry with the acquisition of certain assets of National Envelope Corporation, which we refer to as National. Our envelope segment represented approximately 49.3% of our net sales for the three months ended March 29, 2014.


Our envelope segment offers direct mail products used for customer solicitations and transactional envelopes used for
billing and remittance by end users including financial institutions, insurance companies and telecommunications companies. We also produce a broad line of specialty and stock envelopes which are sold through wholesalers, and to the office product market through distributors.

Print. We are one of the leading commercial printers in North America. Our print segment represented approximately 26.2% of our net sales for the three months ended March 29, 2014.

Our print segment primarily caters to the consumer products, automotive, travel and leisure and telecommunications industries. We provide a wide array of print offerings to our customers including electronic prepress, digital asset archiving, direct-to-plate technology, high-quality color printing on web and sheet-fed presses, digital printing and content management. The broad selection of print products we produce includes car brochures, annual reports, direct mail products, advertising literature, corporate identity materials and brand marketing materials. Our content management business offers complete solutions, including: editing, content processing, content management, electronic peer review, production, distribution and reprint marketing.

Label and Packaging. We are a leading label manufacturer and the largest North American prescription label manufacturer for retail pharmacy chains. On December 31, 2012, we added to our label business with the acquisition of Express Label Company, which we refer to as Express Label. Our specialty packaging business currently focuses on specialty folded carton packaging and shrink-sleeve packaging. Our label and packaging segment represented approximately 24.5% of our net sales for the three months ended March 29, 2014.

Our label and packaging segment produces a diverse line of custom labels for a broad range of industries including manufacturing, warehousing, packaging, food and beverage, and health and beauty, which we sell through extensive networks within the resale channels. We provide direct mail and overnight packaging labels, food and beverage labels, and shelf and scale labels for national and regional customers. We produce pressure-sensitive prescription labels for the retail pharmacy chain market. We produce premium, high-quality promotional packaging offerings including folded carton and full body shrink sleeves. Our primary customers for our specialty packaging products are pharmaceutical, apparel, neutraceutical and other large, multinational consumer product companies.

Consolidated Operating Results

This MD&A includes an overview of our condensed consolidated results of operations for the three months ended March 29, 2014, and March 30, 2013, followed by a discussion of the results of operations of each of our reportable segments for the same periods. Our results for the three months ended March 29, 2014, include the operating results of National. Our results for the three months ended March 30, 2013, do not include the operating results of National. 2014 Outlook
The print-related industries are highly fragmented and extremely competitive due to over-capacity and pricing pressures. We believe these factors, combined with a slow general economic recovery, will continue to impact our results of operations in 2014.

Our current management focus is on the following areas:

Improving Sales Performance

Our sales focus has been, and will continue to be, on our customers' experience across each of our businesses, ensuring we meet our customers' demands. We seek to expand our relationship with them through cross-selling initiatives available within our platform. During 2013, we implemented a customer relationship management tool across our entire sales platform, and we focused on our e-commerce platform through both capital investments and incremental headcount. We have been successful in our recruiting efforts focusing on attracting not only talented individuals with experience in our current business lines, but also individuals with experience in complementary industry channels. We expect these focus points, along with our expanded geographic presence from the acquisition of certain assets of National, will allow us to experience modest sales growth despite operating in challenging industries and an uncertain economy.

In addition, the uncoated freesheet paper market, which is the primary input for our envelope and certain other products, experienced supply reductions beginning in the fourth quarter of 2013, and into the first quarter of 2014. As a result, our suppliers announced price increases which became effective for us during our fourth quarter of 2013. We began to pass along these increases,


as well as other ancillary raw material costs, which we have not been able to pass along to our envelope customers over the past two years, in the fourth quarter of 2013. Additionally, during the first quarter of 2014, our paper suppliers announced a second round of price increases. While we have had early success passing along price increases, we cannot be assured we will be successful in every effort. Moreover, any increase in price may have an adverse impact on the product volume levels our customers have ordered previously.

