1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended January 30, 1999
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: 0-15077
SHOREWOOD PACKAGING CORPORATION
(Exact name of registrant as specified in its Charter)
DELAWARE 11-2742734
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
277 PARK AVENUE
NEW YORK, NEW YORK 10172
(Address of principal executive offices)
(212) 371-1500
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 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 |_|
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
MARCH 1, 1999 27,431,000
Date Number of Shares
Page 1 of 20
2
SHOREWOOD PACKAGING CORPORATION
AND SUBSIDIARIES
INDEX PAGE
Part I: Financial Statements
Consolidated Balance Sheets
January 30, 1999 (Unaudited) and
May 2, 1998 (Audited) 3
Consolidated Condensed Statements of Earnings
13 weeks ended January 30, 1999 (Unaudited) and
13 weeks ended January 31, 1998 (Unaudited) 4
Consolidated Condensed Statements of Earnings
39 weeks ended January 30, 1999 (Unaudited) and
39 weeks ended January 31, 1998 (Unaudited) 5
Consolidated Condensed Statements of Cash Flows
39 weeks ended January 30, 1999 (Unaudited) and
39 weeks ended January 31, 1998 (Unaudited) 6
Notes to Consolidated Condensed Financial Statements 7 - 11
Management's Discussion and Analysis of Financial
Condition and Results of Operations 12 - 18
Part II: Other Information 19
Certain statements under the caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations," and elsewhere in this Form 10-Q,
constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. These statements are typically
identified by their inclusion of phrases such as "the Company anticipates," "the
Company believes" and other phrases of similar meaning. Such forward-looking
statements involve known and unknown risks, uncertainties, and other factors
that may cause the actual results, performance or achievements of the Company to
be materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. Such factors include,
among others: general economic and business conditions; competition; political
changes in international markets; raw material and other operating costs; costs
of capital equipment; changes in foreign currency exchange rates; changes in
business strategy or expansion plans; the results of continuing environmental
compliance testing and monitoring; quality of management; availability, terms,
and development of capital; fluctuating interest rates; and other factors
referenced in this Form 10-Q.
Page 2 of 20
3
SHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE DATA)
JANUARY 30, MAY 2,
1999 1998
(UNAUDITED) (AUDITED)
ASSETS
Current Assets:
Cash and cash equivalents $ 10,769 $ 7,268
Accounts receivable, net 46,728 32,054
Inventories 51,059 46,591
Deferred tax assets 317 317
Refundable income taxes -- 411
Prepaid expenses and other current assets 5,824 9,202
--------- ---------
Total Current Assets 114,697 95,843
Property, Plant and Equipment, net 249,973 200,293
Excess of Cost Over the Fair Value of Net Assets Acquired, net 119,888 18,295
Other Assets 13,046 11,553
--------- ---------
$ 497,604 $ 325,984
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 39,559 $ 33,100
Accrued expenses 29,378 13,887
Income taxes payable 4,238 2,864
Current maturities of long-term debt 20,000 15,000
--------- ---------
Total Current Liabilities 93,175 64,851
Long-Term Debt 247,878 126,437
Other Long-Term Liabilities 1,300 794
Deferred Income Taxes 22,750 21,395
--------- ---------
Total Liabilities 365,103 213,477
--------- ---------
Temporary Equity Relating to Put Options -- 2,710
Commitments and Contingencies
Stockholders' Equity:
Series A preferred stock, $10 par value; 50,000 shares
authorized, none issued -- --
Preferred stock, $10 par value; 5,000,000 shares authorized
none issued -- --
Common stock, $.01 par value; 60,000,000 shares authorized;
35,502,542 issued and 27,416,668 outstanding in January and
34,106,974 issued and 27,092,100 outstanding in May 355 341
Additional paid-in capital 74,438 52,448
Retained earnings 141,793 121,976
Cumulative foreign currency translation adjustment (7,458) (4,274)
Treasury stock (8,085,874 and 7,014,874 shares at
cost in January and May) (76,627) (60,694)
--------- ---------
Total Stockholders' Equity 132,501 109,797
--------- ---------
$ 497,604 $ 325,984
========= =========
The accompanying notes are an integral part of these financial statements.
Page 3 of 20
4
SHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF EARNINGS
(IN THOUSANDS EXCEPT PER SHARE DATA)
(UNAUDITED)
13 WEEKS 13 WEEKS
ENDED ENDED
JANUARY 30, JANUARY 31,
1999 1998
Net Sales $ 141,397 $ 96,629
--------- ---------
Costs and Expenses:
Cost of Sales 107,039 74,934
Selling, General and Administrative 18,586 11,095
Amortization of Excess of Cost Over the Fair Value of
Net Assets Acquired 797 188
--------- ---------
Earnings from Operations 14,975 10,412
Other Income (Expense), net (277) 377
Interest Expense (4,166) (1,857)
--------- ---------
Earnings Before Provision for Income Taxes 10,532 8,932
Provision for Income Taxes 4,108 3,394
--------- ---------
Net Earnings $ 6,424 $ 5,538
========= =========
EARNINGS PER SHARE INFORMATION:
BASIC
Net Earnings Per Common Share $ .24 $ .20
========= =========
DILUTED
Net Earnings Per Common Share $ .23 $ .20
========= =========
WEIGHTED AVERAGE SHARES OUTSTANDING
BASIC 26,995 27,026
========= =========
DILUTED 27,872 27,695
========= =========
The accompanying notes are an integral part of these financial statements.
