SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter ended September 30, 1998
Commission File Number 000-24021
CUNNINGHAM GRAPHICS INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
New Jersey 22-3561164
(State of incorporation) (I.R.S. Employer
Identification Number)
629 Grove Street
Jersey City, NJ
(Address of principal executive offices)
07310
(Zip Code)
201-217-1990
(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 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 [ ]
The number of shares of Common Stock, no par value, of the Registrant
outstanding at November 10, 1998 was 5,295,000
CUNNINGHAM GRAPHICS INTERNATIONAL, INC.
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
INDEX
Page
----
Part I -- Financial Information
Item 1 -- Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of December 31, 1997
and September 30, 1998.......................................... 1
Condensed Consolidated Statements of Income for the Three Months
and Nine Months Ended September 30, 1997 and 1998............... 2
Condensed Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 1997 and 1998............................... 3
Notes to Condensed Consolidated Financial Statements............... 4
Item 2 -- Management's Discussion and Analysis of Financial Condition
and Results of Operations.............................................. 7
Part II -- Other Information
Item 2 -- Changes in Securities and Use of Proceeds.................... 17
Item 6 -- Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K
None
Part I. FINANCIAL INFORMATION
CUNNINGHAM GRAPHICS INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
December 31, September 30,
1997 1998
-------- --------
(Note) (Unaudited)
Assets
Current assets:
Cash and cash equivalents ............................ $ 67 $ 11,071
Accounts receivable .................................. 5,673 10,388
Inventories .......................................... 940 1,473
Prepaid expenses and other current assets ............ 78 438
Notes and advances receivable -- stockholder/officers 136 --
Deferred income taxes ................................ 47 282
-------- --------
Total current assets ..................................... 6,941 23,652
Property and equipment -- net ............................ 3,579 8,288
Goodwill -- net .......................................... -- 10,863
Other assets ............................................. 418 221
-------- --------
$ 10,938 $ 43,024
======== ========
Liabilities and stockholders' equity
Current liabilities:
Current portion of long-term debt .................... $ 407 $ 667
Revolving lines of credit ............................ 300 460
Current portion of obligations under capital leases .. 178 653
Accounts payable ..................................... 3,854 3,681
Accrued expenses ..................................... 1,474 3,567
-------- --------
Total current liabilities ................................ 6,213 9,028
Long-term debt -- net of current portion ................. 1,185 935
Obligations under capital leases -- net of current portion 332 1,310
Deferred income taxes .................................... 57 613
Other liabilities ........................................ -- 85
Commitments and contingencies
Stockholders' equity:
Preferred stock, no par value, 10,000,000 authorized,
none issued ....................................... -- --
Common stock, no par value, 30,000,000 authorized,
5,295,000 issued and outstanding .................. 6 29,265
Additional paid-in capital ........................... 734 --
Cummulative foreign currency translation adjustment .. -- (26)
Retained earnings .................................... 2,411 1,814
-------- --------
3,151 31,053
-------- --------
$ 10,938 $ 43,024
======== ========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
Note: The balance sheet as of December 31, 1997 has been derived from the
audited financial statements at that date but does not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements.
1
CUNNINGHAM GRAPHICS INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except shares and per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
1997 1998 1997 1998
----------- ----------- ----------- -----------
Net sales ........................................ $ 8,593 $ 14,191 $ 25,768 $ 38,118
Operating expenses:
Costs of production .......................... 6,494 10,139 19,260 27,609
Selling, general and administration .......... 1,274 2,070 4,199 5,565
Depreciation and amortization ................ 189 370 515 837
----------- ----------- ----------- -----------
7,957 12,579 23,974 34,011
Income from operations ........................... 636 1,612 1,794 4,107
Interest income (expense) .................... (59) 78 (196) 36
Other income (expense) ....................... 14 27 33 46
----------- ----------- ----------- -----------
Income before income taxes ....................... 591 1,717 1,631 4,189
Provision for income taxes ................... 33 687 95 1,483
----------- ----------- ----------- -----------
Net income ....................................... $ 558 $ 1,030 $ 1,536 $ 2,706
=========== =========== =========== ===========
Earnings per common share:
Basic ........................................ $ 0.19
===========
Diluted ...................................... $ 0.19
===========
Weighted average number of common shares:
Basic ........................................ 5,295,000
===========
Diluted ...................................... 5,332,762
===========
Pro Forma Data (unaudited)
Income before income taxes ....................... $ 591 $ 1,631 $ 4,189
Pro forma provision for income taxes ......... 242 669 1,803
----------- ----------- -----------
Pro forma net income ............................. $ 349 $ 962 $ 2,386
=========== =========== ===========
Pro forma earnings per common share:
Basic ........................................ $ 0.55