Integrating Certain Assets of National

We believe our acquisition of certain assets of National will provide much needed capacity reductions within the envelope industry. We developed and began implementing our plan to integrate those assets with our existing envelope operations in the third quarter of 2013. At this time, we expect this integration to take in excess of a year to complete due to the condition of National's operating platform and asset base at the time of acquiring these assets out of bankruptcy. To date, we have completed the consolidation of our west coast operations, which included the consolidation of three envelope facilities into one facility. Additionally, we have announced the consolidation of six additional envelope facilities into three facilities.

Improving our Cost Structure

We continue to monitor our cost structure as marketplace conditions warrant, and expect to further reduce costs as necessary. In 2013 and through the first quarter of 2014, as a result of continued margin pressures from rising input costs and price pressures experienced within our envelope and print segments, we initiated plans to further reduce our cost structure. With the facility consolidations related to integrating National with our existing operations and select downsizing of certain commercial print assets, we believe our fixed costs will be reduced significantly as we exit 2014. We also continue to focus on strategic investments, capital expenditures and acquisitions in areas that we believe will strengthen our manufacturing platform and product offerings. We continue to review strategic alternatives for business lines we believe are underperforming or non-strategic to our future operations.

Improving our Capital Structure

Since the beginning of 2011, we have been focused on improving our capital structure through a number of initiatives including working capital improvements, exiting underperforming or non-strategic businesses, and taking advantage of attractive leverage loan and high yield debt market conditions. Since we began this initiative, we have substantially reduced our outstanding debt and weighted average interest rate, despite our continued reinvestments of cash into our businesses via four acquisitions, focused capital expenditures, and incurring over $57 million in transaction costs associated with the improvement of our capital structure. In December of 2013, primarily due to our acquisition of certain assets of National, we increased our borrowing capacity on our asset-based revolving credit facility, which we refer to as the ABL Facility, to $230 million from $200 million, supported by over $60 million of suppressed capacity underlying our ABL Facility. The accordion feature within our ABL Facility will, subject to the satisfaction of customary conditions, permit us to borrow up to an additional $20 million to further enhance our capital structure by using this lower interest rate vehicle to address our higher interest rate debt currently outstanding. In February of 2014, we amended the covenant requirements under our $360 million secured term loan facility, which we refer to as the Term Loan Facility, to eliminate the maximum consolidated leverage ratio and replace it with a maximum consolidated first lien leverage ratio, providing us additional financial flexibility in 2014. We believe the leverage loan and high yield debt markets remain robust. As such, we may pursue additional refinancing of our current outstanding debt to achieve any one of or a combination of: (i) reductions in future cash interest expense; (ii) extension of our existing maturities; or (iii) greater flexibility to address our subordinated debt instruments as they become callable in the future.

Discontinued Operations

In September 2013, we completed the sale of our custom envelope business, which we refer to as Custom Envelope, within our envelope segment. To date, we have received net proceeds of $45.8 million, of which $1.0 million was received in the first quarter of 2014. In addition to these proceeds, $1.2 million of additional purchase price consideration has been held in escrow and will be paid subject to certain financial adjustments. The operating results of this divestiture are reported in discontinued operations in our condensed consolidated financial statements for all periods presented.

During the second quarter of 2013, we decided to exit the San Francisco market and closed a manufacturing facility within our print segment. The operating results of this manufacturing facility are reported in discontinued operations in our condensed consolidated financial statements for all periods presented.

Collectively, we refer to these businesses as the Discontinued Operations.


Reportable Segments

We operate three complementary reportable segments: the envelope segment, the print segment and the label and packaging segment.

See below for a summary of net sales and operating income for our reportable segments that we use internally to assess our operating performance. Our fiscal quarters end on the Saturday closest to the last day of the calendar month. Our three month reporting periods consisted of 13 weeks and ended on March 29, 2014, and March 30, 2013.

