United States
Securities and Exchange Commission
Washington, D.C. 20549
Form 10-K
(x) Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the fiscal year ended January 1, 2000
or
( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the Transition period from ______________ to _____________
Commission file number 333-24519
Pen-Tab Industries, Inc.
(Exact name of registrant as specified in its charter)
Delaware 54-1833398
(State or other jurisdiction (I.R.S. Employer
Incorporation or organization) Identification Number)
167 Kelley Drive
Front Royal, VA 22630
Telephone: (540) 622-2000
(Address, including zip code, and telephone number, including area code,
of registrant's principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes __X__ No ____
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
from 10-K. (X)
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date. As of March 31, 2000, there
were outstanding 100 shares of common stock, $0.01 par value, all of which are
privately owned and are not traded on a public market.
Pen-Tab Industries, Inc.
Form 10-K
For the Fiscal Year Ended January 1, 2000
Certain statements contained in this Annual Report are forward-looking
statements (as such term is defined in the Private Securities Litigation Reform
Act of 1995). Because such statements include risks and uncertainties, actual
results may differ materially from those expressed or implied by such
forward-looking statements. Factors that could cause actual results to differ
materially include, but are not limited to, risks associated with the
integration of businesses following an acquisition, competitors with broader
product lines and greater resources or the Company's inability to attract and
retain highly qualified management, technical, creative and sales and marketing
personnel. The Company disclaims any intent or obligation to update any
forward-looking statements.
Index
Part I.
Item 1. Business 1
Item 2. Properties 7
Item 3. Legal Proceedings 7
Item 4. Submission of Matters to a Vote of Security Holders 8
Part II.
Item 5. Market for Registrant's Common Stock and Related Stockholder
Matter 8
Item 6. Selected Financial Data 8
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
Item 7a. Quantitative and Qualitative Disclosures About Market Risk 18
Item 8. Financial Statements and Supplementary Data 18
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures 18
Part III.
Item 10. Directors and Executive Officers of the Registrant 18
Item 11. Executive Compensation 20
Item 12. Security Ownership of Certain Beneficial Owners and
Management 21
Item 13. Certain Relationships and Related Transactions 21
Part IV.
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 21
Signature 24
Part I
Item 1. Business
General
Pen-Tab Industries, Inc. (together with its majority-owned subsidiaries,
the "Company") was incorporated in 1997 in the state of Delaware, the successor
corporation to a Virginia corporation of the same name. The Company is a
wholly-owned subsidiary of Pen-Tab Holdings, Inc. ("Holdings") a Virginia
corporation.
The Company is a leading U.S. manufacturer and marketer of school, home and
office supply products. The Company's core products include binders, pads,
filler paper, spiral and coilless notebooks, planners, envelopes, school
supplies and arts and crafts products. In 1992, the Company recognized a
previously unfulfilled demand for higher quality, upscale school and
office-related products. The Company pioneered a line of these differentiated
higher price point, branded products to serve the school and office product
markets. The Company has developed strong consumer recognition for its
proprietary office styles and its upscale school styles under the Pen-Tab(R),
Pen-Tab Pro(R) and Expert(R) brand names. These differentiated products provide
both the Company and the retailer with higher margins. The Company's August 1998
acquisition of Stuart Hall Company, Inc. ("Stuart Hall") expanded the Company's
product line into the market of licensed products. The acquisition broadened the
Company's product offerings by adding licensed products to Pen-Tab's proprietary
styles and brands. Stuart Hall's license portfolio includes Dragonball Z(R),
Seventeen(R), Looney Tunes, Coca-Cola(R) brand, Nickelodeon(TM), Rugrats(R),
MTV: Music Television(TM) and Disney's Winnie the Pooh. For fiscal 1999, core
products represented an estimated 50.0% of revenue and differentiated products
represented an estimated 50.0% of revenue. For fiscal 1999, school-related
products represented an estimated 63.9% of revenue and office-related products
represented an estimated 36.1% of revenue.
The Company's move into differentiated products and the acquisition of
Stuart Hall are the primary reasons for the increase in sales and profitability.
From 1995 to 1999, the Company's sales have grown from $84.3 million to $155.4
million and EBITDA (as defined herein) has grown from $10.5 million to $23.9
million. During the same period, the Company's EBITDA margin increased from
12.5% to 15.4%. The Company's strategy is to grow through continued internal
design of new, differentiated product lines and strategic acquisitions.
The Company has a long-standing customer base featuring mass merchandisers,
national discount stores, wholesale clubs, and office supply superstores in the
United States and Canada. The Company is headquartered in a state-of-the-art
282,000 sq. ft. facility in Front Royal, Virginia. The Company also maintains
manufacturing facilities in Los Angeles and Kansas City. The Company
has invested heavily in state-of-the-art automated production equipment to
provide a low cost manufacturing environment.
Recent Developments
Management change. On June 29, 1999, the Company appointed Marc English as
Chief Executive Officer. Mr. English was previously President and Chief
Executive Officer of CSS Industries' Cleo unit, a consumer products company
primarily engaged in the manufacturing and sale to mass-market retailers of
seasonal gift-wrap products. In addition, Mr. English has held marketing and
sales management positions with other companies, including CPS Corp., also in
the gift-wrap industry. Mr. English replaced Mr. Hodes who resigned from the
position as Chief Executive Officer of the Company.
1
Company Initiatives/Reorganization. Under the leadership of Marc English,
the Company performed a review of all operations with the goals of increasing
market share, streamlining operations, reducing debt and increasing
profitability.