===========
Diluted ...................................... $ 0.54
===========
Proforma weighted average number of common shares:
Basic ........................................ 4,347,431
===========
Diluted ...................................... 4,407,190
===========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
2
CUNNINGHAM GRAPHICS INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW Nine
Months Ended September 30, 1997 and 1998
(in thousands)
(Unaudited)
1997 1998
-------- --------
Cash flows from operating activities
Net income ................................................................ $ 1,536 $ 2,706
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization ......................................... 559 874
Gain on sale of equipment ............................................. (11) --
Deferred income taxes ................................................. (22) 153
Changes in operating assets and liabilities, net of effects of acquisition:
Accounts receivable ................................................... (1,004) (2,379)
Inventory ............................................................. (322) (292)
Prepaid expenses and other assets ..................................... 25 (275)
Other assets .......................................................... 19 198
Advance to officers ................................................... 24 136
Accounts payable ...................................................... 14 (1,024)
Accrued expenses ...................................................... 330 530
Other liabilities ..................................................... -- (40)
-------- --------
Net cash provided by operating activities ................................. 1,148 587
Cash flows from investing activities
Proceeds from the disposition of equipment ............................ 1,349 --
Acquisition of property and equipment ................................. (1,602) (2,944)
Acquisition of Roda Limited, net of cash acquired ..................... -- (6,149)
-------- --------
Net cash used in investing activities ..................................... (253) (9,093)
Cash flows from financing activities
Net proceeds from sale of common stock ................................ -- 29,250
Net principal payments on revolving lines of credit ................... (650) (320)
Proceeds from long-term borrowings, third party ....................... 38 --
Principal payments on long-term borrowings, third-party ............... (192) (2,901)
Principal payments on obligations under capital lease ................. (143) (241)
Principal payments on notes payable - related parties ................. (227) --
Distrubuted to stockholders ........................................... (201) (6,237)
-------- --------
Net cash (used in) provided by financing activities ....................... (1,375) 19,551
-------- --------
Effect of exchange rate changes on cash and cash equivalents .............. -- (41)
-------- --------
Net (decrease) increase in cash and cash equivalent ....................... (480) 11,004
Cash and cash equivalents, beginning of year .............................. 543 67
-------- --------
Cash and cash equivalents, end of period .................................. $ 63 $ 11,071
======== ========
Supplemental disclosure of noncash investing and
financing activities
Issuance of common stock in conjunction with the acquisition
of Roda Limited ....................................................... $ -- $ 2,207
======== ========
Acquisition of equipment under capital leases ............................. $ -- $ 967
======== ========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
3
CUNNINGHAM GRAPHICS INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
1. Organization and Basis of Presentation
Cunningham Graphics International, Inc. (the "Company") was incorporated in New
Jersey on January 12, 1998 with an authorized capital of 30,000,000 shares of
Common Stock, no par value (the "Common Stock") and 10,000,000 shares of
Preferred Stock, no par value. The Company provides a wide range of graphic
communication services to financial institutions and corporations, focusing on
producing and distributing time-sensitive analytical research and marketing
materials and on providing on-demand printing.
On April 22, 1998 Cunningham Graphics, Inc. (the "Predecessor") reorganized (the
"Reorganization") such that all the stockholders of the Predecessor contributed
all of the outstanding shares of common stock of the Predecessor to Cunningham
Graphics International, Inc., in exchange for a total of 2,595,260 shares of
common stock, no par value (the "Common Stock") and promissory notes (the
"Exchange Notes") in the aggregate principal amount of $2.6 million. In the
Reorganization, the Company also assumed the Predecessor's obligations under
promissory notes in the aggregate principal amount of $2.2 million, representing
undistributed S corporation taxable income (the "Distribution Notes").
Collectively the Exchange Notes and Distribution Notes are known as the
"Reorganization Notes." The Company's Registration Statement on Form S-1 (File
No. 333-46541) was declared effective by the Securities and Exchange Commission
on April 21, 1998. The Company's Registration Statement on Form S-1 (File No.
333-50713), filed pursuant to Rule 462(b) under the Securities Act of 1933, as
amended, became effective on April 22, 1998. Pursuant to the foregoing
Registration Statements, the Company's initial public offering (the "Offering")
of 2,530,000 shares of Common Stock, no par value per share, began on April 22,
1998 (See Note 4). Accordingly, the financial statements in this Quarterly
Report on Form 10-Q reflect the results of operations of the Predecessor through
April 22, 1998 (the effective date of the Offering) and the combined results of
the Company from April 23,1998 through September 30, 1998.
