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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2007
OR
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 333-133825
SGS INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
| DELAWARE | 20-3939981 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
626 West Main Street, Suite 500 Louisville, Kentucky | 40202 | |
| (Address of principal executive offices) | (Zip Code) | |
(502) 637-5443
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of March 31, 2007 there were 1,000 shares of the registrant’s common stock, $0.01 par value, outstanding.
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FINANCIAL INFORMATION
| Item 1. | Financial Statements |
SGS International, Inc. and Subsidiaries
Consolidated Statements of Income
(unaudited)
(in thousands of dollars)
| Three Months Ended March 31, 2007 | Three Months Ended March 31, 2006 | |||||||
| (as Restated, see Note F) | ||||||||
REVENUES | $ | 74,107 | $ | 68,823 | ||||
COSTS AND EXPENSES: | ||||||||
Cost of goods sold (exclusive of depreciation) | 47,872 | 46,661 | ||||||
Selling, general and administrative expenses | 10,301 | 8,512 | ||||||
Depreciation and amortization | 5,105 | 4,250 | ||||||
Interest expense | 8,947 | 8,538 | ||||||
Other (income)/expense, net | (292 | ) | 72 | |||||
Total costs and expenses | 71,933 | 68,033 | ||||||
INCOME FROM CONTINUING OPERATIONS | ||||||||
BEFORE INCOME TAXES | 2,174 | 790 | ||||||
PROVISION FOR INCOME TAXES | 837 | 286 | ||||||
INCOME FROM CONTINUING OPERATIONS | 1,337 | 504 | ||||||
INCOME FROM (LOSS ON) DISCONTINUED OPERATIONS | ||||||||
(including gain on disposal of $ 935) | 842 | (185 | ) | |||||
PROVISION (BENEFIT) FOR INCOME TAXES | 170 | (52 | ) | |||||
INCOME (LOSS) FROM DISCONTINUED OPERATIONS | 672 | (133 | ) | |||||
NET INCOME | $ | 2,009 | $ | 371 | ||||
The accompanying notes are an integral part of the financial statements.
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SGS International, Inc. and Subsidiaries
Consolidated Balance Sheets (March 31, 2007 is unaudited)
(in thousands of dollars, except share data)
| March 31, 2007 | December 31, 2006 | |||||
ASSETS | ||||||
Current assets: | ||||||
Cash and cash equivalents | $ | 33,804 | $ | 12,658 | ||
Receivables from customers, less allowances of $1,652 and | ||||||
$1,422 at March 31, 2007 and December 31, 2006, respectively | 58,662 | 57,417 | ||||
Inventories | 6,082 | 5,733 | ||||
Deferred income taxes | 818 | 1,676 | ||||
Prepaid expenses and other current assets | 8,773 | 8,053 | ||||
Total current assets | 108,139 | 85,537 | ||||
Properties, plants and equipment, net | 51,745 | 52,413 | ||||
Goodwill | 163,212 | 157,778 | ||||
Other intangible assets, net | 167,160 | 163,113 | ||||
Deferred financing costs, net | 9,819 | 10,177 | ||||
Other assets | 447 | 509 | ||||
TOTAL ASSETS | $ | 500,522 | $ | 469,527 | ||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||
Current liabilities: | ||||||
Accounts payable, trade | $ | 16,616 | $ | 15,719 | ||
Accrued compensation | 6,801 | 6,122 | ||||
Accrued taxes, including taxes on income | 1,949 | 1,680 | ||||
Accrued interest | 7,060 | 1,091 | ||||
Other current liabilities | 7,812 | 7,046 | ||||
Current portion of short-term and long-term obligations | 1,704 | 3,605 | ||||
Total current liabilities | 41,942 | 35,263 | ||||
Long-term obligations, net of current portion | 340,486 | 318,384 | ||||
Non-current liabilities | 517 | 517 | ||||
Deferred income taxes | 5,472 | 5,395 | ||||
Total liabilities | 388,417 | 359,559 | ||||
Commitments and contingencies | ||||||
Stockholders’ equity: | ||||||
Common stock, $.01 par value, 1,000 shares authorized and outstanding | — | — | ||||
Additional capital | 107,000 | 107,000 | ||||
Accumulated other comprehensive income - unrealized translation adjustments, net of tax | 2,559 | 2,431 | ||||
Retained earnings | 2,546 | 537 | ||||
Total stockholders’ equity | 112,105 | 109,968 | ||||
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY | $ | 500,522 | $ | 469,527 | ||
The accompanying notes are an integral part of the financial statements.
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SGS International, Inc. and Subsidiaries
Consolidated Statement of Stockholders’ Equity
(unaudited)
(in thousands of dollars)
| Comprehensive Income | Common Stock | Additional Capital | Retained Earnings | Accumulated Other Comprehensive Income | Total Stockholders’ Equity | |||||||||||||
Balance at December 31, 2006 | $ | — | $ | 107,000 | $ | 537 | $ | 2,431 | $ | 109,968 | ||||||||
Comprehensive income: | ||||||||||||||||||
Net income | $ | 2,009 | — | — | 2,009 | — | 2,009 | |||||||||||
Cumulative translation adjustments, net | 128 | — | — | — | 128 | 128 | ||||||||||||
Comprehensive income | $ | 2,137 | ||||||||||||||||
Balance at March 31, 2007 | $ | — | $ | 107,000 | $ | 2,546 | $ | 2,559 | $ | 112,105 | ||||||||
The accompanying notes are an integral part of the financial statements.
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SGS International, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(unaudited)
(in thousands of dollars)
| Three Months Ended March 31, 2007 | Three Months Ended March 31, 2006 | |||||||
| (as Restated, see Note F) | ||||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | $ | 12,820 | $ | 13,604 | ||||
CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||
Acquisition of property, plant and equipment | (2,925 | ) | (1,899 | ) | ||||
Proceeds from divestiture of business, net of cash divested | 628 | — | ||||||
Business acquisitions | (11,950 | ) | — | |||||
Net cash used in investing activies | (14,247 | ) | (1,899 | ) | ||||
CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||
Borrowings on acquisition facility | 22,980 | — | ||||||
Payments on long-term debt | (414 | ) | (416 | ) | ||||
Net cash provided by (used in)financing activies | 22,566 | (416 | ) | |||||
Effect of exchange rate changes on cash | 7 | 10 | ||||||
INCREASE IN CASH AND CASH EQUIVALENTS | 21,146 | 11,299 | ||||||
CASH AND CASH EQUIVALENTS, | ||||||||
BEGINNING OF PERIOD | 12,658 | 4,081 | ||||||
CASH AND CASH EQUIVALENTS, | ||||||||
END OF PERIOD | $ | 33,804 | $ | 15,380 | ||||
The accompanying notes are an integral part of the financial statements.
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SGS International, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
(all amounts in thousands of dollars, unless otherwise stated)
| A. | Summary of Significant Accounting Policies |
General Nature of Business
SGS International, Inc. (“the Company”), headquartered in Louisville, Kentucky, supplies photographic and digital images and manufactures flexographic printing plates and rotogravure cylinders for the packaging printing industry. As of March 31, 2007, the Company has 35 locations in the United States, Canada, Mexico, the United Kingdom, and the Netherlands.
Acquisitions
On February 28, 2007, the Company’s subsidiary, Southern Graphic Systems, Inc., entered into an Asset Purchase Agreement (the “Purchase Agreement”) with C.M. Jackson Associates, Inc. (“CMJ”), a supplier of design and creative, production art and pre-press, packaging management, project tracking and digital asset management services with an emphasis on “store brands.” Under the Purchase Agreement, the Company acquired substantially all of CMJ’s assets for an aggregate cash purchase price of $11,650 (the “Purchase Price”). In conjunction with this acquisition, the Company borrowed $8,000 on its acquisition facility. The acquired assets include CMJ’s leasehold interest in its single facility located in Ramsey, New Jersey. The Company will operate the acquired business under the “C.M. Jackson Associates, Inc.” name. The Purchase Agreement contains customary representations, warranties, covenants and indemnification provisions. $5,000 per the Purchase Agreement is to be payable as compensation to the former owners of the CMJ business who are now employees of SGS in two equal installments on February 28, 2008 and 2009, respectively. As of March 31, 2007, $312.5 of compensation has been recognized. These deferred installments are subject to forfeiture if certain key CMJ employees now employed by the Company terminate their employment before the expiration of their respective employment agreements. A portion of the second deferred installment is payable only if the acquired business achieves a specified threshold of earnings before interest, depreciation and amortization. The purchase price allocation for this acquisition is listed below. The purchase price allocation for this acquisition is subject to completion of final fair value allocations.