On December 30, 1999, the Company approved a plan to rationalize its
manufacturing operations. The plan includes a plant consolidation, equipment
moves, plant/product changes, and warehouse consolidation. The rationalization
is expected to result in an approximate 20% reduction in manufacturing space.
The fourth quarter reorganization charge of $6.1 million represents the
Company's rationalization plan and includes employee termination costs,
including benefits, costs to exit facilities, lease termination costs, and
property taxes after ceasing operations. The major undertakings of the
rationalization plan are expected to be completed in 2000. Upon full
implementation, the plan is expected to have a significant positive effect on
the Company's financial performance, resulting in an estimated annualized cost
savings of approximately $3 million.
On March 31, 2000, the Company decided to divest its vinyl packaging
business segment, which operates as Vinylweld L.L.C. The divestiture is
anticipated to occur by the end of the first quarter of 2001.
Covenant Violations/Amendments to Credit Facility/Note Holder Consent. As a
result of insufficient third quarter 1999 earnings, the Company was in default
of a covenant based on EBITDA (earnings before interest, taxes, depreciation,
amortization, and certain non-cash charges, as defined in the agreement) and
cash interest and principal payments (fixed charge coverage ratio) for the
twelve months ended October 2, 1999. On November 16, 1999, the Company amended
its credit facility to waive the fixed charge coverage ratio covenant default.
This amendment also provided that the interest rate increase by 0.625%.
As a result of insufficient fourth quarter 1999 earnings, the Company was
in default of the fixed charge coverage ratio covenant and the minimum net worth
covenant, as defined in the agreement, at and for the twelve months ended
January 1, 2000. In addition, due to the earnings shortfall and Enterprise
Resource Planning ("ERP") system implementation issues which led to higher than
expected inventories and accounts receivable collection delays, the Company was
in default of the annual revolver clean up provision. The clean up provision
requires the Company, for a period of not less than thirty days between
September 30 and November 15, to reduce the outstanding balance on the revolver
to $25 million or less. The Company was also in default of the borrowing base
formula, as defined in the agreement, whereby the balance outstanding on the
revolver was in excess of the borrowing base formula computed amount. On March
13, 2000, the Company amended its credit facility. The amendment (i) waived the
defaults, (ii) revised the borrowing base definition to provide for an over
advance of up to $16.5 million for the period of March 1, 2000 through July 15,
2000, (iii) increased the interest rate by 0.875% plus another 0.50% during the
over advance period, (iv) revised the annual clean up provision amount to $27
million from $25 million and revised the clean up period to be between October
15 and January 15 from between September 30 and November 15, (v) revised the
fixed charge coverage ratio to 1.00:1 (from 1.50:1) for the twelve month periods
ended March 31, 2000 and June 30, 2000 and to 1.50:1 (from 1.75:1) thereafter,
(vi) limits capital expenditures to $2 million for fiscal 2000 and (vii)
requires total debt, as defined in the agreement, not to exceed $153 million at
June 30, 2000. The Company paid a fee of $0.5 million in conjunction with the
Credit Facility amendment and will amortize such fee over the remaining life of
the Credit Facility (March 2000 through August 2001).
Prior to the amendment discussed in the preceding paragraph and as a result
of the covenant violations described above, the Company was not allowed to make
the required interest payment of approximately $4 million due on February 1,
2000 to the holders of the Company's $75 million 10.875% Senior Subordinated
Notes due 2007. As a condition of the aforementioned amendment, the Company
obtained consent from substantially all of the note holders to accept the
February 1, 2000 interest payment in the form of new notes, in aggregate
principal amount substantially equal to such interest payment, in lieu of a cash
payment. As a result, the Company will be deemed to have made the cash interest
payment and simultaneously issued new notes to existing noteholders in exchange
for such cash payment.
2
Subsequent to January 1, 2000, a major stockholder of Pen-Tab Holdings,
Inc. ("Holdings") purchased approximately $60 million of the $75 million 10.875%
Senior Subordinated Notes in the secondary market.
Competitive Strengths
The combination of the Company's products, customers and proven track
record distinguishes it as a leading manufacturer and marketer of school, home
and office products in North America. The Company attributes this success and
it's continued opportunities for growth and profitability to the following
competitive strengths:
Market leader in differentiated, branded school, home and office products.
The Company is a market leader in differentiated, branded school, home and
office products. The Company has pioneered a line of high-quality, functionally
superior, higher price point and margin, branded items to serve the school and
office products markets. Demand for proprietary differentiated products has
risen steadily since 1993 when the Company first introduced them and the Company
expects a significant portion of its future growth to come from increased sales
of differentiated products.
Licensed Products. Through the acquisition of Stuart Hall, Pen-Tab has
rounded out its differentiated product offering with a portfolio of licensed
products. This portfolio includes licenses with Dragonball Z(R), Seventeen(R),
Looney Tunes, Coca-Cola(R) brand, Nickelodeon(TM), Rugrats(R), MTV: Music
Television(TM), X Games(TM), and Disney's Winnie the Pooh.
Brand name recognition. Through the manufacturing of high-quality products
for over 60 years, the Company has developed strong brand recognition with
consumers, retailers and distributors. The Company focuses on building its brand
name by internally designing new, differentiated products and product formats.