On April 27, 1998, the Company closed the acquisition (the "Acquisition") of the
outstanding ordinary share capital of Roda Limited, an English corporation
("Roda") for consideration consisting of cash in the amount of $4.1 million and
169,739 shares of Common Stock, valued at the Offering price of $13.00 per
share. In addition, the Company placed into custody of its lawyers in London
$1.8 million, to be utilized to acquire the outstanding preference share capital
of Roda on or before June 30, 1998. The outstanding preference share capital of
Roda was acquired on June 4, 1998 for $1.8 million. The excess of the purchase
price over the net assets acquired totaled approximately $11.0 million and was
recorded as goodwill. The goodwill is being amortized over a 40-year period.
4
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X of the Securities and Exchange Commission (the "SEC").
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included. The
condensed unaudited financial statements should be read in conjunction with the
final prospectus of Cunningham Graphics International, Inc. dated April 22,
1998. Operating results for the three-month and nine month periods ended
September 30, 1998 are not necessarily indicative of the results that may be
expected for the entire year ending December 31, 1998.
2. Pro forma Income Taxes
Through April 22, 1998, the Company and its shareholders had elected to be taxed
as an S corporation pursuant to the Internal Revenue Code and certain state and
local tax regulations. Therefore, with regards to the Company's actual results
through September 30, 1998, no provision has been made in the accompanying
financial statements for federal and certain state and local income taxes
through April 22, 1998, since such income taxes were the liability of the
Predecessor's stockholders.
As a result of the Reorganization, the Company's S corporation election
terminated on April 22, 1998, and the Company recorded additional deferred tax
assets of $235,000 and additional deferred tax liabilities of $329,000 and a
corresponding net tax charge of $94,000 in the statement of income in accordance
with the provisions of Financial Accountings Standards Board issued Statement
No. 109.
The accompanying condensed consolidated statement of operations for the three
months and nine months ended September 30, 1998 and 1997 include a provision for
income taxes on an unaudited pro forma basis as if the Company had been a C
corporation subject to applicable federal and state income taxes during the
entire periods presented.
3. Pro Forma Earnings Per Share
Pro forma earnings per share is computed using pro forma net income and pro
forma shares outstanding and has been determined based on the methodology
outlined immediately below. However, after April 22, 1998, the number of shares
utilized in determining earnings per share exclude the number of common shares
that the Predecessor would have needed to issue in order to settle the
Reorganization Notes.
5
The pro forma shares used is based on the weighted average of (i) the initial
Cunningham Graphics International, Inc. founding share, (ii) 2,595,260 shares
issued to stockholders of the Predecessor in the Reorganization, (iii) 369,231
shares, representing the value of the $4.8 million principal amount of the
Reorganization Notes at the Offering price of $13.00 per share, (iv) 169,739
shares issued in connection with the Acquisition, and (v) the 2,530,000 shares
issued in connection with the Offering, inclusive of 330,000 shares subject to
an over-allotment option.
4. Initial Public Offering
On April 27, 1998, the Company closed the Offering of 2,530,000 shares of Common
Stock inclusive of 330,000 shares subject to an over-allotment option that was
exercised, at a price of $13.00 per share. The Reorganization Notes were paid
from the net proceeds of the Offering.
5. Pro Forma Consolidated Results of Operations
The following table presents the unaudited pro forma consolidated results of
operations for the year ended December 31, 1997 and the nine month period ended
September 30, 1998, as if the Acquisition of Roda had occurred on January 1,
1997: (in thousands, except earnings per share)
For the year Nine months
Ended Ended
December 31, September 30,
1997 1998
------------ --------------
Sales $42,705 $40,860
Pro forma net income $ 1,576 $ 2,359
Pro forma earnings per share common share $ .44 $ .54
The pro forma net income amounts reflect (i) the elimination of Roda's goodwill
amortization of $90,000 for the full year 1997 and $31,000 for the period
January 1, 1998 through April 26, 1998 related to the 1996 management buyout of
Roda, (ii) the Company's recognition of amortization of goodwill from the
Acquisition of $272,000 for full year 1997 and $92,000 for the period January 1
through April 26, (iii) the elimination of $106,000 for full year 1997 of
minority interest in the earnings of Roda and (iv) a pro forma provision for
income taxes for the Company and Roda on a combined basis computed utilizing
effective tax rates of 41% for United States income taxes and 31% for United
Kingdom income taxes for both the full year 1997 and the nine month period ended
September 30, 1998. The pro forma results are not necessarily indicative of the
results of operations that would have occurred had the acquisition taken place
on January 1, 1997 nor are they intended to be indicative of results that may
occur in the future.
The pro forma shares used for both the full year 1997 and for the nine months
periods ended September 30, 1998 has been determined based on the methodology
outlined immediately below. However, after April 22, 1998, the number of shares
utilized in determining earnings per share exclude the number of common shares
that the Predecessor would have needed to issue in order
6
to settle the Reorganization Notes and after April 27, 1998 the number of shares
exclude the number of common shares corresponding to the $5.9 million cash paid
to Roda stockholders in connection with the Acquisition.