Page 4 of 20
5
SHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF EARNINGS
(IN THOUSANDS EXCEPT PER SHARE DATA)
(UNAUDITED)
39 WEEKS 39 WEEKS
ENDED ENDED
JANUARY 30, JANUARY 31,
1999 1998
Net Sales $ 402,134 $ 312,053
--------- ---------
Costs and Expenses:
Cost of Sales 307,246 240,448
Selling, General and Administrative 46,855 33,634
Amortization of Excess of Cost Over the Fair Value of
Net Assets Acquired 1,431 561
--------- ---------
Earnings from Operations 46,602 37,410
Other Income, net 582 1,105
Interest Expense (9,257) (5,762)
--------- ---------
Earnings Before Provision for Income Taxes, Extraordinary Item
and Cumulative Effect of a Change in Accounting Principle 37,927 32,753
Provision for Income Taxes 14,793 12,446
--------- ---------
Earnings Before Extraordinary Item and Cumulative Effect of a
Change in Accounting Principle 23,134 20,307
Extraordinary Item, net of Income Tax Benefit of $177 (277) --
Cumulative Effect on Prior Years Related to the Adoption of
SOP 98-5 Reporting on the Cost of Start-Up Activities (3,040) --
--------- ---------
Net Earnings $ 19,817 $ 20,307
========= =========
EARNINGS PER SHARE INFORMATION:
BASIC
Earnings Before Extraordinary Item and Cumulative Effect of a
Change in Accounting Principle $ .87 $ .75
Extraordinary Item (0.01) --
Cumulative Effect of a Change in Accounting Principle (0.12) --
--------- ---------
Net Earnings Per Common Share $ .74 $ .75
========= =========
DILUTED
Earnings Before Extraordinary Item and Cumulative Effect of a
Change in Accounting Principle $ .85 $ .73
Extraordinary Item (0.01) --
Cumulative Effect of a Change in Accounting Principle (0.12) --
--------- ---------
Net Earnings Per Common Share $ .72 $ .73
========= =========
WEIGHTED AVERAGE SHARES OUTSTANDING
BASIC 26,647 27,100
========= =========
DILUTED 27,355 27,759
========= =========
The accompanying notes are an integral part of these financial statements.
Page 5 of 20
6
SHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
39 WEEKS 39 WEEKS
ENDED ENDED
JANUARY 30, JANUARY 31,
1999 1998
Cash flows from operating activities:
Net earnings $ 19,817 $ 20,307
Adjustments to reconcile earnings to net cash flows
provided from operations:
Non-cash cumulative effect of change in
accounting principle 3,040 --
Non-cash extraordinary item, net of tax 277
Depreciation and amortization 16,682 13,166
Deferred income taxes 1,977 4,517
Changes in operating assets and liabilities, net of business
acquired:
Accounts receivable 5,268 5,538
Inventories 744 (1,197)
Prepaid expenses and other current assets 2,483 (3,066)
Other assets (2,304) (552)
Accounts payable, accrued expenses and other
long term liabilities (3,936) 811
--------- ---------
Net cash flows provided from operating activities 44,048 39,524
--------- ---------
Cash Flows from Investing Activities:
Capital expenditures (32,862) (54,257)
Business acquisition, net of cash acquired (120,729) --
--------- ---------
Net cash flows used in investing activities (153,591) (54,257)
--------- ---------
Cash Flows from Financing Activities:
Net proceeds from revolver borrowings 114,591 26,710
Additions to long-term borrowings 100,000 --
Repayments of long-term borrowings (87,728) --
Purchase of treasury stock (15,933) (13,416)
Issuance of common stock 2,004 1,679
--------- ---------
Net cash flows provided from financing activities 112,934 14,973
--------- ---------
Effect of exchange rate changes on cash and cash equivalents 110 274
--------- ---------
Increase in cash and cash equivalents 3,501 514
Cash and cash equivalents at beginning of period 7,268 3,153
--------- ---------
Cash and cash equivalents at end of period $ 10,769 $ 3,667
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid, net of capitalized amounts $ 6,844 $ 3,789
========= =========
Income taxes paid $ 11,077 $ 6,189
========= =========
The accompanying notes are an integral part of these financial statements.
Page 6 of 20
7
SHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
1. BASIS OF PRESENTATION
In the opinion of the Company, the accompanying unaudited consolidated condensed
financial statements contain all adjustments (consisting only of normal
recurring adjustments) necessary to present fairly the financial position, the
results of operations, and the changes in cash flows at January 30, 1999 and for
all periods presented.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. These financial statements should be read in
conjunction with the Consolidated Financial Statements and Notes included in the
Company's May 2, 1998 Annual Report to Stockholders on Form 10-K as filed with
the Securities and Exchange Commission ("1998 Form 10-K").