This allows the Company to achieve higher margins than would be achievable with
core products. Several trademarks, sub-brands and proprietary styles, including
Pen-Tab(R), Pen-Tab Pro(R), Stuart Hall, Attitude(R), Tough Tracks(R),
Executive(R) and Expert(R), have been developed to service targeted market
sectors.
Long-standing customer base. The Company has cultivated long-term customer
relationships with well-capitalized, high-growth retailers and distributors in
the school, home and office products industry. Management has identified the
fastest growing distribution channels in the Company's marketplaces and has
focused its resources on the key accounts in those channels. The Company's
customers include the nation's largest discount stores and mass merchandisers,
wholesale clubs, office supply superstores, contract stationers and grocery and
drug store chains.
Leading edge information systems. The Company has recently invested in a
new state-of-the-art Enterprise Resource Planning ("ERP") software system to
manage the manufacturing, accounting, distribution, inventory, sales and billing
systems. The system integrates all of the Company's locations to provide timely
information to management. The Company uses electronic data interchange programs
with most of its large customers.
Growth Strategy
Focus on rapidly growing customers. The Company serves many of the largest
and best-positioned customers in the school, home and office products industry
including mass merchandisers warehouse clubs, national office products
superstores, national contract stationers and grocery and drug store chains.
Anticipating further consolidation in the school, home and office products
industry, the Company expects that its national scope and broad product line
will be increasingly important in meeting the needs of its customers. The
Company will continue to target those customers driving consolidation in the
school, home and office products retail industry.
Continue to introduce differentiated products. Differentiated, higher
value-added products give the Company a greater selection to offer its customers
and improve product line profitability for both the Company and its customers.
The Company plans to continue to distinguish itself from other suppliers and
3
improve profitability through product innovation, differentiation and line
extensions. The Company will accomplish this by continued internal design of
new, differentiated product lines.
Focus on partnering relationships. The Company will continue to utilize and
expand the integrated efforts of the creative, sales and marketing personnel to
develop and foster partnering relationships with major customers. Partnering
should allow the Company to continue designing products in concert with its
major customers while expanding production of upscale products that meet a
mutual vision.
Broaden product distribution. The Company's market presence and
distribution strength position it to sell new or acquired product lines across
its distribution channels, including mass merchandisers, national office
products superstores, national contract stationers, office product wholesalers
and grocery and drug store chains.
Continued growth through acquisition. In addition to the growth the Company
expects to come from the development of new, differentiated products and product
lines and expanding sales of existing products and product lines, the Company
actively evaluates acquisition candidates. Future strategic acquisitions may be
undertaken to broaden the Company's product lines, expand its manufacturing
capacity, and strengthen its presence within the various channels of
distribution in the worldwide market.
Products and Services
The Company designs, manufactures and markets school, home and
office-related products. The Company's core products include binders, pads,
filler paper, wirebound notebooks, and envelopes. The Company manufactures over
1,000 variations of these core products, based on differences in color, size,
count, packaging and other features.
Several years ago, management recognized a market need for well-designed,
high-quality, functionally superior school and office products. To serve this
need, the Company pioneered a new line of branded differentiated products with
value-added features. The Company's high-quality, fashion-forward school-related
designs and high quality, functionally superior, office-related products have
been very successful with major mass merchandisers and consumers. Approximately
50.0 percent of the Company's 1999 sales are derived from differentiated
products, which have been developed over the last six years.
School-related products (63.9% of 1999 net sales). The Company produces
tablets, spiral and coilless notebooks, filler paper and binders for the school
market. The Company's high-technology production equipment is designed to
produce these products in mass quantity in virtually any configuration according
to the customer needs. The Company also designs, assembles and markets nylon
binders, planners, knapsacks and other school products. Products are packaged in
a variety of quantities, rulings, sizes and papers.
The Company is the recognized market leader for higher quality, upscale,
creatively designed school products largely for the teenage market. The
Company's marketing and design departments have carefully researched market
demands to develop a range of product offerings. The Company created a broad
line of innovative styles and designs to appeal to segmented markets of
school-age children through its Pen-Tab Pro(R), Tough Tracks(R), Pro Ball(R) and
Pen-Tab Online(R) product lines. Durable nylon covers and colorful designs have
been incorporated into core products to differentiate its line. Whereas certain
basic school supplies often work as a loss leader for retailers, the Company's
differentiated products give a mass merchandiser a fashion-forward image and an
attractive profit margin.
Through the acquisition of Stuart Hall, the Company is now a leading
manufacturer and marketer of licensed school products. Stuart Hall's licensed
portfolio includes Dragonball Z(R), Seventeen(R), Looney Tunes, Coca-Cola(R)
brand, Nickelodeon(TM), Rugrats(R), MTV: Music Television(TM), X Games(TM) and
Disney's Winnie the Pooh. These licenses are proprietary to the Company in its
category and allow for
4
higher margins than non-licensed products. The Company's many licenses appeal to
segmented markets of school age children.
Leveraging its creative capabilities and experience, the Company has
created a brand name for high quality, upscale school supplies. For example,
Tough Tracks(R) line incorporates a rugged, outdoors look which is targeted at
environmentally-conscious school children and utilizes textures, designs and
colors to appeal to the target market. The "Pro Series" is the Company's best
selling premium notebook line. Features of this line include pressboard covers,
inside pockets, coated double wire, extended tab dividers, and heavyweight 20
lb. paper.
The Company also produces a variety of paper products for use in creative
and artistic leisure activities, including construction paper, poster paper,
tracing paper and drawing pads. The Company sells these items both in
conventional packaging and in innovative combination packs and jumbo bonus
packs. The Company distinguishes its arts and crafts packages by including
special "kids activity ideas" to encourage creativity.