Pro forma shares used is based on the weighted average of (i) the initial
Cunningham Graphics International, Inc. founding share, (ii) 2,595,260 shares to
be issued in the Reorganization, (iii) 369,231 shares representing the number of
shares having a value, at the initial public offer price of $13.00,
corresponding to the principal amount of the Reorganization Notes, (iv) 169,739
shares issuable in connection with the Acquisition, and (v) 456,992 shares,
representing the number of shares having a value at the offering price of $13.00
per share, corresponding to the $5.9 million liability for cash payable to the
Roda stockholders in connection with the Acquisition and (vi) the 2,530,000
shares issued in connection with the Offering, inclusive of 330,000 shares
subject to an over-allotment option.
6. Reporting Comprehensive Income:
The Company adopted Statement of Financial Standards (SFAS) No. 130, "Reporting
Comprehensive Income" in April 1998. SFAS No. 130 establishes standards for
reporting and display of comprehensive income (all changes in equity during a
period except those resulting from investments by owners and distributions to
owners) and its components in the financial statements. This new standard is
effective for the Company for 1998 and it is currently anticipated to only
impact the Company's financial statements related to the reporting of exchange
rate translation gains and losses of Roda. For the three and nine months ended
September 30, 1998 the Company reported comprehensive income totaling
$1,056,000, and $2,732,000 respectively, consisting of net income plus equity
adjustments from foreign currency translations on an after-tax basis. There were
no non-owner investments and distributions changes in equity for all of 1997,
therefore comprehensive income equaled net income for the three and nine-month
periods ended September 30, 1997.
Item 2. Management's Discussion and Analysis and Analysis of Financial
Conditions of Operations.
Overview
Unless otherwise indicated or the context otherwise requires, all references
herein to the "Company" mean Cunningham Graphics International, Inc. and its
subsidiaries collectively subsequent to its initial public offering and the
acquisition (the "Acquisition") of Roda Limited, an English company ("Roda"),
and Cunningham Graphics, Inc. (the "Predecessor") alone, with respect to periods
prior thereto.
The Company provides a wide range of graphic communications services to
financial institutions and corporations, focusing on producing and distributing
time-sensitive analytical research and marketing materials and providing
on-demand printing services. To date, the Company has experienced significant
domestic growth through the (i) expansion of its existing customer base, (ii)
addition of products and services, (iii) assimilation of in-house printing
operations, (iv)
7
acquisition of selected assets and (v) establishment of strategic alliances
which, in the case of Roda, led to the Acquisition on April 27, 1998.
On April 22, 1998 the Predecessor reorganized (the "Reorganization") such that
it became a wholly owned subsidiary of the Company. On April 27, 1998, the
Company completed an initial public offering of 2,530,000 shares of its Common
Stock (the "Offering") at a price of $13.00 per share. The net proceeds of the
Offering to the Company after deducting underwriting discounts and commissions
and other expenses were $29.3 million.
Until the Reorganization, the Predecessor was taxed as an S corporation. The
Reorganization caused a termination of the S corporation status. As a result,
the Company became subject to additional federal and state income taxes. The
Company recorded additional deferred tax assets of approximately $235,000 and
additional deferred tax liabilities of approximately $329,000 and a
corresponding net tax charge of approximately $94,000 in its statement of
income. This tax expense is reflected in the Company's provision for income
taxes on the Condensed Statement of Income for the nine months ended September
30, 1998.
The Company's net sales are derived primarily from providing printing and
distribution services for customers in the financial services, insurance and
publishing industries, a substantial component of which is the printing and
distribution of financial and analytical research and marketing materials for
the financial services industry. The Company also derives part of its net sales
from providing fulfillment services, including labeling, mailing, inserting, kit
assembly, and inventory management for its customers. Finally the Company
provides computer and data output services and other document related services
for customers.
The Company's operating expenses consist of the following: (i) costs of
production, (ii) selling, general and administrative expenses and (iii)
depreciation and amortization. Costs of production consist primarily of the cost
of paper and other production materials, labor, outside services, insurance and
other production expenses including repairs and maintenance and rent. Selling,
general and administrative expenses consist primarily of management,
administrative and marketing expenses, salaries for officers, salaries and
commissions earned by sales persons and professional fees.