The results of operations for the 13 week period and 39 week period ended
January 30, 1999 are not necessarily indicative of the results for the full
year.
2. BUSINESS ACQUISITION
In October 1998, the Company purchased substantially all of the assets and
assumed substantially all of the liabilities of Queens Group, Inc. ("Queens")
for a purchase price of $129.5 million comprised of approximately $113.7 million
in cash including the assumption of debt, and 1.0 million shares of Company
common stock. In addition, the Company incurred expenses associated with the
transaction of approximately $2.5 million. Simultaneously with the closing of
the transaction, the Company repaid all outstanding bank debt of Queens,
approximating $19.0 million. Queens was engaged in the manufacture of value
added printed packaging primarily for the home entertainment industry. The
transaction was financed through a new credit facility as described below.
The acquisition was recorded using the purchase method of accounting and,
accordingly, the results of operations of Queens are included in the
consolidated results of operations of the Company since the date of acquisition.
The purchase price of the acquisition has been allocated to the net assets
acquired based upon the related fair values which is subject to refinement based
upon the receipt of final appraisals and other analyses. The excess of cost over
the fair value of net assets acquired approximated $103.3 million and is being
amortized over 40 years.
The following unaudited pro forma information for the 39 weeks ended January 30,
1999 and January 31, 1998 includes the operations of the Company, inclusive of
the operations of Queens, as if the acquisition had occurred at the beginning of
the respective periods presented. The pro forma gives effect to the amortization
expense associated with the excess of cost over the fair value of net assets
acquired, adjustments related to the fair market value of the assets and
liabilities acquired (which is subject to further refinement), shares issued in
connection with the transaction, interest expense related to financing the
acquisition, and related income tax effects.
Page 7 of 20
8
SHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(continued)
39 WEEKS 39 WEEKS
ENDED ENDED
JANUARY 30, 1999 JANUARY 31, 1998
Revenues $ 467,637 $428,222
========= ========
Earnings from Operations $ 51,122 $ 46,474
========= ========
Net Earnings Before Extraordinary Items and Cumulative
Effect of a Change in Accounting Principle $ 24,012 $ 22,458
========= ========
Net Earnings Per Share Before Extraordinary Items and
Cumulative Effect of a Change in Accounting Principle
Basic $ .87 $ .80
========= ========
Diluted $ .85 $ .78
========= ========
3. NEW CREDIT FACILITY AND INTEREST RATE DERIVATIVES
In October 1998, in order to facilitate the acquisition of Queens as described
in Note 2 and other global opportunities which may arise over the next several
years, the Company entered into a new credit agreement with its lending banks to
replace its existing credit facility. The new credit facility provides for up to
$325 million of borrowings and consists of a $100 million term loan to be paid
in equal quarterly installments over five years and a $225 million revolving
credit facility maturing at the end of five years. The revolving credit is
available, in its entirety, without any borrowing base limitation. Borrowings
pursuant to the facility will bear interest at the discretion of the Company, at
either the Bank's prime rate (7.75% at January 30, 1999) or at the LIBOR rate
(three month term of 4.97% at January 30, 1999) plus 62.5 to 125 basis points
based upon financial ratios as defined in the underlying Agreement. Initially,
borrowings bear interest at 125 basis points above the LIBOR rate. Unused
commitment fees will range from 20 to 30 basis points (initially 30 basis points
based upon the same financial ratios).
In connection with the refinancing, the Company recorded a net of tax
extraordinary charge representing the write-off of previously deferred finance
costs incurred in connection with the former credit facility of approximately
$277 thousand.
The Company uses interest rate derivatives to manage its exposure to fluctuating
interest rates. These transactions effectively change a portion of the Company's
interest rate exposure from a floating-rate to a fixed-rate basis. The Company's
interest rate derivatives are generally structured for the Company to pay a
fixed rate and receive a floating rate based on LIBOR, as determined in
three-month intervals ( a "Vanilla Swap"). The Company has Vanilla Swap
agreements relating to $150.0 million of borrowings under the credit facility
expiring in the quarter ended January 2001 providing a weighted average LIBOR
rate of 5.044% throughout the period.
In July 1997, the Company entered into a reversion swap agreement relating to
$50.0 million of borrowings under the credit facility. Under the agreement, the
Company pays a fixed rate of 5.73% and receives a floating rate based upon
LIBOR, as determined in three month intervals. This agreement terminates in
April 2002. This transaction effectively changes a portion of the Company's
interest rate exposure from a floating-rate to a fixed-rate basis. After the
first year, however, the fixed rate reverts back to floating for any three month
period during which the LIBOR rate exceeds 6.625%. The rate reverts back to the
fixed rate of 5.73% for any subsequent period for which the LIBOR rate drops
below 6.625%.
Page 8 of 20
9
SHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(continued)
In October 1997, the Company entered into an intermediate-term interest rate
swap agreement relating to approximately $35.0 million of borrowings under the
credit facility. Under the agreement, the Company pays a fixed rate of 5.74% and
receives a floating rate based on LIBOR, as determined in three-month intervals.