Purchase price | $ | 11,650 | ||
Transaction costs | 300 | |||
Total acquisition price | $ | 11,950 | ||
Allocation of acquisition price: | ||||
Current assets | $ | 265 | ||
Properties, plant and equipment | 217 | |||
Goodwill | 5,398 | |||
Customer relationships | 5,200 | |||
Other intangible assets | 900 | |||
Liabilities assumed | (30 | ) | ||
Total acquisition price | $ | 11,950 | ||
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SGS International, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited - continued)
(all amounts in thousands of dollars, unless otherwise stated)
Results of operations of the acquired business are included in the consolidated statement of income from the date of the acquisition. Pro forma results of the Company, assuming the acquisition had been made at the beginning of each period presented, would not have been materially different from the results reported.
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America for interim financial reporting and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and related footnotes that would normally be required by accounting principles generally accepted in the United States of America for complete financial reporting. These unaudited consolidated financial statements should be read in conjunction with the Company’s consolidated audited financial statements for the year ended December 31, 2006 in the Company’s Form 10-K filed with the Securities and Exchange Commission. The December 31, 2006 balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.
The accompanying unaudited condensed consolidated financial statements include all adjustments (consisting of a normal and recurring nature) that management considers necessary for a fair statement of financial information for the interim periods. Interim results are not necessarily indicative of the results that may be expected for the remainder of the year ending December 31, 2007.
Principles of Consolidation
The accompanying condensed consolidated financial statements include the accounts of SGS International, Inc., its wholly owned subsidiaries and companies more than fifty percent owned. These subsidiaries primarily include Southern Graphic Systems, Inc., Project Dove Holdco, Inc., Project Dove Manitoba, L.P., Southern Graphic Systems-Canada, Co., Southern Graphic Systems Mexico, S. De R.L. De C.V, SGS Packaging Europe Holdings Limited, SGS Packaging Europe Limited, MCG Graphics, Ltd., The Box Room Limited, SGS Packaging Netherlands B.V. and Mozaic Group, Ltd (“Mozaic”).
On February 28, 2007, the Company sold its controlling interest in Mozaic to a third party. The Company has retained a 10% interest in Mozaic. The accompanying consolidated balance sheet as of March 31, 2007 does not included the accounts of Mozaic. The accompanying consolidated statement of income and statement of cash flows for the three months ended March 31, 2007 include the accounts of Mozaic only through February 28, 2007. The Company currently has a user license agreement with Mozaic through December 31, 2007 with options to renew annually. This agreement grants the Company rights to access and use the RPM Branded Asset Management Software and RPM Branded Data Tracker Software. The use of these services is approximately $50,000.00 per month which is subject to change upon renewal of the agreement.
The following table represents the major classes of assets and liabilities as of the date of the disposal of Mozaic.
Current assets | $ | 3,120 | |||||
Non-current assets | 812 | ||||||
Current liabilities | $ | 4,209 | |||||
Non-current liabilities | 288 | ||||||
Below are the amounts of revenue and pre-tax profit/(loss) reported from the discontinued operations of Mozaic. Please note that in the quarter ended March 31, 2007, the profit of $842 includes a gain on the sale of Mozaic of $935. Net of this gain on sale, the pre-tax loss is ($93).
|
| ||||||
| March 31, 2007 | March 31, 2006 | ||||||
Revenues | $ | 2,406 | $ | 3,323 | |||
Pre-tax profit (loss) | 842 | (185 | ) | ||||
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SGS International, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited - continued)
(all amounts in thousands of dollars, unless otherwise stated)
Use of Estimates
The condensed consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America and require management to make certain estimates and assumptions. These may affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements. They may also affect the reported amounts of revenues and expenses during the reporting period. Areas that require significant judgments, estimates and assumptions include revenue recognition, accounts receivable and the allowance for doubtful accounts, impairment of goodwill, other intangible assets and long-lived assets, accrued health and welfare benefits, and tax matters. Management uses historical experience and all available information to make these judgments and actual results could differ from those estimates upon subsequent resolution of some matters.
Recently Issued and Adopted Accounting Standard
The Company adopted the provisions of Financial Accounting Standards Board (FASB) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, and interpretation of FASB Statement No. 109” (FIN 48) on January 1, 2007. At the adoption date and as of March 31, 2007, the Company had no material unrecognized tax benefits and no adjustments to liabilities or operations were required.
The Company recognizes interest and penalties related to uncertain tax positions in income tax expense, which were zero for the three months ended March 31, 2007.
Tax years December 30, 2005 to December 31, 2005 and January 1, 2006 to December 31, 2006 are subject to examination by the federal and state taxing authorities, respectively. There are no income tax examinations currently in process. For the tax years ended December 31, 2003 through December 29, 2005, the Company has been indemnified for all taxes, interest and penalties by the previous owner.
| B. | Goodwill and Other Intangible Assets |
Goodwill and other intangible assets consist of the following:
| March 31, 2007 | December 31, 2006 | |||||||
Goodwill, cost | $ | 163,212 | $ | 157,778 | ||||
Customer relationships, cost | 153,850 | 148,572 | ||||||
Customer relationships, accumulated amortization | (9,262 | ) | (7,415 | ) | ||||
Other intangible assets, cost | 24,020 | 23,115 | ||||||
Other intangible assets, accumulated amortization | (1,448 | ) | (1,159 | ) | ||||
| $ | 330,372 | $ | 320,891 | |||||
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SGS International, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited - continued)
(all amounts in thousands of dollars, unless otherwise stated)
The change in goodwill during the three months ended March 31, 2007 is due to the following:
Goodwill at December 31, 2006 | $ | 157,778 | |
Acquisition during the three months ended March 31, 2007 | 5,398 | ||
Changes due to foreign currency fluctuations | 36 | ||
Goodwill at March 31, 2007 | $ | 163,212 | |
The change in customer relationships, cost during the three months ended March 31, 2007 is due to the following:
Customer relationships, cost at December 31, 2006 | $ | 148,572 | |
Acquisition during the three months ended March 31, 2007 | 5,200 | ||
Changes due to foreign currency fluctuations | 78 | ||
Customer relationships, cost at March 31, 2007 | $ | 153,850 | |
The change in other intangible assets, cost during the three months ended March 31, 2007 is due to the following:
Other intangible assets, cost at December 31, 2005 | $ | 23,115 | |
Acquisition during the three months ended March 31, 2007 | 900 | ||
Changes due to foreign currency fluctuations | 5 | ||
Other intangible assets, cost at March 31, 2007 | $ | 24,020 | |
Amortization of customer relationships and other intangible assets is estimated to be approximately $8,749 in 2007 and $8,825 each year from 2008 through 2011.
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SGS International, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited - continued)
(all amounts in thousands of dollars, unless otherwise stated)
| C. | Interest Expense |
Interest expense consists of the following:
| Three Months Ended March 31, 2007 | Three Months Ended March 31, 2006 | ||||||
Interest on senior term loan | $ | 2,283 | $ | 2,077 | |||
Interest on senior subordinated notes | 6,000 | 6,000 | |||||
Amortization of deferred financing costs | 358 | 297 | |||||
Commitment fees on senior credit facility | 173 | 194 | |||||
Interest on acquisition facility | 106 | — | |||||
Other | 27 | (30 | ) | ||||
Total | $ | 8,947 | $ | 8,538 | |||
| D. | Contingencies and Commitments |
Various lawsuits, claims and proceedings have been or may be instituted or asserted against entities within the Company. While the amounts claimed may be substantial, the ultimate liability cannot be determined because of the considerable uncertainties that exist. Therefore, it is possible that results of operations or liquidity in a particular period could be materially affected by certain contingencies. However, based on currently available facts and in light of legal and other defenses available to us, management believes that the disposition of matters that are pending or asserted will not have a materially adverse effect on the Company’s financial position, results of operations, and liquidity.
| E. | Income Taxes |
The effective tax rate for the quarter ended March 31, 2007 for continuing operations was 38.5%, compared to 36.2% for the quarter ended March 31, 2006. The increase in the effective tax rate was primarily due to the impact of foreign operations. Income before income taxes for the foreign operations were higher for the quarter ended March 31, 2007 than for the quarter ended March 31, 2006.