Sales of school-related products are seasonal and peak during spring and
summer. Orders for back-to-school products are generally placed during March
through April, and shipped May through August. The Company builds a substantial
inventory of finished back-to-school products before shipment. Certain
differentiated products that are manufactured overseas are only mass-produced
with firm customer commitments to limit inventory risk.
Management believes the growth opportunities for differentiated, creatively
designed school products remain largely untapped. The Company has numerous
exciting new products for the coming year, and management expects continued
growth from these items.
Office-related products (36.1% of 1999 net sales). The Company produces a
variety of similar products for the office, including pads and envelopes. Sales
of office products are not seasonal. New, differentiated products for the office
market have included double wire spiral pads with hard covers, organizers and
other high-quality, functionally superior products sold under the Executive(R),
Expert(R) and Platinum(R) brands.
The office products market represents significant growth potential for the
Company. Office products distribution is shifting to the Company's existing core
customer base of mass merchandisers wholesale clubs and office supply
superstores. In addition, the Company has recently established strong
relationships with several of the nation's largest contract stationers.
Management believes the same opportunity exists to develop innovative higher
quality products for the office supply market as in the school products market.
The Company's creative department has already created several high-quality,
functionally superior designs for planners and pads in the office supply market.
5
Sales, Distribution and Marketing
The Company markets its broad range of products to a wide variety of
customers through virtually every channel of distribution for school, home and
office products including the largest mass merchandisers, warehouse clubs,
office product superstores, major contract stationers and grocery and drug store
chains. The Company's aggregate net sales to two customers accounted for
approximately 22.8% and 12.0%, respectively of the Company's net sales for
fiscal 1999.
The largest retailers, wholesalers and contract stationers have been
rapidly expanding as industry channels are undergoing consolidation. Management
has identified the fastest growing distribution channels in their marketplaces
and has focused the resources of the Company to the key accounts in those
channels. Management selectively pruned its customer base over the past several
years to concentrate on strong growth-oriented companies, which purchase a more
profitable product mix.
The Company will continue to target those customers driving consolidation
in the office products industry and believes that it is strongly positioned to
meet the special requirements of these customers in the growing distribution
channels of the school, home and office products industry. Leading merchandisers
favor larger suppliers with national manufacturing capabilities, such as the
Company, that has implemented automated ordering, manufacturing and distribution
practices. These customers seek suppliers, such as the Company, who are able to
offer broad product lines, higher value-added innovative products, national
distribution capabilities, low costs and reliable service. Furthermore, as these
customers continue to grow and consolidate their supplier bases, the Company's
ability to meet their special requirements should be an increasingly important
competitive advantage.
Senior sales management personally handles the Company's largest accounts.
The Company also employs approximately 30 manufacturer representative agencies
with over 100 agents to market its products. The Company assists the
representative agencies in servicing these accounts. The Company's sales staff
is compensated by a base salary and a bonus based on performance. Manufacturer
representatives are compensated strictly based on commission.
Management starts its product plan by segmenting its customer base (e.g.
for the teen market, consumers with a focus on a sports, fashion, rugged or
'techie' image). Product designs are then evaluated through research, focus
groups and sample testing. Through over 60 years of customer presence,
Pen-Tab(R) and Stuart Hall have developed strong brand identity for quality
products. Its Pen-Tab Pro(R), Tough Tracks(R), Attitude(R), Executive(R),
Expert(R) and Pen-Tab Paper Store(R) lines are also building customer loyalty in
segmented markets. The Company typically leads marketing efforts with its core
established product lines and leverages this stable business to increase sales
of its value-added differentiated products.
6
Competition
The markets for the Company's products are highly competitive. The
Company's principal methods of competition are customer service, price, product
differentiation, quality and breadth of product line offerings. The markets in
which the Company operates have become increasingly characterized by a limited
number of large companies selling under recognized trade names. These larger
companies, including the Company, have the economies of scale, national
presence, management information systems and breadth of product line required by
the major customers. In addition to branded product lines, manufacturers also
produce private-label products, especially in the context of broader supply
relationships with office product superstores and contract stationers.
The school, home and office products industry is fragmented, ranging from
large national and foreign manufacturers to single-facility, regional
manufacturers. A few manufacturers, including the Company, have developed strong
brand name recognition for a number of product lines. Other national companies
include Mead and American Pad & Paper Company. In addition, the Company still
competes with a large number of smaller, regional companies, which have more
limited product lines.
Intellectual Property
The Company seeks trademark protection for all of its product line trade
names. The Company presently holds several trademarks covering designs, symbols
and trade names used in connection with its products, including Pen-Tab(R),
Pen-Tab Pro(R), Attitude(R), Executive(R), Expert(R) and Pen-Tab Paper Store(R).
Licensed Products
The Company is a party to numerous license agreements. These license
agreements permit the Company to use various licensed properties on its
products. The license agreements generally have terms of one to three years,
have minimum royalty requirements and a fixed percentage of the selling price as
a royalty due the licensor.
Employees
The Company had approximately 760 employees as of January 1, 2000.