This transaction effectively changes a portion of the Company's interest rate
exposure from a floating-rate to a fixed-rate basis. The agreement began on May
5, 1998 and terminates May 5, 1999. The agreement may be extended at the
discretion of the financial institution for an additional year.
On June 16, 1998, the Financial Accounting Standards Board adopted Statement on
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities." Adoption of SFAS No. 133 is not required at
this time. The adoption of SFAS 133 is not expected to have a material impact on
the Company's financial statements.
4. INCOME TAXES
The effective income tax rate for the three and nine month periods ended January
30, 1999 is 39.0% and was 38.0% for the corresponding prior periods. These rates
reflect a blend of domestic and foreign taxes and are adjusted periodically
based upon the estimated annual effective tax rate and any increase or decrease
in the provision for income taxes is reflected in the period in which the
estimate is changed. The effective income tax rate for the entire fiscal year
ended May 2, 1998 was 37.9%.
5. INVENTORIES
Inventories consist of the following:
JANUARY 30, 1999 MAY 2, 1998
Raw materials and supplies $21,434 $17,862
Work in process 8,414 7,833
Finished goods 21,211 20,896
------- -------
$51,059 $46,591
======= =======
6. COMPREHENSIVE EARNINGS
Effective May 3, 1998 the Company adopted SFAS No. 130, "Reporting Comprehensive
Income" which requires that all items that are required to be recognized under
accounting standards as components of other comprehensive income be reported in
the financial statements. The Company's total comprehensive earnings were as
follows:
39 WEEKS ENDED 39 WEEKS ENDED
JANUARY 30, 1999 JANUARY 31, 1998
Net earnings $ 19,817 $ 20,307
Other comprehensive earnings (losses):
Change in equity due to foreign currency translation adjustment (3,184) (2,429)
-------- --------
Comprehensive earnings $ 16,633 $ 17,878
======== ========
Page 9 of 20
10
SHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(continued)
7. COMMITMENTS AND CONTINGENCIES
a. Treasury Stock
The Company's Board of Directors has authorized the purchase of the Company's
common stock as follows:
DATE OF AUTHORIZATION AUTHORIZED SHARES
January 1993 3.0 million
December 1995 3.0 million
April 1997 1.86 million
Shares are authorized for purchase from time to time in the open market, subject
to the terms of the Company's credit facility. As of January 30, 1999,
approximately 1.6 million shares remain authorized for purchase.
b. Temporary Equity Relating to Put Options
The Company periodically sells common equity put options ("put options") on
shares of its common stock which are exerciseable six months from the date of
issuance.
Temporary equity relating to put options on the accompanying consolidated
balance sheets represent the amount the Company would be obligated to pay if all
unexpired put options were exercised.
c. China Facility
The Company has completed building a state-of-the-art manufacturing facility in
the city of Guangzhou, China (the "China Facility"), which commenced operations
in the third quarter of fiscal 1999. Through January 30, 1999, the Company has
invested approximately $39.7 million representing costs associated with the
lease of the related land, construction of the manufacturing facility, purchase
of the necessary machinery and equipment and other expenses associated with the
start-up of the facility. The Company anticipates spending an additional $5.3
million during the remainder of fiscal 1999 with funds generated from operations
as well as the existing credit facility and the Westvaco transaction described
below.
In connection with the start-up of the facility, the Company incurred and
capitalized certain start-up costs aggregating approximately $3.0 million. On
April 3, 1998, Statement of Position Number 98-5, "Reporting on the Costs of
Start-Up Activities" was issued by the American Institute of Certified Public
Accountants, which requires the expensing of the start-up costs when incurred.
Although adoption is not required until fiscal 2000, the Company adopted this
Statement of Position on the first day of fiscal 1999. Accordingly, the Company
recorded a $3.0 million pre-tax charge in its first quarter of fiscal 1999 as a
cumulative effect of a change in accounting principle. This pre-tax charge has
not been offset by a corresponding tax benefit as these expenses relate to the
China Facility which will enjoy a tax holiday for its first three years of
profitable operation. The Company will not report the tax benefits until
realized. Included in net earnings for the three and nine months ending January
30, 1999 were losses of approximately $1.5 million and $2.5 million, (of which
approximately $1.2 million and $2.2 million, respectively, is included in
selling, general and administrative expenses) respectively, relating to costs
incurred for the China Facility.