The Company has not recorded a deferred tax liability for undistributed earnings of certain international subsidiaries because such earnings are considered permanently invested in foreign countries. As of March 31, 2007, undistributed earnings of international subsidiaries considered permanently reinvested were approximately $1,743. The unrecognized deferred tax liability is dependent on many factors, including withholding taxes under current tax treaties and foreign tax credits. Determination of the amount of unrecognized deferred income tax liability related to these earnings is not practicable. The Company does not consider undistributed earnings from certain other international operations to be permanently reinvested. A portion of the estimated tax liabilities upon repatriation of earnings from these international operations is expected to be offset with foreign tax credits.
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SGS International, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited - continued)
(all amounts in thousands of dollars, unless otherwise stated)
| F. | Restatement of Condensed Consolidated Quarterly Financial Statements (unaudited) |
The Company’s unaudited interim consolidated statement of income has been restated for the quarter ended March 31, 2006 to reflect the correction of errors as described below.
The following table summarizes the effects of the restatement adjustments discussed below on income before income taxes for each of the previously reported quarterly periods.
| Quarter Ended March 31, 2006 | ||||
Effects of restatement adjustments: | ||||
Income before income taxes, as originally reported | $ | 1,178 | ||
Work-in-process inventory | (17 | ) | ||
Revenue for unbilled accounts receivable | (493 | ) | ||
Properties, plants and equipment, including depreciation and amortization | 46 | |||
Other | (109 | ) | ||
Income before income taxes, as restated | 605 | |||
Effects of income (loss) on discontinued operations | (185 | ) | ||
Income from continuing operations before income taxes, as restated with discontinued operations | $ | 790 | ||
Work-in-process Inventory
The adjustment to income before income taxes represent costs that had been recognized in previous periods that should have been recorded when the inventory was sold.
Revenue for Unbilled Accounts Receivable
The adjustment to income before income taxes is to recognize revenue for items shipped but not billed when the criteria of Staff Accounting Bulletin No. 104, “Revenue Recognition” had been met.
Errors in Recording Depreciation and Amortization
The adjustment to income before income taxes to accurately record depreciation and amortization for fixed and intangible assets is due to the following items:
| • | The Company was in the process of installing a fixed asset ledger system during 2006. As a result, certain balances within construction work in process were not properly transferred to the fixed asset categories of buildings, equipment, or software in a timely manner. The delay in transferring these assets into the respective fixed asset categories and designating the assets as placed in service resulted in an understatement of depreciation and amortization expense of $169 in the quarter ended March 31, 2006. |
| • | The Company understated depreciation expense and amortization expense due to depreciating fixed assets and amortizing customer relationships using incorrect useful lives. Accordingly, depreciation expense and amortization expense were understated by $308 in the quarter ended March 31, 2006. |
| • | The Company inappropriately expensed amounts that should have been capitalized as fixed assets. Accordingly, cost of goods sold was overstated by $523 in the quarter ended March 31, 2006. |
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Notes to Condensed Consolidated Financial Statements (Unaudited - continued)
(all amounts in thousands of dollars, unless otherwise stated)
Other Items
The following items also represented errors detected that impacted the restatements for the quarter ended March 31, 2006:
| • | The Company did not recognize the appropriate amount of revenue for a significant customer in accordance with the pricing terms of the related sales contract. As a result, revenue was overstated in the quarter ended March 31, 2006. |
| • | The Company amortized deferred financing fees using the straight-line method, as opposed to the effective interest method. As a result, interest expense was restated in the quarter ended March 31, 2006. |
| • | The Company did not recognize a foreign currency loss on the portion of the senior secured term loan denominated in pound sterling. As a result, other expense was restated for the quarter ended March 31, 2006. |
Tax Impact
The restatement to the provision for taxes on income is due to the tax effects of the adjustments to income before income taxes and the restatement to record a valuation allowance in the amount of $75 on a deferred tax asset.
The following table presents the Company’s unaudited interim consolidated statement of income as previously reported and as restated for the quarter ended March 31, 2006 to reflect the correction of errors as described above.
Quarter Ended March 31, 2006 | ||||||||||
| As Originally Reported | As Restated | As Restated with Discontinued Operations | ||||||||
Revenues | $ | 72,749 | $ | 72,146 | $ | 68,823 | ||||
Costs and expenses: | ||||||||||
Cost of goods sold (exclusive of depreciation) | 49,859 | 49,353 | 46,661 | |||||||
Selling, general, and administrative expenses | 9,127 | 9,127 | 8,512 | |||||||
Depreciation and amortization | 3,892 | 4,369 | 4,250 | |||||||
Interest expense | 8,670 | 8,558 | 8,538 | |||||||
Other expense, net | 23 | 134 | 72 | |||||||
Total costs and expenses | 71,571 | 71,541 | 68,033 | |||||||
Income from continuing operations before income taxes | 1,178 | 605 | 790 | |||||||
Provision for income taxes | 402 | 234 | 286 | |||||||
Income from continuing operations | 776 | 371 | 504 | |||||||
Loss on discontinued operations | 0 | 0 | (185 | ) | ||||||
Benefit for taxes on income | 0 | 0 | (52 | ) | ||||||
Net income | $ | 776 | $ | 371 | $ | 371 | ||||
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SGS International, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited - continued)
(all amounts in thousands of dollars, unless otherwise stated)
The following table presents the Company’s unaudited interim condensed consolidated statement of cash flows as previously reported and as restated for the three months ended March 31, 2006 for the error corrections described above.
| Three Months Ended March 31, 2006 | ||||||||
| As Originally Reported | Restated | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES | $ | 13,081 | $ | 13,604 | ||||
CASH FLOWS FROM INVESTING ACTIVITIES - | ||||||||
Acquisition of property, plant and equipment | (1,376 | ) | (1,899 | ) | ||||
Net cash used in investing activities | (1,376 | ) | (1,899 | ) | ||||
CASH FLOWS FROM FINANCING ACTIVITIES - | ||||||||
Payments on long-term debt | (416 | ) | (416 | ) | ||||
Net cash used in financing activities | (416 | ) | (416 | ) | ||||
Effect of exchange rate changes on cash | 10 | 10 | ||||||
Increase in cash and cash equivalents | 11,299 | 11,299 | ||||||
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD | 3,308 | 4,081 | ||||||
CASH AND CASH EQUIVALENTS, END OF PERIOD | $ | 14,607 | $ | 15,380 | ||||
| G. | Supplemental Guarantor Information |
The Successor’s debt includes the senior credit facility and the 12% senior subordinated notes. As of March 31, 2007, the U.S. borrowings under the senior credit facility have been guaranteed by Southern Graphics Inc. (the parent of SGS International, Inc.), Southern Graphic Systems, Inc. and Project Dove Holdco, Inc. As of March 31, 2007, The Canadian borrowings under the senior credit facility have been guaranteed by SGS Packaging Europe Holdings Limited, SGS Packaging Europe Limited, MCG Graphics Limited, Southern Graphic Systems Mexico, S. De R.L. De C.V., The Box Room Limited, SGS Packaging Netherlands, B.V., Synnoflex Inc., Southern Graphic Systems, Inc., Project Dove Holdco, Inc., Project Dove Manitoba, L.P., Southern Graphics Inc., and SGS International, Inc. The senior subordinated notes are general unsecured obligations and are guaranteed on a senior subordinated basis by certain of the Successor’s domestic subsidiaries and rank secondary to the Successor’s senior credit facility. Guarantor subsidiaries for the senior subordinated notes include Southern Graphic Systems, Inc. and Project Dove Holdco, Inc. Non- Guarantor subsidiaries for the senior subordinated notes include the remaining direct and indirect domestic and foreign subsidiaries. The subsidiary guarantors are 100% owned by the Successor, the guarantees are full and unconditional, and the guarantees are joint and several.