Approximately 500 employees are represented by collective bargaining agreements
at the Missouri, Illinois and California facilities. In Missouri the employees
are represented by the United Paperworkers International Union AFL-C10, CLC
Local 765, whose contract expires August 8, 2000. In California, the employees
are represented by the Graphic Communications Union Local No. 388-M AFL-CIO,
whose contract expires November 30, 2001. In Illinois, the employees are
represented by the Warehouse, Mail Order, Office and Professional Employees
Local 743 Affiliated International Brotherhood, Teamsters AFL-CIO, whose
contract expires December 19, 2001. The Company enjoys an amicable relationship
with unionized labor. The following table provides information on the Company's
employees by operating function:
7
Employees Categorized by Function
---------------------------------
Manufacturing 675
Sales, Marketing and Creative 30
Administrative 40
Executive 15
--------
Total 760
========
As of January 1, 2000, the Company's manufacturing employees numbered 180 in the
Virginia facility, 150 in the California facility, 165 in the Chicago facility
and 180 in the Kansas City Facility.
Item 2. Properties
The following table summarizes the Company's facilities by location.
Company Facilities
- -----------------------------------------------------------------------------------------------------
Approximate Owned/ Lease
Location Square Feet Leased Product Categories Expiration
- -------- ----------- ------ ------------------ ----------
Front Royal, VA 282,000 Owned School, Office & Home N/A
Kansas City, MO 491,000 Leased School, Office & Home 2005
City of Industry, CA 250,000 Leased School, Office & Home 2002
Chicago, IL 210,000 Leased Vinyl Packaging 2004
The Company's Front Royal, VA facility was financed with Industrial Revenue
Development Bonds and is pledged as collateral.
Item 3. Legal Proceedings
The Company is a party to various litigation matters incidental to the
conduct of its business. Management does not believe that the outcome of any of
the matters in which it is currently involved will have a material effect on the
financial condition or results of operations of the Company.
Environmental, Health and Safety Matters
The Company is subject to federal, state, and local environmental and
occupational health and safety laws and regulations. Such laws and regulations,
among other things, impose limitations on the discharge of pollutants and
establish standards for management of waste. While there can be no assurance
that the Company is at all times in complete compliance with all such
requirements, the Company believes that any such noncompliance is unlikely to
have a material adverse effect on the Company. As is the case with manufacturers
in general, if a release or threat of release of hazardous materials occurs on
or from the Company's properties or any associated offsite disposal location, or
if contamination from prior activities is discovered at any properties owned or
operated by the Company, the Company may be held liable for response costs and
damages to natural resources. There can be no assurance that the amount of any
such liability would not be material.
8
Item 4. Submission of Matters to a Vote of Security Holders.
None
Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
None
Item 6. Selected Financial Data (Dollars in Thousands)
The financial statements of Pen-Tab Industries, Inc. for fiscal year 1995
represents the combined historical financial statements of Pen-Tab Industries,
Inc., a New York corporation, and its affiliated company Pen-Tab Industries of
California, Inc., a Delaware corporation, which were controlled under common
ownership. Intercompany accounts and transactions have been eliminated in
combination. Effective July 1, 1996, the two companies were merged into a new
Virginia corporation, called Pen-Tab Industries, Inc., with no change in
ownership, and accordingly, the historical book values of the companies' assets
and liabilities were carried forward to the new company. In connection with the
merger, Pen-Tab Industries, Inc. recorded a charge to retained earnings of $295
relating to the cancellation of treasury stock previously held by the two
companies, and eliminated the treasury stock and related additional capital
balances.
On February 4, 1997, Pen-Tab Industries, Inc., a Virginia corporation,
changed its name to Pen-Tab Holdings, Inc. On February 4, 1997 Holdings formed a
wholly owned subsidiary called Pen-Tab Industries, Inc., a Delaware corporation.
On February 4, 1997, the Company issued $75 million 10 7/8% Senior Subordinated
Notes due 2007 and Holdings effected a recapitalization pursuant to which
Holdings repurchased approximately 748 shares of Class A common stock and 122
shares of Class B common stock from management shareholders for approximately
$47,858, converted an additional 14 shares of Class A common stock and 358
shares of Class B common stock into redeemable preferred stock, and sold 37
shares of Class A common stock, 3 shares of Class B common stock and 125,875
shares of redeemable preferred stock to outside investors for proceeds of
approximately $15,010. Holdings' shareholders concurrently approved an amendment
to Holdings' articles of incorporation to increase the number of authorized
shares to 8,352,500, consisting of 6,000,000 shares of Class A Common Stock, par
value $.01 per share, 2,000,000 shares of Class B Common Stock, par value $.01
per share, and 352,500 shares of redeemable preferred stock. Following
completion of the above transaction, Holdings' shareholders approved a stock
split pursuant to which each share of Holdings' Class A Common Stock and Class B
Common Stock then outstanding was converted into 60,937.50 shares of such common
stock.
The Financial statements of Pen - Tab Industries, Inc. for fiscal year 1998
reflect the acquisition of Stuart Hall Company, Inc. and the results of their
operations from the acquisition on August 20, 1998, through the fiscal year end
of January 2, 1999.
Set forth below are selected historical financial data and other financial
data of the Company as of the dates and for the periods presented. The selected
historical financial data as of January 1, 2000, January 2, 1999, January 3,
1998, December 28, 1996, December 30, 1995, and for the fiscal years then ended
were derived from the Audited Financial Statements of the Company.
9
The information contained in this table and accompanying notes should be
read in conjunction with the "Management Discussion and Analysis of Financial
Condition and Results of Operations," the Audited Consolidated Financial
Statements and the accompanying notes and schedules thereto appearing elsewhere.