Page 10 of 20
11
SHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(continued)
On October 28, 1998, the Company entered into a definitive agreement with
Westvaco Corporation to sell to Westvaco a 45% minority interest in its China
Facility. Westvaco is a major producer of paper, paperboard, envelopes,
packaging and specialty chemicals, with manufacturing facilities in the United
States, Brazil and the Czech Republic. The final agreement provides for Westvaco
to pay Shorewood, in cash, 45% of the total costs of the China investment plus
an additional $5 million. Day-to-day management control of the operation will
remain with the Company; however, Shorewood will work closely with Westvaco on
marketing programs and new product development. In addition, Westvaco will
participate in, among other things, decisions regarding significant
acquisitions, divestitures, and expansion through the sale of equity to third
parties. The gain on the sale will be recorded upon closing of the transaction,
expected to take place in the fourth quarter of fiscal 1999.
d. Environmental Matters
On a continuing basis, the Company monitors its compliance with applicable
environmental laws and regulations. As part of this process the Company
cooperates with appropriate governmental authorities to perform any necessary
testing and compliance procedures. The Company is not currently aware of any
environmental compliance matters that it believes will have a material effect on
the consolidated financial statements.
e. 1995 Performance Bonus Plan
In July 1995, the Board of Directors approved the 1995 Performance Bonus Plan
(the "Plan"), applicable to its Chairman of the Board and President (the
"Executive"). Under the Plan, for each of the five fiscal years of the Company
commencing with fiscal year 1996, the Executive will be entitled to a graduated
bonus (the "Performance Bonus") based upon a comparison of the Company's
earnings from operations plus depreciation and amortization (the "Performance
Measure") in that award year with the immediately preceding fiscal year. The
size of the Performance Bonus, if any, is tied to the level of the Company's
performance, as measured by the Performance Measure. The maximum Performance
Bonus payable in respect of any award year under the Plan is $2.0 million. The
Board of Directors and shareholders have approved the extension of the Plan for
an additional three years.
f. New Employment Agreements
Effective May 3, 1998, the Company entered into new five year employment
agreements with the Executive and its Executive Vice President and Chief
Financial Officer ("EVP") providing for annual base salaries of $800 thousand
and $450 thousand, respectively. In connection with his agreement, the Company
paid to the Executive as a signing bonus the aggregate amount of $1 million,
payable in full although earned ratably over his five-year employment period,
provided that the Executive continues to be employed with the Company at the end
of each such year. Simultaneously with the authorization of the employment
agreements by the Board of Directors, the Company granted the Executive and the
EVP options to purchase 250 thousand and 100 thousand shares of stock,
respectively. The options are exerciseable at $13.75 per share (the fair market
value at the date of grant).
g. Related Party Transaction
In the second quarter of fiscal 1999 the Company temporarily advanced $800
thousand to the Executive. The Executive repaid the advance and related interest
in the third quarter.
Page 11 of 20
12
SHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
In October 1998, the Company purchased substantially all of the assets and
assumed substantially all of the liabilities of Queens Group, Inc. ("Queens")
for a purchase price of $129.5 million comprised of approximately $113.7 million
in cash including the assumption of debt, and 1.0 million shares of Company
common stock. In addition, the Company incurred expenses associated with the
transaction of approximately $2.5 million. Simultaneously with the closing of
the transaction, the Company repaid all outstanding bank debt of Queens,
approximating $19.0 million. Queens was engaged in the manufacture of value
added printed packaging primarily for the home entertainment industry. The
transaction was financed through a new credit facility as described below.
The acquisition was recorded using the purchase method of accounting and,
accordingly, the results of operations of Queens are included in the
consolidated results of operations of the Company since the date of acquisition.
The purchase price of the acquisition has been allocated to the net assets
acquired based upon the related fair values which is subject to refinement based
upon the receipt of final appraisals and other analyses. The excess of cost over
the fair value of net assets acquired approximated $103.3 million and is being
amortized over 40 years.
The following unaudited pro forma information for the 39 weeks ended January 30,
1999 and January 31, 1998 includes the operations of the Company, inclusive of
the operations of Queens, as if the acquisition had occurred at the beginning of
the respective periods presented. The pro forma gives effect to the amortization
expense associated with the excess of cost over the fair value of net assets
acquired, adjustments related to the fair market value of the assets and
liabilities acquired (which is subject to further refinement), shares issued in
connection with the transaction, interest expense related to financing the
acquisition, and related income tax effects.
39 WEEKS 39 WEEKS
ENDED ENDED
JANUARY 30, 1999 JANUARY 31, 1998
Revenues $ 467,637 $428,222
========= ========
Earnings from Operations $ 51,122 $ 46,474
========= ========
Net Earnings Before Extraordinary Items and Cumulative
Effect of a Change in Accounting Principle $ 24,012 $ 22,458
========= ========
Net Earnings Per Share Before Extraordinary Items and
Cumulative Effect of a Change in Accounting Principle
Basic $ .87 $ .80
========= ========
Diluted $ .85 $ .78
========= ========
Page 12 of 20
13
SHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Net Sales
Net sales for the three and nine month periods ended January 30, 1999 were
$141.4 million and $402.1 million as compared to net sales of $96.6 million and
$312.1 million for the corresponding prior periods, an increase of 46.3% and
28.9%, respectively. Included in the 13 and 39 week periods ended January 30,
1999 are sales produced by former Queens facilities of $38.2 and $56.5 million,
respectively. In addition to the sales increase related to the former Queens
facilities, the Company experienced increases in sales in the home entertainment
and the tobacco industries. Based upon current buying patterns and known
increases in awarded market share in the tobacco industry, the Company
anticipates that its growth in sales as compared to the prior year will continue
throughout fiscal 1999.