Following are condensed consolidating financial statements of the Company. Investments in subsidiaries are either consolidated or accounted for under the equity method of accounting. Intercompany balances and transactions have been eliminated.
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Notes to Condensed Consolidated Financial Statements (Unaudited - continued)
( in thousands of dollars)
Supplemental Condensed Consolidating Balance Sheet
March 31, 2007
| Parent / Issuer | Consolidated Guarantor Subsidiaries | Consolidated Non- Guarantor Subsidiaries | Eliminations | Consolidated | ||||||||||||
Assets | ||||||||||||||||
Current assets | ||||||||||||||||
Cash and cash equivalents | $ | 22,439 | $ | 2,156 | $ | 9,209 | $ | — | $ | 33,804 | ||||||
Receivables from customers, less allowances | — | 41,851 | 16,811 | — | 58,662 | |||||||||||
Intercompany receivables | 291,601 | 27,231 | 41,293 | (360,125 | ) | — | ||||||||||
Inventories | — | 3,615 | 2,467 | — | 6,082 | |||||||||||
Deferred income taxes | — | 659 | 159 | — | 818 | |||||||||||
Prepaid expenses and other current assets | 78 | 6,454 | 2,241 | — | 8,773 | |||||||||||
Total current assets | 314,118 | 81,966 | 72,180 | (360,125 | ) | 108,139 | ||||||||||
Investment in subsidiaries | 108,175 | 23,001 | 14,800 | (145,976 | ) | — | ||||||||||
Properties, plants and equipment, net | — | 43,738 | 8,007 | — | 51,745 | |||||||||||
Goodwill | — | 122,789 | 40,423 | — | 163,212 | |||||||||||
Other intangible assets, net | — | 131,477 | 35,683 | — | 167,160 | |||||||||||
Deferred financing costs, net | 9,819 | — | — | — | 9,819 | |||||||||||
Deferred income taxes | 2,317 | — | — | (2,317 | ) | — | ||||||||||
Other assets | — | 200 | 247 | — | 447 | |||||||||||
Total assets | $ | 434,429 | $ | 403,171 | $ | 171,340 | $ | (508,418 | ) | $ | 500,522 | |||||
Liabilities | ||||||||||||||||
Current liabilities | ||||||||||||||||
Accounts payable, trade | $ | 473 | $ | 10,631 | $ | 5,512 | $ | — | $ | 16,616 | ||||||
Intercompany payables | — | 306,244 | 53,881 | (360,125 | ) | — | ||||||||||
Accrued compensation | — | 5,245 | 1,556 | — | 6,801 | |||||||||||
Accrued taxes, including taxes on income | — | 489 | 1,460 | — | 1,949 | |||||||||||
Accrued interest | 8 | 7,038 | 14 | — | 7,060 | |||||||||||
Other current liabilities | — | 5,605 | 2,207 | — | 7,812 | |||||||||||
Current portion of short-term and long-term obligations | 1,230 | 57 | 417 | — | 1,704 | |||||||||||
Total current liabilities | 1,711 | 335,309 | 65,047 | (360,125 | ) | 41,942 | ||||||||||
Noncurrent liabilities | ||||||||||||||||
Long-term obligations, net of current portion | 320,613 | 155 | 19,718 | — | 340,486 | |||||||||||
Noncurrent liabilities | — | — | 517 | — | 517 | |||||||||||
Deferred income taxes | — | 2,283 | 5,506 | (2,317 | ) | 5,472 | ||||||||||
Total liabilities | 322,324 | 337,747 | 90,788 | (362,442 | ) | 388,417 | ||||||||||
Contingencies and commitments | ||||||||||||||||
Stockholders’ equity | 112,105 | 65,424 | 80,552 | (145,976 | ) | 112,105 | ||||||||||
Total liabilities and stockholders’ equity | $ | 434,429 | $ | 403,171 | $ | 171,340 | $ | (508,418 | ) | $ | 500,522 | |||||
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SGS International, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited—continued)
(in thousands of dollars)
Supplemental Condensed Consolidating Balance Sheet
December 31, 2006
| Parent / Issuer | Consolidated Guarantor Subsidiaries | Consolidated Non- Guarantor Subsidiaries | Eliminations | Consolidated | ||||||||||||
| Assets | ||||||||||||||||
Current assets | ||||||||||||||||
Cash | $ | 2,100 | $ | 2,286 | $ | 8,272 | $ | — | $ | 12,658 | ||||||
Receivables from customers, less allowances | — | 39,005 | 18,412 | — | 57,417 | |||||||||||
Intercompany receivables | 289,829 | 37,289 | 41,748 | (368,866 | ) | — | ||||||||||
Inventories | — | 3,588 | 2,145 | — | 5,733 | |||||||||||
Deferred income taxes | — | 1,547 | 129 | — | 1,676 | |||||||||||
Prepaid expenses and other current assets | 80 | 6,020 | 1,953 | — | 8,053 | |||||||||||
Total current assets | 292,009 | 89,735 | 72,659 | (368,866 | ) | 85,537 | ||||||||||
Investment in subsidiaries | 105,366 | 23,001 | 14,800 | (143,167 | ) | — | ||||||||||
Properties, plants and equipment, net | — | 43,322 | 9,091 | — | 52,413 | |||||||||||
Goodwill | — | 117,391 | 40,387 | — | 157,778 | |||||||||||
Other intangible assets, net | — | 127,049 | 36,064 | — | 163,113 | |||||||||||
Deferred financing costs, net | 10,177 | — | — | — | 10,177 | |||||||||||
Deferred income taxes | 1,923 | — | — | (1,923 | ) | — | ||||||||||
Other assets | — | 275 | 234 | — | 509 | |||||||||||
Total assets | $ | 409,475 | $ | 400,773 | $ | 173,235 | $ | (513,956 | ) | $ | 469,527 | |||||
| Liabilities | ||||||||||||||||
Current liabilities | ||||||||||||||||
Accounts payable, trade | $ | 413 | $ | 8,852 | $ | 6,454 | $ | — | $ | 15,719 | ||||||
Intercompany payables | — | 314,588 | 54,278 | (368,866 | ) | — | ||||||||||
Accrued compensation | — | 4,025 | 2,097 | — | 6,122 | |||||||||||
Accrued taxes, including taxes on income | — | 391 | 1,289 | — | 1,680 | |||||||||||
Accrued interest | 6 | 1,058 | 27 | — | 1,091 | |||||||||||
Other current liabilities | — | 4,318 | 2,728 | — | 7,046 | |||||||||||
Current portion of short-term and long-term obligations | 1,000 | 57 | 2,548 | — | 3,605 | |||||||||||
Total current liabilities | 1,419 | 333,289 | 69,421 | (368,866 | ) | 35,263 | ||||||||||
Noncurrent liabilities | ||||||||||||||||
Long-term obligations, net of current portion | 298,088 | 155 | 20,141 | — | 318,384 | |||||||||||
Non current liabilities | — | — | 517 | — | 517 | |||||||||||
Deferred income taxes | — | 2,952 | 4,366 | (1,923 | ) | 5,395 | ||||||||||
Total noncurrent liabilities | 298,088 | 3,107 | 25,024 | (1,923 | ) | 324,296 | ||||||||||
Total liabilities | 299,507 | 336,396 | 94,445 | (370,789 | ) | 359,559 | ||||||||||
Contingencies and commitments | ||||||||||||||||
Stockholders’ equity | 109,968 | 64,377 | 78,790 | (143,167 | ) | 109,968 | ||||||||||
Total liabilities and stockholders’ equity | $ | 409,475 | $ | 400,773 | $ | 173,235 | $ | (513,956 | ) | $ | 469,527 | |||||
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SGS International, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited—continued)
(in thousands of dollars)
Supplemental Condensed Consolidating Statement of Income
For the Three Months Ended March 31, 2007
| Parent / Issuer | Consolidated Guarantor Subsidiaries | Consolidated Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
| Revenues | |||||||||||||||||||
Sales | $ | — | $ | 54,137 | $ | 19,970 | $ | — | $ | 74,107 | |||||||||
Sales to related parties | — | 1,071 | 422 | (1,493 | ) | — | |||||||||||||