8
Results of Operations
The following tables set forth certain items from the Company's Statements of
Income as a percentage of net sales for the periods indicated:
Three Months ended September 30, 1998 compared to three months ended September
30, 1997
For Three Months Ended
September 30,
----------------------
1997 1998
------ ------
Net sales 100.0% 100.0%
Costs of production 75.6 71.4
Selling, general and administrative 14.8 14.6
Depreciation and amortization 2.2 2.6
------ ------
Income from operations 7.4 11.4
Interest income (expense) (0.7) 0.5
Other income (expense) 0.2 0.2
------ ------
Income before income taxes 6.9 12.1
Provision for income taxes 0.4 4.8
------ ------
Net Income 6.5% 7.3%
====== ======
Pro Forma Data:
Income before income taxes 6.9%
Pro forma provision for income taxes 2.8
------
Pro forma net income 4.1%
======
Net sales. The Company reported net sales of $14.2 million for the three months
ended September 30, 1998 compared to $8.6 million for the same period in 1997,
an increase of $5.6 million or 65.1%. The increase was attributable to the
inclusion of $2.5 million of Roda's net sales in 1998, together with an increase
of $3.1 million in net sales from domestic operations.
Costs of production. Costs of production were $10.1 million for the three months
ended September 30, 1998, as compared to $6.5 million for the same period in
1997, an increase of $3.6 million or 55.4%. Costs of production were
approximately 71.4% of net sales for the three months ended September 30, 1998,
compared to 75.6% for the same period in 1997. The reduction of costs of
production as a percentage of net sales was attributable to the inclusion of
Roda's lower percentage costs of production in 1998 and certain improvements and
benefits resulting from the fixed nature of certain costs in the domestic
operations.
Selling, general and administrative expenses. Selling, general and
administrative expenses were $2.1 million for the three months ended September
30, 1998, as compared to $1.3 million for the same period in 1997, an increase
of $0.8 million or 61.5%. This increase was a result of the inclusion of Roda's
operations and an investment in new marketing and management personnel in London
and domestically. Selling, general and administrative expenses were 14.6 % of
net sales for the three months ended September 30, 1998 compared to 14.8% for
the same period in
9
1997. The decrease in selling, general and administrative expenses as a
percentage of net sales reflects the benefits resulting from the fixed nature of
certain costs associated with the increase in net sales domestically and from
the Acquisition.
Depreciation and amortization: Depreciation and amortization expenses were
$370,000 for the three months ended September 30, 1998, as compared to $189,000
for the same period in 1997, an increase of $181,000, or 95.8%. The increase was
the result of the inclusion of Roda's depreciation expenses after the
Acquisition, goodwill amortization associated with the Acquisition and the
purchase of new equipment.
Provision for income taxes. On April 22, 1998 the Company converted from an S
corporation to a C corporation for tax purposes (the "Conversion") in
conjunction with the Reorganization. For comparative purposes pro forma
provision for income taxes was calculated as if the Conversion had occurred on
January 1, 1997. The provision for income taxes was $687,000 for the three
months ended September 30, 1998, as compared to the pro forma provision for
income taxes of $242,000 for the same period in 1997. As a percentage of profits
before taxes the tax rate was 40% for the three months ended September 30, 1998
and 41.0% for the same period in 1997. The decrease is the result of the
inclusion of Roda, which has a lower tax rate.
Net income. Net income was $1.0 million or $0.19 per share on a diluted basis
with 5,332,762 weighted average common shares outstanding for the quarter ended
September 30, 1998 compared to pro forma net income of $349,000 for the same
period of the previous year.
10
Nine Months ended September 30, 1998 compared to nine months ended September 30,
1997
For Nine Months Ended
September 30,
--------------------
1997 1998
----- -----
Net sales 100.0% 100.0%
Costs of production 74.7 72.4
Selling, general and administrative 16.3 14.6
Depreciation and amortization 2.0 2.2
----- -----
Income from operations 7.0 10.8
Interest income (expense) (0.8) 0.1
Other income (expense) 0.1 0.1
----- -----
Income before income taxes 6.3 11.0
Provision for income taxes 0.4 3.9
----- -----
Net income 5.9% 7.1%
===== =====
Pro Forma Data:
Income before income taxes 6.3% 11.0%
Pro forma provision for income taxes 2.6 4.7
----- -----
Pro forma net income 3.7% 6.3%
===== =====
Net sales. The Company reported net sales of $38.1 million for the nine months
ended September 30, 1998 compared to $25.8 million for the same period in 1997,
an increase of $12.3 million or 47.7%. The increase was attributable to, the
inclusion of $4.3 million of Roda's net sales after the Acquisition together
with an increase of $8.0 million in net sales from domestic operations.
Costs of production. Costs of production were $27.6 million for the nine months
ended September 30, 1998, as compared to $19.3 million for the same period in
1997, an increase of $8.3 million or 43.0%. Costs of production were 72.4% of
net sales for the nine months ended compared to 74.7% for the same period in
1997. The reduction of costs of production as a percentage of net sales was
attributable to the inclusion of Roda's lower percentage costs of production for
the period subsequent to the Acquisition and certain improvements and benefits
resulting from the fixed nature of certain costs.