The Company believes that future sales growth will be generated through
continued penetration of its existing markets, as well as its expansion into
China. The Company reported its initial revenues from the facility in China
during the third quarter of fiscal 1999 of approximately $300 thousand.
Cost of Sales
Cost of sales as a percentage of sales for the three and nine month periods
ended January 30, 1999 were 75.7% and 76.4% as compared to 77.5% and 77.1% for
the corresponding prior periods. The decrease in cost of sales as a percentage
of sales in the quarter is primarily attributable to favorable product mix, and
favorable absorption of fixed overhead costs as a result of the higher sales
volume. These decreases were partially offset by increased costs attributable to
the learning curve related to new products and newly installed equipment which
began operating during the last nine months. The decreases were further offset
by losses on initial sales from its facility in China.
The Company remains sensitive to price competitiveness in the markets that it
serves, and in the areas that are targeted for growth and believes that the
installation of state-of-the-art printing and manufacturing equipment (and
related labor and production efficiencies) will enable it to compete
effectively.
Selling, General and Administrative Expenses
Selling, general and administrative expenses (including the amortization of
excess cost over the fair value of net assets acquired) as a percentage of sales
for the three and nine month periods ended January 30, 1999 were 13.7% and 12.0%
as compared to 11.7% and 11.0% for the corresponding prior periods. Included in
selling, general and administrative expenses in the three and nine month periods
of the current year were approximately $1.2 million and $2.2 million,
respectively, of costs relating to the facility in Guangzhou, China (the "China
Facility"). Selling, general and administrative expense as a percentage of sales
for the former Queens facilities are greater than that of existing Shorewood
facilities.
Page 13 of 20
14
SHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(CONTINUED)
Other Income (Expense), net
Other income (expense), net, for the three and nine month periods ended January
30, 1999 was $(277) thousand and $582 thousand, respectively. The net loss for
the three month period includes net foreign exchange losses of $421 thousand and
losses on disposal of fixed assets of $200 thousand. These losses were partially
offset by approximately $344 thousand of investment income. The net gain for the
nine month period includes $567 thousand of investment income and net foreign
exchange gains of $427 thousand, offset by losses on disposal of fixed assets of
$412 thousand.
Investment and other income, net, for the three and nine months ended January
31, 1998 were $377 thousand and $1.1 million, respectively. The net gain for the
three month period was primarily due to net foreign exchange gains of $281
thousand and interest and investment income of $173 thousand. These gains were
partially offset by a loss on the sale of equipment. The net gain for the nine
month period includes a net foreign exchange gain of $437 thousand, interest and
investment income of $413 thousand and a net gain on the sale of equipment of
$255 thousand.
The Company's exposure to foreign exchange transaction gains or losses primarily
relate to the Company's Canadian facilities which have U.S. dollar denominated
net assets. The Company believes that fluctuations in foreign exchange rates
will not have a material impact on the operations or liquidity of the Company,
based upon current and historical levels of working capital at the Canadian
facilities. Recently, several Asian currencies experienced weaknesses which had
the impact of reducing some demand for Company products produced in North
America intended for ultimate use in export markets. The Canadian dollar has
also experienced recent weakness against the U.S. dollar. The recent investments
in the China Facility will expose the Company to additional foreign exchange
risks related to the Renminbi ("Rmb"). Should the Canadian dollar or the Rmb
weaken, the Company would experience a reduction in the net worth of the
Company's investments in Canada and China (through the cumulative translation
adjustment account and other comprehensive income). In addition, the translation
of the net operating results for Canada and China (whether losses or profits)
would be reduced. Exposure to foreign exchange transaction gains or losses in
China is expected to be minimal as the Company will make purchases and sales in
both Rmb and the U.S. dollar, and settlement periods on both accounts receivable
and accounts payable are expected to be short.
Interest Expense
Interest expense for the three and nine month periods ended January 30, 1999 was
$4.2 million and $9.3 million as compared to $1.9 million and $5.8 million for
the corresponding prior periods. The increase in interest costs is primarily
attributable to increased borrowings relating to financing the acquisition of
Queens and funding non-cash working capital. Capitalized interest decreased from
$600 thousand to $554 thousand for the three month period and increased from
$1.3 million to $1.6 million for the nine month period, primarily related to the
Company's construction of its facility in China. The Company has not capitalized
interest related to the China Facility since the date the facility started
production, which occurred in the third quarter of fiscal 1999. The Company
anticipates that the amount of interest to be capitalized in the fourth quarter
of fiscal 1999 will decrease reflecting the commencement of operations in China.
Page 14 of 20
15
SHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(CONTINUED)
The Company uses interest rate derivatives to manage its exposure to fluctuating
interest rates. These transactions effectively change a portion of the Company's
interest rate exposure from a floating-rate to a fixed-rate basis. The Company's
interest rate derivatives are generally structured for the Company to pay a
fixed rate and receive a floating rate based on LIBOR, as determined in
three-month intervals ( a "Vanilla Swap"). The Company has Vanilla Swap
agreements relating to $150.0 million of borrowings under the credit facility
expiring in the quarter ended January 2001 providing a weighted average LIBOR
rate of 5.044% throughout the period.