Total revenues | — | 55,208 | 20,392 | (1,493 | ) | 74,107 | |||||||||||||
| Costs and expenses | |||||||||||||||||||
Cost of goods sold | — | 34,652 | 14,713 | (1,493 | ) | 47,872 | |||||||||||||
Selling, general and administrative expenses | 615 | 8,417 | 1,269 | — | 10,301 | ||||||||||||||
Depreciation and amortization | — | 3,999 | 1,106 | — | 5,105 | ||||||||||||||
Interest expense | 657 | 7,729 | 561 | — | 8,947 | ||||||||||||||
Other (income) expense, net | (207 | ) | (89 | ) | 4 | — | (292 | ) | |||||||||||
Total costs and expenses | 1,065 | 54,708 | 17,653 | (1,493 | ) | 71,933 | |||||||||||||
Equity in net income of subsidiaries | 2,679 | — | — | (2,679 | ) | — | |||||||||||||
Income from continuing operations before income taxes | 1,614 | 500 | 2,739 | (2,679 | ) | 2,174 | |||||||||||||
Provision (benefit) for taxes on income (loss) | (395 | ) | 220 | 1,012 | — | 837 | |||||||||||||
Income from continuing operations | 2,009 | 280 | 1,727 | (2,679 | ) | 1,337 | |||||||||||||
Income from discontinued operations | — | — | 842 | — | 842 | ||||||||||||||
Provision (benefit) for taxes on income (loss) | — | — | 170 | — | 170 | ||||||||||||||
Net income | $ | 2,009 | $ | 280 | $ | 2,399 | $ | (2,679 | ) | $ | 2,009 | ||||||||
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SGS International, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited—continued)
(in thousands of dollars)
Supplemental Condensed Consolidating Statement of Income
For the Three Months Ended March 31, 2006
(as Restated, see note F)
| Parent / Issuer | Consolidated Guarantor Subsidiaries | Consolidated Non-Guarantor Subsidiaries | Eliminations | Consolidated | ||||||||||||||||
| Revenues | ||||||||||||||||||||
Sales | $ | — | $ | 53,891 | $ | 14,932 | $ | — | $ | 68,823 | ||||||||||
Sales to related parties | — | 922 | 541 | (1,463 | ) | — | ||||||||||||||
Total revenues | — | 54,813 | 15,473 | (1,463 | ) | 68,823 | ||||||||||||||
| Costs and expenses | ||||||||||||||||||||
Cost of goods sold | — | 37,046 | 11,078 | (1,463 | ) | 46,661 | ||||||||||||||
Selling, general and administrative expenses | 125 | 7,230 | 1,157 | — | 8,512 | |||||||||||||||
Depreciation and amortization | — | 3,303 | 947 | — | 4,250 | |||||||||||||||
Interest expense | 8,235 | (41 | ) | 344 | — | 8,538 | ||||||||||||||
Other (income) expense, net | 111 | (32 | ) | (7 | ) | — | 72 | |||||||||||||
Total costs and expenses | 8,471 | 47,506 | 13,519 | (1,463 | ) | 68,033 | ||||||||||||||
Equity in net income of subsidiaries | 5,605 | — | — | (5,605 | ) | — | ||||||||||||||
Income from continuing operations before income taxes | (2,866 | ) | 7,307 | 1,954 | (5,605 | ) | 790 | |||||||||||||
Provision (benefit) for taxes on income (loss) | (3,237 | ) | 2,785 | 738 | — | 286 | ||||||||||||||
Income from continuing operations | 371 | 4,522 | 1,216 | (5,605 | ) | 504 | ||||||||||||||
Income from discontinued operations | — | — | (185 | ) | — | (185 | ) | |||||||||||||
Provision (benefit) for taxes on income (loss) | — | — | (52 | ) | — | (52 | ) | |||||||||||||
Net income | $ | 371 | $ | 4,522 | $ | 1,083 | $ | (5,605 | ) | $ | 371 | |||||||||
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SGS International, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited—continued)
(in thousands of dollars)
Supplemental Condensed Consolidating Statement of Cash Flows
For the Three Months Ended March 31, 2007
| Parent / Issuer | Consolidated Guarantor Subsidiaries | Consolidated Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Cash provided by operations | $ | 9,560 | $ | 897 | $ | 2,363 | $ | — | $ | 12,820 | |||||||||
Investing activities: | |||||||||||||||||||
Acquisition of property, plant and equipment | — | (2,527 | ) | (398 | ) | — | (2,925 | ) | |||||||||||
Proceeds from divesture of business, net of cash divested | — | 1,500 | (872 | ) | — | 628 | |||||||||||||
Business acquisition, net of cash acquired | (11,950 | ) | — | — | — | (11,950 | ) | ||||||||||||
Cash used in investing activities | (11,950 | ) | (1,027 | ) | (1,270 | ) | — | (14,247 | ) | ||||||||||
Financing activities: | |||||||||||||||||||
Borrowings on acquisition facility | 22,980 | — | — | — | 22,980 | ||||||||||||||
Payments on long-term debt | (250 | ) | — | (164 | ) | — | (414 | ) | |||||||||||
Cash provided by (used in) financing activities | 22,730 | — | (164 | ) | — | 22,566 | |||||||||||||
Effect of exchange rate changes on cash | — | — | 7 | — | 7 | ||||||||||||||
Net change in cash and cash equivalents | 20,340 | (130 | ) | 936 | — | 21,146 | |||||||||||||
Cash and cash equivalents, beginning of period | 2,100 | 2,285 | 8,273 | — | 12,658 | ||||||||||||||
Cash and cash equivalents, end of period | $ | 22,440 | $ | 2,155 | $ | 9,209 | $ | — | $ | 33,804 | |||||||||
Supplemental Condensed Consolidating Statement of Cash Flows For the Three Months Ended March 31, 2006 (as Restated, see note F) |
| ||||||||||||||||||
| Parent / Issuer | Consolidated Guarantor Subsidiaries | Consolidated Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Cash provided by operations | $ | 5,514 | $ | 1,019 | $ | 7,071 | $ | — | $ | 13,604 | |||||||||
Investing activities: | |||||||||||||||||||
Acquisition of property, plant and equipment | (472 | ) | (1,322 | ) | (105 | ) | — | (1,899 | ) | ||||||||||
Business acquisition, net of cash acquired | — | — | — | — | — | ||||||||||||||
Cash used in investing activities | (472 | ) | (1,322 | ) | (105 | ) | — | (1,899 | ) | ||||||||||
Financing activities: | |||||||||||||||||||
Net changes in short-term borrowings | — | — | — | — | — | ||||||||||||||
Cash dividends | — | — | — | — | — | ||||||||||||||
Payments on long-term debt | (247 | ) | — | (169 | ) | — | (416 | ) | |||||||||||
Cash provided by financing activities | (247 | ) | — | (169 | ) | — | (416 | ) | |||||||||||
Effect of exchange rate changes on cash | — | — | 10 | — | 10 | ||||||||||||||
Net change in cash | 4,795 | (303 | ) | 6,807 | — | 11,299 | |||||||||||||
Cash and cash equivalents, beginning of period | 2,005 | 851 | 1,225 | — | 4,081 | ||||||||||||||
Cash and cash equivalents, end of period | $ | 6,800 | $ | 548 | $ | 8,032 | $ | — | $ | 15,380 | |||||||||
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| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with Item 1, “ Financial Statements” in Part 1 of this quarterly report on Form 10-Q.
The statements in the discussion and analysis regarding our expectations regarding the performance of our business, our liquidity and capital resources and other non-historical statements are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties. Our actual results may differ materially from those contained in or implied by any of these forward-looking statements.