                                                                For the Three Months Ended
                                                            March 29, 2014      March 30, 2013
                                                                  (in thousands, except
                                                                    per share amounts)
Net sales                                                  $     490,119       $      418,614
Operating income (loss):
Envelope                                                   $       9,806       $        9,010
Print                                                              1,240                1,007
Label and Packaging                                               10,193               11,544
Corporate                                                        (11,167 )             (9,883 )
Total operating income                                            10,072               11,678
Interest expense, net                                             27,910               29,575
Loss on early extinguishment of debt, net                             18                  127
Other (income) expense, net                                         (509 )                296
Loss from continuing operations before income taxes              (17,347 )            (18,320 )
Income tax (benefit) expense                                        (560 )              2,170
Loss from continuing operations                                  (16,787 )            (20,490 )
Income from discontinued operations, net of taxes                    953                1,345
Net loss                                                   $     (15,834 )     $      (19,145 )
(Loss) income per share - basic:
Continuing operations                                      $       (0.25 )     $        (0.32 )
Discontinued operations                                             0.01                 0.02
Net loss                                                   $       (0.24 )     $        (0.30 )

(Loss) income per share - diluted:
Continuing operations                                      $       (0.25 )     $        (0.32 )
Discontinued operations                                             0.01                 0.02
Net loss                                                   $       (0.24 )     $        (0.30 )


Net Sales

Net sales increased $71.5 million, or 17.1%, in the first quarter of 2014, as compared to the first quarter of 2013. Sales in our envelope segment increased $75.2 million and sales in our print segment increased $1.2 million, which was partially offset by decreased sales of $4.9 million in our label and packaging segment.

See Segment Operations below for a detailed discussion of the primary factors affecting the change in our net sales by reportable segment.

Operating Income

Operating income decreased $1.6 million, or 13.8%, in the first quarter of 2014, as compared to the first quarter of 2013. This decrease was primarily due to a decrease in operating income from our label and packaging segment of $1.4 million and an increase in corporate expenses of $1.3 million, partially offset by increases in operating income from our envelope segment of $0.8 million and from our print segment of $0.2 million.

See Segment Operations below for a more detailed discussion of the primary factors for the changes in operating income by reportable segment.

Interest Expense

Interest expense decreased $1.7 million to $27.9 million in the first quarter of 2014, as compared to $29.6 million in the first quarter of 2013. The decrease was primarily due to: (i) principal repayments made on our Term Loan Facility, and our unsecured $50.0 million aggregate principal amount term loan due 2017, which we refer to as the Unsecured Term Loan, since the first quarter of 2013 using cash flow from operations and proceeds from the sale of Custom Envelope; and (ii) lower interest rates as a result of our debt refinancing in the second quarter of 2013. Interest expense in the first quarter of 2014 reflected average outstanding debt of approximately $1.2 billion and a weighted average interest rate of 7.8%. This compares to average outstanding debt of approximately $1.2 billion and a weighted average interest rate of 8.7% in the first quarter of 2013.

We expect interest expense for the remainder of 2014 will be lower than the same period in 2013, which primarily relates to the refinancing completed in the second quarter of 2013.

Loss on Early Extinguishment of Debt

In the first quarter of 2013, in connection with refinancing activities, we
incurred a loss on early extinguishment of debt of $0.1 million, which related
to unamortized debt issuance costs associated with the extinguishment of our
7.875% senior subordinated notes due 2013, which we refer to as the 7.875%
Notes.

Income Taxes
                                                                  For the Three Months Ended
                                                             March 29, 2014       March 30, 2013
                                                                       (in thousands)
Income tax (benefit) expense from U.S. operations           $         (690 )     $       2,044
Income tax expense from foreign operations                             130                 126
Income tax (benefit) expense                                $         (560 )     $       2,170
Effective income tax rate                                              3.2 %             (11.8 )%


Income Tax Expense

In the first quarter of 2014, we had an income tax benefit of $0.6 million, compared to an income tax expense of $2.2 million in the first quarter of 2013. The tax benefit for the first quarter of 2014 and the tax expense for the first quarter of 2013 primarily related to income taxes on our domestic operations. Our effective tax rate in the first quarter of 2014 was lower than the federal statutory rate, primarily due to recording a valuation allowance charge of $4.7 million during the quarter against deferred tax assets generated in the quarter, primarily from pre-tax operating losses. Our effective tax rate in the first quarter of 2013 was lower than the federal statutory rate primarily due to non-deductible expenses and state income taxes.