Selling, general and administrative expenses. Selling, general and
administrative expenses were $5.6 million for the nine months ended September
30, 1998, as compared to $4.2 million for the same period in 1997, an increase
of $1.4 million or 33%. Selling, general and administrative expenses were 14.6 %
of net sales for the nine months ended September 30, 1998 compared to 16.3% for
the same period in 1997. The decrease in selling, general and administrative
expenses as a percentage of net sales reflects the benefits resulting from the
fixed nature of certain costs associated with the increase in net sales
domestically and from the Acquisition. The selling, general and administrative
expenses in absolute dollars increased by $1.4 million when compared to the same
period in 1997. This increase reflects the inclusion of Roda's selling,
11
general and administration expenses after the Acquisition and an investment in
new marketing and management personnel in London and domestically.
Depreciation and amortization: Depreciation and amortization expenses were
$837,000 for the nine months ended September 30, 1998, as compared to $515,000
for the same period 1997, an increase of $322,000, or 62.5%. The increase was
the result of, the inclusion of Roda's depreciation expense after the
Acquisition, goodwill amortization associated with the Acquisition and the
purchase of new equipment.
Pro forma provision for income taxes. On April 22, 1998 the Company converted
from an S corporation to a C corporation for tax purposes (the "Conversion") in
conjunction with the Reorganization. For comparative purposes pro forma
provision for income taxes was calculated as if the Conversion occurred on
January 1, 1997. The pro forma provision for income taxes was $1.8 million for
the nine months ended September 30, 1998, as compared to $669,000 for the same
period in 1997. As a percentage of profit before taxes the tax rate was 43% for
the nine months period ended September 30, 1998, as compared to 41% for same
period in 1997. The increase in pro forma provision for income taxes, as a
percentage of profit before taxes, was due to a special one time charge of
$94,000 charge attributable to the Conversion, partially offset by inclusion of
Roda's operations at a 31% tax rate after the Acquisition.
Pro forma net income. Pro forma net income was $2.4 million or $.54 per share on
a diluted basis with 4,407,190 weighted average common shares outstanding for
the nine months ended September 30, 1998 compared to pro forma net income of
$962,000 for the same period of the previous year.
Liquidity and Capital Resources
As a result of the Offering, the Company received approximately $29.3 million
net proceeds, after deducting underwriting discounts and commissions and other
offering expenses. The Company used $6.1 million to pay for the acquisition of
Roda, $4.8 million to pay notes to stockholders of the Predecessor, $3.6 million
to repay indebtedness of the Company and Roda, $2.2 million for payment to trade
creditors to take advantage of discounts, and $2.7 million for equipment
purchases. See "Part II, Item 2, Changes in Securities and Use of Proceeds." The
Company expects to use the remaining net proceeds from the Offering to fund its
growth strategy.
Until the closing of the Offering, the Company financed its operations,
including working capital and equipment acquisitions, using bank borrowing,
vendor financing, financing lease transactions, as well as from cash flow
generated from operating activities, and stockholder debt and equity
contributions.
Net cash provided by operating activities was $587,000 for the nine months ended
September 30, 1998 and $1.2 million for the same period in 1997.
12
Net cash used in investing activities was $9.1 million for the nine months ended
September 30, 1998 and $253,000 for the same period in 1997. The net cash used
in investing activities for the nine months ended September 30, 1998 consists of
$6.1 million for the Acquisition of Roda and $2.9 million for the acquisition of
property and equipment. The net cash used in investing activities for the nine
months ended September 30, 1997 is net of cash generated from the sale and
leaseback of certain equipment for $1.3 million.
Net cash provided by financing activities was $19.6 million for the nine months
ended September 30, 1998, as compared to net cash used in financing activities
of $1.4 million for the same period in 1997. Net cash provided by financing
activities is attributable to the $29.3 million net proceeds of the Offering,
reduced by, $2.2 million to repay the Summit Bank indebtedness, $1.4 million to
repay certain indebtedness of Roda and $4.8 million to repay indebtedness to the
stockholders of the Predecessor incurred in the Reorganization.
On July 9, 1998 the Company entered into a $30.0 million revolving line of
credit facility with a bank. The revolving line of credit may be used for
acquisitions and includes sub-limits of $5.0 million for purchase of equipment
and $7.5 million for working capital. The facility has a term of three years
through July 9, 2001 and has annual extension options. The revolving line of
credit contains certain covenants that include, among other things, limitations
on the disposition of material amounts of assets and the incurrence of
additional indebtedness. In addition certain financial covenants, as to minimum
net worth, maximum leverage and debt coverage ratios must be maintained.