In July 1997, the Company entered into a reversion swap agreement relating to
$50.0 million of borrowings under the credit facility. Under the agreement, the
Company pays a fixed rate of 5.73% and receives a floating rate based upon
LIBOR, as determined in three month intervals. This agreement terminates in
April 2002. This transaction effectively changes a portion of the Company's
interest rate exposure from a floating-rate to a fixed-rate basis. After the
first year, however, the fixed rate reverts back to floating for any three month
period during which the LIBOR rate exceeds 6.625%. The rate reverts back to the
fixed rate of 5.73% for any subsequent period for which the LIBOR rate drops
below 6.625%.
In October 1997, the Company entered into an intermediate-term interest rate
swap agreement relating to approximately $35.0 million of borrowings under the
credit facility. Under the agreement, the Company pays a fixed rate of 5.74% and
receives a floating rate based on LIBOR, as determined in three-month intervals.
This transaction effectively changes a portion of the Company's interest rate
exposure from a floating-rate to a fixed-rate basis. The agreement began on May
5, 1998 and terminates May 5, 1999. The agreement may be extended at the
discretion of the financial institution for an additional year.
On June 16, 1998, the Financial Accounting Standards Board adopted Statement on
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities." Adoption of SFAS No. 133 is not required at
this time. The adoption of SFAS 133 is not expected to have a material impact on
the Company's financial statements.
The Company has used, and may continue to use, interest rate swaps and caps to
manage its exposure to fluctuating interest rates under its debt agreements.
Income Taxes
The effective income tax rate for the three and nine month periods ended January
30, 1999 is 39.0% and was 38.0% for the corresponding prior periods. These rates
reflect a blend of domestic and foreign taxes and are adjusted periodically
based upon the estimated annual effective tax rate, which for the entire fiscal
year ended May 2, 1998 was 37.9%.
The China Facility will enjoy a tax holiday for the first three years of
profitable operations, and thereafter be taxed at lower rates than the Company's
North American operations. Anticipated losses during the early periods of
operation will not result in related tax benefits. Such benefits will be
recognized when realized. The Company anticipates that this situation will
temporarily result in an increase in its effective tax rate in fiscal 1999.
Page 15 of 20
16
SHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(CONTINUED)
China Facility
The Company has completed building a state-of-the-art manufacturing facility in
the city of Guangzhou, China (the "China Facility"), which commenced operations
in the third quarter of fiscal 1999. Through January 30, 1999, the Company has
invested approximately $39.7 million representing costs associated with the
lease of the related land, construction of the manufacturing facility, purchase
of the necessary machinery and equipment and other expenses associated with the
start-up of the facility. The Company anticipates spending an additional $5.3
million during the remainder of fiscal 1999 with funds generated from operations
as well as the existing credit facility and the Westvaco transaction described
below.
In connection with the start-up of the facility, the Company incurred and
capitalized certain start-up costs aggregating approximately $3.0 million. On
April 3, 1998, Statement of Position Number 98-5, "Reporting on the Costs of
Start-Up Activities" was issued by the American Institute of Certified Public
Accountants, which requires the expensing of the start-up costs when incurred.
Although adoption is not required until fiscal 2000, the Company adopted this
Statement of Position on the first day of fiscal 1999. Accordingly, the Company
recorded a $3.0 million pre-tax charge in its first quarter of fiscal 1999 as a
cumulative effect of a change in accounting principle. This pre-tax charge has
not been offset by a corresponding tax benefit as these expenses relate to the
China Facility which will enjoy a tax holiday for its first three years of
profitable operation. The Company will not report the tax benefits until
realized. Included in net earnings for the three and nine months ending January
30, 1999 were losses of approximately $1.5 million and $2.5 million, (of which
approximately $1.2 million and $2.2 million, respectively, is included in
selling, general and administrative expenses) respectively, relating to costs
incurred for the China Facility.
On October 28, 1998, the Company entered into a definitive agreement with
Westvaco Corporation to sell to Westvaco a 45% minority interest in its China
Facility. Westvaco is a major producer of paper, paperboard, envelopes,
packaging and specialty chemicals, with manufacturing facilities in the United
States, Brazil and the Czech Republic. The final agreement provides for Westvaco
to pay Shorewood, in cash, 45% of the total costs of the China investment plus
an additional $5 million. Day-to-day management control of the operation will
remain with the Company; however, Shorewood will work closely with Westvaco on
marketing programs and new product development. In addition, Westvaco will
participate in, among other things, decisions regarding significant
acquisitions, divestitures, and expansion through the sale of equity to third
parties. The gain on the sale will be recorded upon closing of the transaction,
expected to take place in the fourth quarter of fiscal 1999.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents at January 30, 1999 was $10.8 million as compared to
$7.3 million at May 2, 1998, and working capital was $21.5 million as compared
to $31.0 million as of the same dates respectively. The current ratio at January
30, 1999 was 1.2 to one and was 1.5 to one at May 2, 1998. The Company has a
cash management program whereby collection of accounts receivable are used to
retire revolver obligations, and payments of accounts payable and accrued
expenses are funded through the revolving credit facility.