Overview
We are a global leader in the digital imaging and communication industry, offering design-to-print graphic services to the international consumer products packaging market. We offer a full spectrum of innovative digital solutions that streamline the capture, management, execution, and distribution of graphics information. Our brand development, creative design, prepress, image carriers and print support services are utilized in each of the three main printing processes: flexography, gravure and lithography. Our customers, many of which we have served for over 20 years, include large branded consumer products companies, mass merchant retailers and the printers and converters that service them. Our services ensure that our customers are able to obtain or produce consistent, high quality packaging materials often on short turnaround times.
RESULTS OF OPERATIONS
The information presented below for the three months ended March 31, 2007 and 2006 was prepared by management and is unaudited. In the opinion of management, all adjustments necessary for a fair statement of our financial position and operating results for such quarters and as of such dates have been included. (Dollar amounts below are in thousands and percentages are expressed as a percentage of sales.)
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Quarter ended March 31, 2007 compared to quarter ended March 31, 2006
| Three Months Ended March 31, 2007 | Three Months Ended March 31, 2006 | |||||||||||||
| (as Restated, see note F) | ||||||||||||||
| (unaudited) | (unaudited) | |||||||||||||
Sales | $ | 74,107 | 100.0 | % | $ | 68,823 | 100.0 | % | ||||||
Costs and expenses: | ||||||||||||||
Cost of goods sold | 47,872 | 64.6 | % | 46,661 | 67.8 | % | ||||||||
Selling, general, and administrative expenses | 10,301 | 13.9 | % | 8,512 | 12.4 | % | ||||||||
Depreciation and amortization | 5,105 | 6.9 | % | 4,250 | 6.2 | % | ||||||||
Interest expense | 8,947 | 12.1 | % | 8,538 | 12.4 | % | ||||||||
Other expense (income), net | (292 | ) | -0.4 | % | 72 | 0.1 | % | |||||||
Total costs and expenses | 71,933 | 97.1 | % | 68,033 | 98.9 | % | ||||||||
Income from continuing operations before income taxes | 2,174 | 2.9 | % | 790 | 1.1 | % | ||||||||
Provision for income taxes | 837 | 1.1 | % | 286 | 0.4 | % | ||||||||
Income from continuing operations | 1,337 | 1.8 | % | 504 | 0.7 | % | ||||||||
Income from (loss on) discontinued operations | 842 | 1.1 | % | (185 | ) | -0.3 | % | |||||||
Provision (benefit) for income taxes | 170 | 0.2 | % | (52 | ) | -0.1 | % | |||||||
Income (loss) from discontinued operations | 672 | 0.9 | % | (133 | ) | -0.2 | % | |||||||
Net income | $ | 2,009 | 2.7 | % | $ | 371 | 0.5 | % | ||||||
Sales. Sales for the quarter ended March 31, 2007 increased $5.3 million, or 7.7%, to $74.1 million from $68.8 million for the quarter ended March 31, 2006. The increase in sales was principally due to organic growth which accounted for $3.8 million of the increase. The acquisitions during 2006 added incremental revenue for the quarter ended March 31, 2007 of $1.2 million. The acquisition of the operations of C. M. Jackson Associates, Inc. on February 28, 2007 added incremental revenue for the quarter ended March 31, 2007 of $0.3 million.
Cost of Goods Sold. Cost of goods sold for the quarter ended March 31, 2007 increased $1.2 million, or 2.6%, to $47.9 million from $46.7 million for the quarter ended March 31, 2006. The acquisitions during 2006 added incremental cost of goods sold for the quarter ended March 31, 2007 of $1.1 million. The acquisition of the operations of C. M. Jackson Associates, Inc. on February 28, 2007 added incremental costs of goods sold for the quarter ended March 31, 2007 of $0.3 million.
Selling, General and Administrative Expenses. Selling, general and administrative expenses for the quarter ended March 31, 2007 increased $1.8 million, or 21.0%, to $10.3 million from $8.5 million for the quarter ended March 31, 2006. The increase in selling, general and administrative expenses is primarily due to $0.4 million of incremental expenses associated with the operations of C. M. Jackson Associates, Inc., an increase in professional service fees of $0.4 million and an increase in severance costs of $0.4 million.
Depreciation and Amortization Expenses. Depreciation and amortization expenses for the quarter ended March 31, 2007 increased $0.8 million, or 20.1%, to $5.1 million from $4.3 million for the quarter ended March 31, 2006. This increase was primarily due to depreciation and amortization of assets acquired or placed in service after March 31, 2006.
Interest Expense.Interest expense for the quarter ended March 31, 2007 increased by $0.4 million, or 4.8%, to $8.9 million from $8.5 million for the quarter ended March 31, 2006. This increase was primarily due to the increase in interest rates from the quarter ended March 31, 2007 compared to the quarter ended March 31, 2006.
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Other Expense (Income), net.Other expense (income), net for the quarter ended March 31, 2007 was $0.3 million of income compared to $0.1 million of expense for the quarter ended March 31, 2006. This fluctuation was primarily due to an increase in interest income on our cash and cash equivalents during the quarter ended March 31, 2007 compared to the quarter ended March 31, 2006.
Income from continuing operations before income taxes. Income from continuing operations before income taxes for the quarter ended March 31, 2007 increased by $1.4 million to $2.2 million from $0.8 million for the quarter ended March 31, 2006. This increase was primarily due to the increases in sales from organic growth previously discussed.
Income from (loss on) discontinued operations, including gain on disposal.The income from (loss on) discontinued operations fluctuated from a gain of $0.8 million for the quarter ended March 31, 2007 to a loss of $0.2 million for the quarter ended March 31, 2006. This fluctuation was primarily due to the gain on the divestiture of Mozaic Group, Ltd. of $0.9 million during the quarter ended March 31, 2007.
Provision for income taxes from continuing operations. The effective tax rate for the quarter ended March 31, 2007 was 38.5%, compared to 36.2% for the quarter ended March 31, 2006. The increase in the effective tax rate was primarily due to the impact of foreign operations. Income before income taxes for the foreign operations were higher for the quarter ended March 31, 2007 than for the quarter ended March 31, 2006.
Net income. Net income for the quarter ended March 31, 2007 increased by $1.6 million to $2.0 million from $0.4 million for the quarter ended March 31, 2006. This increase was primarily due to the reasons previously discussed.
Liquidity and Capital Resources
At March 31, 2006, we had $33.8 million in cash and cash equivalents and $34.1 million in adjusted working capital1 compared with $12.7 million in cash and cash equivalents and $41.2 million in adjusted working capital1 at December 31, 2006. The $21.1 million increase in cash is primarily due to $23.0 million of borrowings on the acquisition facility, $15.0 million of which were utilized in an acquisition on April 2, 2007. The $7.1 million decrease in adjusted working capital is primarily due to an increase in accrued interest of $6.0 million.
| 1 | Adjusted working capital is defined as current assets (excluding cash and cash equivalents and related party receivables) less current liabilities (excluding short-term debt, current portion of long-term debt and related party payables). However, adjusted working capital is not a recognized measurement under GAAP, and when analyzing our financial position, investors should use adjusted working capital in addition to, and not as an alternative for working capital, as defined in GAAP. The following table reconciles working capital to adjusted working capital: |
| March 31, 2007 | December 31, 2006 | |||||||
Working capital | $ | 66,197 | $ | 50,274 | ||||
Less cash | (33,804 | ) | (12,658 | ) | ||||
Add current portion of short-term and long-term obligations | 1,704 | 3,605 | ||||||
Adjusted working capital | $ | 34,097 | $ | 41,221 | ||||
We expect that cash generated from operating activities and availability under our revolving credit facility, which is included in our senior secured credit facility, will be our principal sources of liquidity. At March 31, 2007, there were no borrowings outstanding
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under the revolving credit facility, which had $35 million of borrowing availability. Based on our current level of operations, we believe our cash flow from operations and availability under the revolving credit facility will be adequate to meet our liquidity needs for at least the next twelve months. There is no assurance, however, that our business will generate sufficient cash flows from operations, or that future borrowings will be available to us under our revolving credit facility in an amount sufficient to enable us to repay our indebtedness, or to fund our other liquidity needs.