Valuation Allowance

We review the likelihood that we will realize the benefit of our deferred tax assets, and therefore the need for valuation allowances, on a quarterly basis, or more frequently if events indicate that a review is required. In determining the requirement for a valuation allowance, the historical and projected financial results of the legal entity or consolidated group recording the net deferred tax asset is considered, along with all other available positive and negative evidence. The factors considered in our determination of the probability of the realization of the deferred tax assets include, but are not limited to: recent historical financial results, historical taxable income, projected future taxable income, the expected timing of the reversals of existing temporary differences, the duration of statutory carryforward periods and tax planning strategies. If, based upon the weight of available evidence, it is more likely than not the deferred tax assets will not be realized, a valuation allowance is recorded.

Concluding that a valuation allowance is not required is difficult when there is significant negative evidence which is objective and verifiable, such as cumulative losses in recent years. We utilize a rolling twelve quarters of pre-tax income or loss adjusted for significant permanent book to tax differences as a measure of our cumulative results in recent years. In the United States, our analysis indicates that we have cumulative three year historical losses on this basis. While there are significant impairment, restructuring and refinancing charges driving our cumulative three year loss, this is considered significant negative evidence which is objective and verifiable and, therefore, difficult to overcome. However, the three year loss position is not solely determinative and accordingly, we consider all other available positive and negative evidence in our analysis. Based upon our analysis, we believe it is more likely than not that the net deferred tax assets in the United States will not be fully realized in the future. Accordingly, we increased our valuation allowance related to those net deferred tax assets by $4.7 million to $108.0 million in the first three months of 2014. Deferred tax assets related to foreign tax credit carryforwards also did not reach the more likely than not realizability criteria and accordingly, were subject to a valuation allowance. During the first three months of 2014, our valuation allowance related to these deferred tax assets was unchanged at $7.4 million.

There is no corresponding income tax benefit recognized with respect to losses incurred and no corresponding income tax expense recognized with respect to earnings generated in jurisdictions with a valuation allowance. This causes variability in our effective tax rate. We intend to maintain the valuation allowances until it is more likely than not that the net deferred tax assets will be realized. If operating results improve on a sustained basis, or if certain tax planning strategies are implemented, our conclusions regarding the need for valuation allowances could change, resulting in the reversal of the valuation allowances in the future, which could have a significant impact on income tax expense or benefit in the period recognized and subsequent periods.

Income from Discontinued Operations, Net of Taxes As a result of exploring opportunities to divest certain non-strategic or underperforming businesses within our manufacturing platform, we decided to exit the San Francisco market and closed a manufacturing facility within the print segment in the second quarter of 2013. Additionally, in the third quarter of 2013, we completed the sale of Custom Envelope within the envelope segment. The results of operations and cash flows of these businesses are reflected within discontinued operations for all periods presented herein, including the related tax effects.
In the first quarter of 2014, income from Discontinued Operations was $1.0 million, which includes: (i) a gain recognized related to the sale of Custom Envelope of $0.8 million, net of tax expense of $0.5 million; and (ii) income from the operations of our Discontinued Operations of $0.2 million, net of tax expense of $0.1 million.
In the first quarter of 2013, income from Discontinued Operations was $1.3 million, which includes income from the operations of our Discontinued Operations of $1.3 million, net of tax expense of $0.9 million.


Segment Operations

Our Chief Executive Officer monitors the performance of the ongoing operations
of our three reportable segments. We assess performance based on net sales and
operating income.

Envelope
                                       For the Three Months Ended
                                   March 29, 2014      March 30, 2013
                                              (in thousands)
Segment net sales                 $     241,671       $      166,453
Segment operating income          $       9,806       $        9,010
Operating income margin                     4.1 %                5.4 %
Restructuring and other charges   $       3,017       $        1,140

Segment Net Sales

Segment net sales for our envelope segment increased $75.2 million, or 45.2%, in the first quarter of 2014, as compared to the first quarter of 2013, primarily due to: (i) sales generated from the integration of certain assets of National . . .

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