Fiscal Year
-------------------------------------------------------------------
1999 1998 1997 1996 1995
-------------------------------------------------------------------
Statement of Operations Data
Net sales $ 155,403 $114,791 $88,014 $ 96,402 $ 84,280
Cost of goods sold 110,631 83,228 65,071 67,313 64,664
Gross profit 44,772 31,563 22,943 29,089 19,616
Selling, general and administrative expenses 26,681 20,469 15,234 15,108 11,388
Amortization of goodwill 1,892 578 - - -
Relocation and reorganization expenses (a) 6,112 - 804 - 1,906
Interest expense, net 17,427 11,425 8,192 2,346 2,883
Other income, net (21) (28) - (4) (55)
Income (loss) from continuing operations
before income taxes (7,319) (881) (1,287) 11,639 3,494
Income tax (benefit) provision (b), (e) (1,492) (290) 1,774 (168) (263)
Income (loss) from continuing operations (5,827) (591) (3,061) 11,807 3,757
Income (loss) from discontinued operations,
net of taxes (750) (90) 216 1,602 1,151
Net income (loss) $ (6,577) $ (681) $ (2,845) $ 13,409 $ 4,908
Other Financial Data
Net cash provided by (used in)operating
activities $ (7,115) 24,880 $ (768) $ 13,356 $ 10,926
Net cash (used in) investing activities (2,854) (116,086) (1,562) (890) (8,521)
Net cash provided by (used in) financing
activities 10,124 77,550 15,895 (13,191) (2,291)
Adjusted EBITDA from continuing operations (c) 23,921 14,529 10,065 16,119 10,543
Adjusted EBITDA margin from continuing
operations (c) 15.4% 12.7% 11.4% 16.7% 12.5%
Depreciation and amortization 8,862 4,892 2,968 2,364 2,760
Capital expenditures $ 2,854 $ 2,854 $ 1,562 $ 890 $ 9,322
Ratio of earnings to fixed charges (d) --(d) --(d) --(d) 5.8x 2.4x
At
------------------------------------------------------------------
Jan. 1 Jan. 2 Jan. 3 Dec. 28 Dec. 30
2000 1999 1998 1996 1995
------------------------------------------------------------------
Balance Sheet Data
Total assets $193,722 $181,943 $ 63,792 $43,504 $43,805
Long-term debt (including current portion) 163,169 132,460 82,754 24,210 28,000
Stockholder's equity (deficit) $ 3,850 $ 10,517 $(28,005) $15,052 $11,044
- -----
(a) During fiscal 1995, the Company relocated its headquarters and its east
coast manufacturing facilities from Glendale, New York to Front Royal, Virginia.
The non-recurring charges of $1.9 million associated therewith are reported as
relocation expense in the statement of operations. During fiscal 1997, the
10
Company reorganized its sales and marketing functions. The non-recurring charges
of $0.8 million for recruitment and acquisition costs of new sales and marketing
executives as well as the severance costs of terminated sales employees are
reported as reorganization expenses in the statement of operations. During 1999,
the Company approved a plan to rationalize its manufacturing operations. The
plan includes a plant consolidation, equipment moves, plant/product changes and
warehouse consolidation. The non-recurring charges of $6.1 million associated
therewith are reported as reorganization expenses in the statement of
operations.
(b) For fiscal years 1995 and until the period ended February 3, 1997, the
Company elected to be treated as an "S" corporation for federal income tax
purposes under which income, losses, deductions and credits were allocated to
and reported by the Company's shareholders based on their respective ownership
interests. Accordingly, no provision for income taxes was required for such
periods, except for state income taxes.
(c) Adjusted EBITDA is defined as net income before interest, income taxes,
depreciation and amortization and certain non-recurring expenses (see (a)
above). Adjusted EBITDA is presented because it is a widely accepted financial
indicator of a company's ability to incur and service debt. However, Adjusted
EBITDA should not be considered in isolation as a substitute for net income
(loss) or cash flow data prepared in accordance with generally accepted
accounting principles or as a measure of a company's profitability or liquidity.
In addition, this measure of Adjusted EBITDA may not be comparable to similar
measures reported by other companies. Adjusted EBITDA amounts for 1999 have been
adjusted for reorganization expenses of $6.1 million related to the
rationalizing of the Company's manufacturing operations. Adjusted EBITDA amounts
for fiscal 1997 has been adjusted for reorganization expenses of $0.8 million,
related to the recruitment and acquisition costs of new sales and marketing
executives as well as the severance costs of terminated sales employees and
fiscal 1995 has been adjusted for non-depreciation relocation expenses of $1.7
million, related to the relocation of the Company's headquarters and east coast
manufacturing facilities from New York to Virginia. Adjusted EBITDA margin is
calculated as the ratio of Adjusted EBITDA to net sales for the period. Funds
depicted by Adjusted EBITDA are not available for management's discretionary use
due to functional requirements to conserve funds primarily for capital
replacement and expansion, and debt service requirements.
(d) For purposes of the ratio of earnings to fixed charges, (i) earnings are
calculated as the Company's earnings before income taxes and fixed charges and
(ii) fixed charges include interest on all indebtedness, amortization of
deferred financing costs and one-third of operating lease expense. Earnings
before fixed charges for the years ended January 1, 2000, January 2, 1999 and
January 3,1998 were insufficient to cover fixed charges by $8.3 million, $1.0
million and $0.9 million, respectively.