We are highly leveraged and our aggregate indebtedness at March 31, 2007 was $342.2 million. In 2011, our debt service requirements will substantially increase as a result of the maturity of the senior secured term loans on December 30, 2011. We anticipate that we will refinance these borrowings prior to the maturity of the senior secured term loans. Our ability to operate our business, service our debt requirements and reduce our total debt will depend upon our future operating performance.
Our senior secured credit facility contains customary financial and other covenants, including a maximum leverage ratio and a minimum interest coverage ratio, as defined in the senior secured credit facility agreement. Our senior secured credit facility also places certain restrictions on our ability to make capital expenditures. As of March 31, 2007 we were in compliance with all covenants. Below are the required financial covenant levels and the actual levels as of March 31, 2007:
| Required | Actual | |||||
Maximum leverage ratio | 6.25 | 5.10 | ||||
Minimum interest coverage ratio | 1.60 | 2.05 | ||||
Maximum capital expenditures trailing four quarters | not to exceed $ | 15.0 million | $ | 9.7 million | ||
Our Board of Directors including its Audit Committee concluded on March 29, 2007 to restate our interim financial statements for the quarters ending March 31, 2006, June 30, 2006, and September 30, 2006 and the December 31, 2005 balance sheet (the “Restatements”). Accordingly, we filed with the Securities and Exchange Commission on April 3, 2007 a Form 12b-25 Notification of Late Filing with respect to the Form 10-K. We requested and received from the lenders under our senior secured credit facility a waiver of any default or event of default resulting from the Restatements. In addition, we requested and received from the senior secured credit facility lenders a waiver of any default arising from the late delivery of our audited annual financial statements.
On February 28, 2007, we entered into an Asset Purchase Agreement (the “Purchase Agreement”) with C.M. Jackson Associates, Inc. (“CMJ”).” Under the Purchase Agreement, the Company acquired substantially all of CMJ’s assets for an aggregate cash purchase price of $11,650. In conjunction with this acquisition, we borrowed $8.0 million on our acquisition facility.
On April 2, 2007, we acquired McGurk Studios Limited and Thames McGurk Limited for an aggregate purchase price of $18.2 million ($16.9 million of cash and $1.3 million through the assumption of short-term and long-term indebtedness). In conjunction with this acquisition, we borrowed $15.0 million on our acquisition facility.
Cash flow
Quarter ended March 31, 2007 compared to the quarter ended March 31, 2006
Cash flows from operating activities.Net cash provided by operating activities was $12.8 million for the quarter ended March 31, 2007 as compared to $13.6 million for the quarter ended March 31, 2006. The primary reasons for the decrease were changes in working capital partially offset by an increase in net income.
Cash flows from investing activities. Net cash used for investing activities was $14.3 million for the quarter ended March 31, 2007 as compared to $1.9 million for the quarter ended March 31, 2006. The increase in cash used for investing activities is primarily due to
the acquisition of the operations of C.M. Jackson Associates, Inc., which included cash payments related to this acquisition of $12.0
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million during the quarter ended March 31, 2007. In addition, capital expenditures increased $1.0 million to $2.9 million for the quarter ended March 31, 2007 as compared to $1.9 million for the quarter ended March 31, 2006. Capital expenditures are generally made to replace existing assets, support new business or customer initiatives, increase productivity, facilitate cost reductions, or meet regulatory requirements. Our operations typically do not have large capital requirements. These increases were partially offset by $1.5 million in proceeds received from the divestiture of our controlling interest in Mozaic Group, Ltd., net of $0.9 million of Mozaic Group, Ltd.’s cash included in the divestiture.
Cash flows from financing activities.Net cash provided by financing activities was $22.6 million for the quarter ended March 31, 2007 as compared to cash used in financing activities of $0.4 million for the quarter ended March 31, 2006. The primary reason for this fluctuation was borrowings of $23.0 million on the acquisition facility during the quarter ended March 31, 2007 compared to zero borrowings on the acquisition facility during the quarter ended March 31, 2006.
Contractual Obligations
The $23.0 million outstanding on the acquisition facility is payable in quarterly installments of approximately $56 through September 2011, with the remaining amount due at maturity on December 31, 2011. Borrowings on the acquisition facility bear interest at a variable rate of LIBOR plus 2.5%. At March 31, 2007, the interest rate was 7.85%.
Off-Balance Sheet Arrangements
We do not have any material off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources.
Critical Accounting Policies
We adopted the provisions of Financial Accounting Standards Board (FASB) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, and interpretation of FASB Statement No. 109” (FIN 48) on January 1, 2007. At the adoption date and as of March 31, 2007, we had no material unrecognized tax benefits and no adjustments to liabilities or operations were required.
We recognize interest and penalties related to uncertain tax positions in income tax expense, which were zero for the three months ended March 31, 2007.
Tax years December 30, 2005 to December 31, 2005 and January 1, 2006 to December 31, 2006 are subject to examination by the federal and state taxing authorities, respectively. There are no income tax examinations currently in process. For the tax years ended December 31, 2003 through December 29, 2005, we have been indemnified for all taxes, interest and penalties by the previous owner.
There have been no other material changes to our critical accounting policies since December 31, 2006.
| Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
At March 31, 2007 there were no material changes in our December 31, 2006 market risks relating to interest and foreign exchange rates.
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| Item 4. | Controls and Procedures |
Disclosure Controls and Procedures
In connection with the preparation of this quarterly report on Form 10-Q for the quarter ended March 31, 2007, members of management, at the direction (and with the participation) of our chief executive officer and chief financial officer, performed an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act)), as of March 31, 2007 and concluded that they were not effective as a result of the material weaknesses described below. Disclosure controls and procedures are controls and other procedures that are designed to ensure that the information required to be disclosed in reports filed or submitted under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (2) accumulated and communicated to management, including the chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.
A material weakness is a control deficiency, or a combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.
There were seven material weaknesses discussed in our Annual Report on Form 10-K as of December 31, 2006, four of which have been remediated as discussed below. The material weaknesses over (1) lack of sufficient resources in our accounting and finance organization, (2) accounting for unbilled accounts receivable and (3) accounting for work in process inventory continue to exist as of March 31, 2007.
Notwithstanding these material weaknesses which continue to exist as of March 31, 2007, management has concluded that our condensed consolidated financial statements included in this quarterly report fairly present in all material respects our financial condition, results of operations and cash flows for the periods presented in accordance with GAAP.
Changes in Internal Control Over Financial Reporting
Based on the evaluation performed as of March 31, 2007, management has concluded that four of the material weaknesses previously reported in the Annual Report on Form 10-K as of December 31, 2006 have been remediated as a result of the following changes in internal control:
| • | Accounting for contract revenue. As of December 31, 2006, we did not maintain effective controls over the accuracy of revenues earned under contracts with non-standard terms and conditions. Beginning in the first quarter of 2007, we established and communicated to appropriate individuals a policy that requires that all customer contracts must be approved by legal counsel prior to signing. This enables us to better track non-standard terms and conditions. We also improved the coordination between the finance department and legal counsel to ensure non-standard terms and conditions receive appropriate accounting treatment. |
| • | Accounting for property, plant and equipment. As of December 31, 2006, we did not maintain effective controls over the completeness and accuracy of our property, plant and equipment. We installed a new fixed asset system in the fourth quarter of 2006, which was fully updated and operational in the first quarter of 2007. This fixed asset system enables us to ensure that property, plant and equipment assets are properly monitored and depreciated in accordance with our fixed asset policy. We also added additional controls during the first quarter of 2007 concerning the preparation and review of reconciliations over the fixed asset accounting process during the monthly closing process. |
| • | Accounting for intangible assets. As of December 31, 2006, we did not maintain effective controls to accurately and completely record amortization of acquired intangibles. Beginning in the first quarter of 2007, we established and communicated to appropriate individuals a policy that requires that all useful lives for all newly acquired intangible assets are to be reviewed for consistency with the established policy in accordance with GAAP. |
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| • | Accounting for accrued and other expenses. As of December 31, 2006, we did not maintain effective controls to ensure the completeness and accuracy of certain of our accrued liabilities, accounts payable and related expense accounts. We hired additional personnel during 2006 and the first quarter of 2007 to improve the handling of cut-off for purchases and expenditures. We also provided additional training and communication in this area during the first quarter of 2007. |
As described above, there were changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended March 31, 2007 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
OTHER INFORMATION
| Item 1. | Legal Proceedings |
Various lawsuits, claims and proceedings have been or may be instituted or asserted against entities within the Company. While the amounts claimed may be substantial, the ultimate liability cannot be determined because of the considerable uncertainties that exist. Therefore, it is possible that results of operations or liquidity in a particular period could be materially affected by certain contingencies. However, based on currently available facts and in light of legal and other defenses available to us, management believes that the disposition of matters that are pending or asserted will not have a materially adverse effect on the Company’s financial position, results of operations, and liquidity.