Complying with the net worth covenant could restrict the ability of the Company
to pay dividends on common stock, although the Company does not have the
intention of paying dividends for the foreseeable future. As of November 10,
1998, $27.9 million remained available for borrowing under the line of credit
subject to the sub-limits stated above.
Roda has a credit facility with the Bank of Scotland (the "Roda Facility")
consisting of a $2.0 million ((pound)1.2 million) term loan and a $750,000
((pound)450,000) revolving line of credit. The line of credit is reviewed by the
bank annually for renewal, but is payable on demand. The debt is collateralized
by substantially all of Roda's assets. As of September 30, 1998, approximately
$460,000 ((pound)271,000) was outstanding on the credit facility and $1.3
million ((pound)779,000) was outstanding under the term loan. The term loan is
payable in equal monthly installments through October 20, 2001. On August 10,
1998 the Company, through its revolving credit facility with its principal
domestic lender, issued a Standby Letter of Credit to Bank of Scotland to
guarantee the Roda Facility and in consideration therefor, the Bank of Scotland
eliminated existing financial covenants under such line of credit.
13
Year 2000 Issue
General Description of the Year 2000 Issue and the Nature and Effects of the
Year 2000 on Information Technology (IT) and Non-IT Systems
The Year 2000 Issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Company's
computer programs or hardware that have date-sensitive software or embedded
chips may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations causing
disruptions of operation, including, among other things, a temporary inability
to process transactions, send invoices, or engage in similar normal business
activities.
The Company has undertaken various initiatives intended to ensure that its
computer equipment and software will function properly with respect to dates in
the Year 2000 and thereafter. For this purpose, the term "computer equipment and
software" includes systems that are commonly thought of as IT systems, including
accounting, data processing, and telephone/PBX systems, cash registers,
hand-held terminals, scanning equipment, and other miscellaneous systems, as
well as systems that are not commonly thought of as IT systems, such as alarm
systems, fax machines, or other miscellaneous systems. Both IT and non-IT
systems may contain imbedded technology, which complicates the Company's Year
2000 identification, assessment, remediation, and testing efforts.
Based on recent assessments, the Company determined that it will be required to
modify or replace portions of its software and certain hardware so that those
systems will properly utilize dates beyond December 31, 1999. The Company
presently believes that with modification or replacements of existing software
and certain hardware, the Year 2000 Issue can be mitigated. However, if such
modifications and replacements are not made, or are not completed timely, the
Year 2000 Issue could have a material impact on the operations of the Company.
The Company's plan to resolve the Year 2000 Issue involves the following four
phases: assessment, remediation, testing, and implementation. To date, the
Company has fully completed its assessment of all systems that could be
significantly affected by the Year 2000. The completed assessment indicated that
most of the Company's significant information technology systems could be
affected, particularly the general ledger, billing, and production and
manufacturing systems. The Company prints and distributes time-sensitive
analytical research and marketing materials, and accordingly does not have any
exposure as it relates to the products being sold. In addition, the Company has
gathered information about the Year 2000 compliance status of its significant
suppliers and subcontractors and continues to monitor their compliance.
Status of Progress in Becoming Year 2000 Compliant, Including Timetable for
Completion of Each Remaining Phase
For its information technology exposures, to date the Company has received the
upgrade from its software manufacturer and expects to complete the upgrade no
later than December 31, 1998. Once the software is upgraded, the Company will
begin its testing and implementation.
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Completion of the testing phase for all significant systems is expected to be
complete by March 31, 1999, with all remediated systems fully tested and
implemented by June 30, 1999, with 100% completion targeted for September 30,
1999.
The Company is currently in the process of assessing its operating equipment and
believes there is minimal risk with regards to the Year 2000 Issue. As such, the
Company is 70% complete in the remediation and testing phase of its operating
equipment and is expected to be completed by March 31, 1999.
Nature and Level of Importance of Third Parties and their Exposure to the Year
2000.
The Company has had communications with all of its significant customers to
determine the extent to which the Company's interface systems are vulnerable to
any failure by third parties. The Company believes that its significant
customers are addressing the issues and will timely adjust their systems.
The Company has queried its significant suppliers and subcontractors that do not
share information systems with the Company (external agents). To date, the
Company is not aware of any external agent with a Year 2000 Issue that would
materially impact the Company's results of operation, liquidity, or capital
resources. However, the Company has no means of ensuring that external agents
will be Year 2000 ready. The inability of external agents to complete their Year
2000 resolution process in a timely fashion could materially impact the Company.
The effect of non-compliance by external agents is not determinable.
Costs of the Year 2000 Issue
The cost of the upgrade to the Company is included in its maintenance contract
with its software vendor and will not have a material impact on the Company's
future financial results. The Company also believes that the miscellaneous
hardware required to be purchased to become year 2000 compliant is not material.