Fiscal Year
----------------------------------------------------------------------
1999 1998 1997 1996 1995
------------------------------------------ --------------------------
Income (loss) before income taxes $(8,261) $ (1,016) $(900) $13,218 $ 4,565
Add back Fixed Charges;
Interest Expense 17,382 11,413 8,194 2,346 2,883
Operating Lease Expense 572 531 400 400 375
------------------------------------------ --------------------------
Earnings before Fixed Charges 9,693 10,928 7,694 15,964 7,823
Fixed Charges 17,954 11,944 8,594 2,746 3,258
Ratio of Earnings to Fixed Charges - - - 5.8x 2.4x
(e) During fiscal 1997, the Company recorded a cumulative deferred tax liability
of $2,316 upon termination of the Company's "S" corporation status.
11
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
General
The following discussion should be read in conjunction with the "Selected
Financial Data", the Audited Financial Statements and the accompanying notes and
schedules thereto appearing elsewhere herein.
Stuart Hall Acquisition. On August 20, 1998 Pen-Tab acquired all of the
capital stock of Stuart Hall Company, Inc., a wholly-owned subsidiary of Newell
Co. The net purchase price was approximately $133.8 million after post-closing
adjustments and expenses, of which $39.2 was generated by an equity contribution
from Pen-Tab Holdings, Inc., Pen-Tab's parent company and the remainder was
financed with drawings on a bank Credit Facility (as hereinafter defined).
Stuart Hall's results of operations since the acquisition date are included in
the Company's results of operations. The acquisition was accounted for as a
purchase.
Differentiated products. In 1992, the Company recognized a previously
unfulfilled demand for higher quality, functionally superior, upscale school and
office-related products. The Company pioneered a line of these higher price
point and margin, branded products to serve the school and office products
markets. A significant portion of the Company's increase in sales since 1992 is
due to the introduction of differentiated products. Additionally, the Company's
differentiated products and product lines result in higher margins for the
Company and its customers. Demand for differentiated products has risen steadily
since 1992 when the Company first introduced them and the Company expects a
significant portion of its future growth to come from increased sales of
differentiated products.
Seasonality. As a result of the seasonal nature of the back-to-school
sector of the business, the Company's inventory and associated working capital
borrowings typically increase throughout the calendar year until the latter part
of May and early June. At such time, the inventory is shipped to customers, and
converted into receivables. By the middle of September, account collections
occur and working capital borrowing is reduced.
Paper prices. Paper represents the largest component of the Company's cost
of goods sold. Certain commodity grades of paper have shown considerable price
volatility during recent years. The Company's pricing policies generally enable
it to set product prices consistently with the Company's cost of paper at the
time of shipment. The Company believes that it is able to price its products so
as to minimize the impact of price volatility on dollar margins. As a result of
new product introductions, a substantial portion of which have little or no
paper content, the Company offers a broader and more diverse product mix which
is less susceptible to paper price fluctuations.
Recent Developments
Management change. On June 29, 1999, the Company appointed Marc English as
Chief Executive Officer. Mr. English was previously President and Chief
Executive Officer of CSS Industries' Cleo unit, a consumer products company
primarily engaged in the manufacturing and sale to mass-market retailers of
seasonal gift-wrap products. In addition, he has held marketing and sales
management positions with other companies, including CPS Corp., also in the
gift-wrap industry. Mr. English replaced Mr. Hodes who resigned from the
position as Chief Executive Officer of the Company.
Company Initiatives/Reorganization. Under the leadership of Marc English,
the Company performed a review of all operations with the goals of increasing
market share, streamlining operations, reducing debt and increasing
profitability.
12
On December 30, 1999, the Company approved a plan to rationalize its
manufacturing operations. The plan includes a plant consolidation, equipment
moves, plant/product changes, and warehouse consolidation. The rationalization
is expected to result in an approximate 20% reduction in manufacturing space.
The fourth quarter reorganization charge of $6.1 million represents the
Company's rationalization plan and includes employee termination costs,
including benefits, costs to exit facilities, lease termination costs, and
property taxes after ceasing operations. The major undertakings of the
rationalization plan are expected to be completed in 2000. Upon full
implementation, the plan is expected to have a significant positive effect on
the Company's financial performance, resulting in an estimated annualized cost
savings of approximately $3 million.
In March 2000, the company decided to divest its vinyl packaging business
segment, which operates as Vinylweld L.L.C. The divestiture is anticipated to
occur by the end of the first quarter of 2001.
Covenant Violations/Amendments to Credit Facility/Note Holder Consent. As a
result of insufficient third quarter 1999 earnings, the Company was in default
of a covenant based on EBITDA (earnings before interest, taxes, depreciation,
amortization, and certain non-cash charges, as defined in the agreement) and
cash interest and principal payments (fixed charge coverage ratio) for the
twelve months ended October 2, 1999. On November 16, 1999, the Company amended
its credit facility to waive the fixed charge coverage ratio covenant default.
This amendment also provided that the interest rate increase by 0.625%.