| Item 1A. | Risk Factors |
There have been no material changes to the risk factors included in our Form 10-K for the year ended December 31, 2006
| Item 6. | Exhibits |
EXHIBIT | DESCRIPTION | |
3. | CERTIFICATE OF INCORPORATION AND BY-LAWS | |
3.1 | Certificate of Incorporation of the Registrant filed with the Secretary of State of the State of Delaware on November 8, 2005, incorporated by reference to exhibit 3.1 to the Registrant’s registration statement on Form S-4 filed on May 5, 2006, File No. 333-133825 | |
3.2 | By-Laws of the Registrant adopted on November 8, 2005, incorporated by reference to exhibit 3.2 to the Registrant’s registration statement on Form S-4 filed on May 5, 2006, File No. 333-133825 | |
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EXHIBIT | DESCRIPTION | |
4. | INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS, INCLUDING INDENTURES | |
4.1 | Certificate of Incorporation. See Exhibit 3.1 | |
4.2 | By-laws. See Exhibit 3.2 | |
4.3 | Indenture dated as of December 30, 2005, by and between the Registrant and Wells Fargo Bank National Association, as trustee, relating to the 12% Senior Subordinated Notes due 2013, incorporated by reference to exhibit 4.3 to the Registrant’s registration statement on Form S-4 filed on May 5, 2006, File No. 333-133825 | |
4.4 | Form of Global 12% Notes due 2013 (included in Exhibit 4.3) | |
4.5 | Form of Regulation S Temporary Global 12% Notes due 2013 (included in Exhibit 4.3) | |
4.6 | Supplemental Indenture, dated April 25, 2006, by and among the Registrant, Southern Graphic Systems, Inc., Project Dove Holdco, Inc. and Wells Fargo Bank, N.A., as trustee, incorporated by reference to exhibit 4.6 to the Registrant’s registration statement on Form S-4 filed on May 5, 2006, File No. 333-133825 | |
4.7 | Registration Rights Agreement, dated as of December 30, 2005, by and between the Registrant, certain of its subsidiaries as Guarantors, and UBS Securities LLC and Lehman Brothers Inc. as Initial Purchasers, incorporated by reference to exhibit 4.7 to the Registrant’s registration statement on Form S-4 filed on May 5, 2006, File No. 333-133825 | |
4.8 | Credit Agreement, dated as of December 30, 2005, among the Registrant and Southern Graphic Systems – Canada, Co., as borrowers, certain of the Registrant’s subsidiaries, as guarantors, UBS Securities LLC and Lehman Brothers Inc., as joint arrangers and joint bookmanagers, UBS AG, Stamford Branch, as issuing bank, US administrative agent, US collateral agent and Canadian collateral agent, Lehman Brothers Inc., as syndication agent, CIT Lending Services Corporation, as documentation agent, National City Bank, as Canadian administrative agent, UBS Loan Finance LLC, as swingline lender, and the lenders referred to therein, incorporated by reference to exhibit 10.7 to the Registrant’s registration statement on Form S-4 filed on May 5, 2006, File No. 333-133825 | |
4.9 | First Amendment to Credit Agreement by and among the Registrant and Southern Graphic Systems - Canada, Co., as borrowers, certain affiliates of the borrowers, as guarantors, and the lenders party to the Credit Agreement as described therein, incorporated by reference to exhibit 10.8 to the Registrant’s registration statement on Form S-4 filed on May 5, 2006, File No. 333-133825 | |
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EXHIBIT | DESCRIPTION | |
4.10 | Security Agreement, dated as of December 30, 2005, by the Registrant, as borrower, certain of the Registrant’s subsidiaries, as guarantors, and UBS AG, Stamford Branch, as US collateral agent, incorporated by reference to exhibit 10.9 to the Registrant’s registration statement on Form S-4 filed on May 5, 2006, File No. 333-133825 | |
4.11 | Canadian Security Agreement, dated as of December 30, 2005, by certain of the Registrant’s subsidiaries, as pledgors, and UBS AG, Stamford Branch, as Canadian collateral agent, incorporated by reference to exhibit 10.10 to the Registrant’s registration statement on Form S-4 filed on May 5, 2006, File No. 333-133825 | |
4.12 | Debenture dated as of December 30, 2005, from SGS-UK Holdings Limited and others, as chargors, in favour of UBS AG, Stamford Branch, as Canadian collateral agent, incorporated by reference to exhibit 10.11 to the Registrant’s registration statement on Form S-4 filed on May 5, 2006, File No. 333-133825 | |
4.13 | Limited Waiver and Consent to Credit Agreement dated as of April 11, 2007 among the Registrant and Southern Graphic Systems – Canada, Co., as borrowers, certain of the Registrant’s subsidiaries, as guarantors, the lenders signatory thereto, UBS AG, Stamford Branch, as US administrative agent, US collateral agent and Canadian collateral agent, and National City Bank, as Canadian administrative agent | |
10. | MATERIAL CONTRACTS | |
10.1* | Undertaking Agreement, dated February 20, 2007, by and between the Registrant and Marriott W. Winchester, Jr. incorporated by reference to exhibit 99.1 to the Registrant’s Form 8-K dated February 20, 2007, File No. 333-133825 | |
10.2 | Asset Purchase Agreement dated as of February 28, 2007, between C. M. Jackson Associates, Inc. and Southern Graphic Systems, Inc., incorporated by reference to exhibit 10.32 to the Registrant’s Form 10-K Report for the year ended December 31, 2006, File No. 333-133825 | |
10.3 | Share Sale and Purchase Agreement dated April 2, 2007 among (1) McGurk Group Limited, Mr. P.J. Fraine, Ms J.K. Martindale, Ms A.J. Crisp and (2) SGS Packaging Europe Holdings Limited and (3) Mr. P.E. McGurk, Mr. L. McGurk, Ms. A.L. Austin, Mr. J.R. McCarthy and (4) Mr. P.E. McGurk and (5) SGS International, Inc. | |
10.4 | Share Sale and Purchase Agreement dated April 2, 2007 among (1) Mr. P.E. McGurk, Mr. L. McGurk, Ms. A.L. Austin, Mr. J.R. McCarthy and (2) SGS Packaging Europe Holdings Limited and (3) McGurk Group Limited, Mr. P.J. Fraine, Ms J.K. Martindale, Ms A.J. Crisp and (4) Mr. P.E. McGurk and (5) SGS International, Inc. | |
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EXHIBIT | DESCRIPTION | |
31 | CERTIFICATIONS PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 | |
31.1 | Certification of Principal Executive Officer | |
31.2 | Certification of Principal Financial Officer | |
32 | CERTIFICATIONS PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 | |
32.1 | 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 | |
| * | Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 601 of Regulation S-K. |
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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.
| SGS INTERNATIONAL, INC. | ||||||
| Date: May 15, 2007 | By: | /s/ HENRY R. BAUGHMAN | ||||
| Henry R. Baughman | ||||||
| President and Chief Executive Officer | ||||||
| (Principal Executive Officer) | ||||||
| Date: May 15, 2007 | By: | /S/ JAMES M. DAHMUS | ||||
| James M. Dahmus | ||||||
| Chief Financial Officer | ||||||
| (Principal Financial Officer) | ||||||
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