Page 16 of 20
17
SHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(CONTINUED)
Cash flow from operating activities for the nine months ended January 30, 1999
was $41.8 million before changes in operating assets and liabilities as compared
to $38.0 million for the corresponding prior period. Cash flows from operations
as well as borrowings under the Company's credit facilities were used to support
$32.9 million in capital investments. In addition, the Company purchased
approximately $15.9 million of treasury stock under the Board of Directors
authorized program described below. The Company anticipates that capital
expenditures will approximate $40.0 million for all of fiscal 1999 including the
completion of the China Facility.
The Company's Board of Directors has authorized the purchase of the Company's
common stock as follows:
DATE OF AUTHORIZATION AUTHORIZED SHARES
January 1993 3.0 million
December 1995 3.0 million
April 1997 1.86 million
Shares are authorized for purchase from time to time in the open market, subject
to the terms of the Company's credit facility. As of January 30, 1999,
approximately 1.6 million shares remain authorized for purchase.
The Board and management of the Company believe the long-term outlook for the
Company to be promising and that the Company's common stock represents an
attractive investment opportunity. The treasury stock purchases will be made
from time to time as market conditions permit.
In October 1998, in order to facilitate the acquisition of Queens as described
in Note 2 and other global opportunities which may arise over the next several
years, the Company entered into a new credit agreement with its lending banks to
replace its existing credit facility. The new credit facility provides for up to
$325 million of borrowings and consists of a $100 million term loan to be paid
in equal quarterly installments over five years and a $225 million revolving
credit facility maturing at the end of five years. The revolving credit is
available, in its entirety, without any borrowing base limitation. Borrowings
pursuant to the facility will bear interest at the discretion of the Company, at
either the Bank's prime rate (7.75% at January 30, 1999) or at the LIBOR rate
(three month term of 4.97% at January 30, 1999) plus 62.5 to 125 basis points
based upon financial ratios as defined in the underlying Agreement. Initially,
borrowings bear interest at 125 basis points above the LIBOR rate. Unused
commitment fees will range from 20 to 30 basis points (initially 30 basis points
based upon the same financial ratios).
In connection with the refinancing, the Company recorded a net of tax
extraordinary charge representing the write-off of previously deferred finance
costs incurred in connection with the former credit facility of approximately
$277 thousand.
Page 17 of 20
18
SHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(CONTINUED)
The loan agreement contains covenants related to levels of debt to cash flow,
current assets to current liabilities, fixed charge coverage, net worth and
investments (including investments in the Company's own common stock), and
restricts the amount of retained earnings available for payment of dividends. At
January 30, 1999, there was approximately $29.5 million of retained earnings
available for the payment of dividends.
The Company expects that cash flow from operations together with the borrowing
capacity under the revolving credit facility will be sufficient to meet the
needs of the business.
SUBSEQUENT EVENTS
On February 10, 1999 the Company made an offer to acquire all of the outstanding
shares of Field Group plc. ("Field") valued at approximately $400 million. If
successful, the acquisition would have been financed through a new credit
facility. On February 17, 1999 the Company withdrew its offer as a result of a
revised higher offer made by another company. Prior to having made its offer,
the Company had accumulated approximately 810 thousand shares of Field on the
open market which it has since tendered to the successful bidder.
YEAR 2000
Commencing in 1997 the Company began the development of a new, comprehensive
computer based information system which will integrate sales, manufacturing,
distribution, financial and human resource modules. It is anticipated that the
new system will be completed and all manufacturing facilities will be "on-line"
by the summer of 1999. While not specifically directed towards the "Year 2000"
issues, the Company's new information system will automatically be Year 2000
compliant at its completion. The Company believes that in and of itself, the
cost of addressing Year 2000 issues is not material to its future operating
results or financial position.
The Company is also gathering information concerning the Year 2000 compliance
status of its suppliers and other entities with whom it exchanges data to
ascertain the impact, if any, of their non-compliance on the Company. In the
event the Company's significant suppliers or other entities with whom it
exchanges data do not timely achieve Year 2000 compliance, the Company's
operations and financial results could be adversely affected.
Page 18 of 20
19
SHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES
Part II
Item 1 LEGAL PROCEEDINGS
Information concerning legal and environmental matters is incorporated
by reference from Part I, Footnotes 5(d) of Notes to Consolidated
Condensed Financial Statements
Item 2 CHANGES IN SECURITIES
None
Item 3 DEFAULTS UPON SENIOR SECURITIES
None
Item 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
Item 5 OTHER INFORMATION
None
Item 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
Page 19 of 20
20
SIGNATURES
Pursuant to the regulations 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.
SHOREWOOD PACKAGING CORPORATION
(Registrant)
by: \s\ Howard M. Liebman
--------------------------
Howard M. Liebman
Executive Vice President and
Chief Financial Officer
Dated: March 16, 1999
Page 20 of 20