Risks of the Year 2000
Management of the Company believes it has an effective program in place to
resolve the Year 2000 issue in a timely manner. As noted above, the Company has
not yet completed all necessary phases of the Year 2000 program. In the event
that the Company does not complete any additional phases, the Company would be
unable to take customer orders, manufacture and ship products, invoice customers
or collect payments. In addition, disruptions in the economy generally resulting
from Year 2000 issues could also materially adversely affect the Company. The
Company could be subject to litigation for computer systems product failure, for
example, equipment shutdown or failure to properly date business records. The
amount of potential liability and lost revenue cannot be reasonably estimated at
this time.
15
Contingency Plan
The Company currently has no contingency plans in place in the event it does not
complete all phases of the Year 2000 program. The Company plans to evaluate the
status of completion in June 1999 and determine whether such a plan is
necessary.
Recent Pronouncements of the Financial Accounting Standards Board
Recent pronouncements of the Financial Accounting Standards Board ("FASB") which
were not required to be adopted at December 31, 1997, include the following
Statements of Financial Accounting Standards ("SFAS").
SFAS No. 131, "Disclosure about Segments of an Enterprise and Related
Information" which will be effective for the Company for the year ending
December 31, 1998, establishes standards for reporting information about
operating segments in the annual financial statements, selected information
about operating segments in the interim financial reports and disclosures about
products and services, geographic areas and major customers. This new standard
will require the Company to report financial information on the basis that is
used internally for evaluating segment performance and deciding how to allocate
resources to segments, which may result in more detailed information in the
notes to the Company's financial statements than is currently required and
provided. The Company does not believe there will be any effect on its financial
reporting upon the implementation of SFAS 131.
Forward Looking Statements
When used in this and in future filings by the Company with the Securities and
Exchange Commission, in the Company's press releases and in oral statements made
with the approval of an authorized executive officer of the Company, the words
or phrases "will likely result." "expects," "plans," "will continue," " is
anticipated," "estimated," "project" or "outlook" or similar expressions
(including confirmations by an authorized executive officer of the Company of
any such expressions made by a third party with respect to the Company) are
intended to identify forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. The Company wishes to caution
readers not to place undue reliance on any such forward-looking statements, each
of which speak only as of the date made. Such statements are subject to certain
risks and uncertainties that could cause actual results to differ materially
from historical earnings and those presently anticipated or projected. The
Company has no obligation to publicly release the result of any revisions that
may be made to any forward-looking statements to reflect anticipated or
unanticipated events or circumstances occurring after the date of such
statements.
16
PART II OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds.
(d) The Securities and Exchange Commission declared the Company's Registration
Statement on Form S-1 (File No. 333-46541) effective on April 21, 1998. The
Company's Registration Statement on Form S-1 (File No. 333-50713), filed
pursuant to Rule 462(b) under the Securities Act of 1933, as amended, became
effective on April 22, 1998. Pursuant to the foregoing Registration Statements,
the Company's initial public offering (the "Offering") of Common Stock, no par
value per share, began on April 22, 1998. All of the 2,530,000 shares of Common
Stock offered by the Company, inclusive of 330,000 shares subject to an
over-allotment option, were sold on April 22 and 23, 1998. The managing
underwriters for the Offering were Schroder & Co. Inc. and Prudential Securities
Incorporated.
The aggregate offering price of the securities sold was $32,890,000. The
Company incurred underwriting discounts and commissions of $2,302,300 and
reasonably estimates that it incurred $1,250,000 on account of Securities and
Exchange Commission registration fees, NASD filing fee, Nasdaq National Market
Fee, "Blue Sky" fees, legal and accounting fees, printing costs and transfer
agent fees. None of the expenses were incurred to directors, officers or persons
owning 10% or more of any class of the Company's securities.
17
The net proceeds of the Offering after deducting expenses was $29,337,700,
which has been applied to date, as follows:
(A) Acquisition of ordinary share capital
of Roda Limited, an English corporation
("Roda"): $ 4,103,148
(B) Acquisition of preference share capital
of Roda: $ 1,837,745
(C) Advance to Roda for repayment of
indebtedness: $ 1,429,305
(D) Acquisition cost associated with Roda $ 166,000
(E) Payment of indebtedness due to
stockholders of the Company prior to
the offering: $ 4,800,000
(F) Payment of indebtedness to bank: $ 2,200,000
(G) Payment of trade creditors to take
advantage of discounts: $ 2,162,391
(H) Equipment purchases $ 2,735,000
------------
TOTAL $ 19,433,589
============
The remaining $9.9 million net proceeds have been invested in short term high
grade Commercial Paper and money market funds.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K
None
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