As a result of insufficient fourth quarter 1999 earnings, the Company was
in default of the fixed charge coverage ratio covenant and the minimum net worth
covenant, as defined in the agreement, at and for the twelve months ended
January 1, 2000. In addition, due to the earnings shortfall and ERP system
implementation issues which led to higher than expected inventories and accounts
receivable collection delays, the Company was in default of the annual revolver
clean up provision. The clean up provision requires the Company, for a period of
not less than thirty days between September 30 and November 15, to reduce the
outstanding balance on the revolver to $25 million or less. The Company was also
in default of the borrowing base formula, as defined in the agreement, whereby
the balance outstanding on the revolver was in excess of the borrowing base
formula computed amount. On March 13, 2000, the Company amended its credit
facility. The amendment (i) waived the defaults, (ii) revised the borrowing base
definition to provide for an over advance of up to $16.5 million for the period
of March 1, 2000 through July 15, 2000, (iii) increased the interest rate by
0.875% plus another 0.50% during the over advance period, (iv) revised the
annual clean up provision amount to $27 million from $25 million and revised the
clean up period to be between October 15 and January 15 from between September
30 and November 15, (v) revised the fixed charge coverage ratio to 1.00:1 (from
1.50:1) for the twelve month periods ended March 31, 2000 and June 30, 2000 and
to 1.50:1 (from 1.75:1) thereafter, (vi) limits capital expenditures to $2
million for fiscal 2000 and (vii) requires total debt, as defined in the
agreement, not to exceed $153 million at June 30, 2000. The Company paid a fee
of $0.5 million in conjunction with the Credit Facility amendment and will
amortize such fee over the remaining life of the Credit Facility.
Prior to the amendment discussed in the preceding paragraph and as a result
of the covenant violations described above, the Company was not allowed to
make the required interest payment of approximately $4 million due on February
1, 2000 to the holders of the Company's $75 million 10.875% Senior Subordinated
Notes due 2007. As a condition of the aforementioned amendment, the Company
obtained consent from substantially all of the note holders to accept the
February 1, 2000 interest payment in the form of new notes, in aggregate
principal amount substantially equal to such interest payment, in lieu of a cash
payment. As a result, the Company will be deemed to have made the cash interest
payment and simultaneously issued new notes to existing noteholders in exchange
for such cash payments.
Results of Operations
The following table sets forth the fiscal years 1997 through 1999, certain
income and expense items of the Company as a percentage of net sales.
13
Fiscal Year
--------------------------------
1999 1998 1997
------ ------ ------
Net sales 100.0% 100.0% 100.0%
Cost of goods sold 71.2% 72.5% 73.9%
------ ------ ------
Gross profit 28.8% 27.5% 26.1%
Selling, general, and administrative
expenses 17.2% 17.8% 17.3%
Amortization of goodwill 1.2% 0.5% -
Reorganization expenses 3.9% - 0.9%
------ ------ ------
Income from continuing operations 6.5% 9.2% 7.9%
====== ====== ======
Fiscal 1999 Compared to Fiscal 1998
Net sales for the year ended January 1, 2000 increased by $40.6 million, or
35.4%, to $155.4 million from $114.8 million for the year ended January 2, 1999.
The increase in sales is primarily attributable to the purchase of Stuart Hall
on August 20, 1998. The increase in sales related to the Stuart Hall acquisition
is partially offset and impacted by (i) an approximate 10% decrease in selling
prices in 1999 from 1998 resulting from a decrease in the cost of paper, (ii)
loss of sales volume to foreign competition, and (iii) an increase in sales
deductions and allowances related to ERP implementation and merger integration
difficulties. For the Pen-Tab segment, which includes Stuart Hall,
differentiated product and core product sales increased by $20.3 million and
$20.3 million, respectively, for the year ended January 1, 2000 as compared to
the year ended January 2, 1999.
Gross profit for the year ended January 1, 2000 increased by $13.2 million
or 41.8% to $44.8 million from $31.6 million for the year ended January 2, 1999.
The gross profit percentage for year ended January 1, 2000 was 28.8% compared to
27.5% for the year ended January 2, 1999. The 1.3% increase in the gross profit
percentage is principally related to (i) a LIFO adjustment increasing gross
profit for the year ended January 1,2000 by $1.5 million due to significant
decrease in the cost of paper versus a LIFO adjustment increasing gross profit
for the year ended January 2, 1999 by $0.7 million, (ii) the increase in
differentiated higher margin product sales in the Pen-Tab segment as a result of
the acquisition of Stuart Hall, and (iii) the difficulties encountered in
integrating Stuart Hall operations into Pen-Tab. Differentiated products
represent approximately 50.0% of net sales in 1999 versus approximately 37.4% in
1998. The increase in gross profit was partially offset by margin erosion on
certain maturing differentiated product lines, lower selling prices due to the
reduction in the cost of paper in 1999, and foreign competition causing lower
selling prices and margins on certain product lines.
SG&A expenses for the year ended January 1, 2000 increased $6.2 million or
30.2% to $26.7 million from $20.5 million for the year ended January 2, 1999. As
a percentage of net sales, SG&A expenses decreased to 17.2% for the year ended
January 1, 2000 from 17.8% for the year ended January 2, 1999. This increase is
primarily the result of (i) a full year of Stuart Hall activity in 1999 versus
four months in 1998 and (ii) increased distribution and commission expenses on
the $40.6 million increase in net sales.
Reorganization expense for the year ended January 1, 2000 is $6.1 million.
The reorganization charges represent a plant consolidation plan that includes
employee termination costs, including benefits, costs to exit facilities, lease
termination costs, and property taxes after ceasing operations.
Discontinued Operations includes the operations of the Company's vinyl
packaging segment. In March 2000, the Company decided to divest this business.
The divestiture is anticipated to occur by the end of the first quarter of 2001.
Net sales for the vinyl packaging segment for the year ended January 1, 2000
decreased by $1.1 million or 11.8% to $8.2 million from $9.3 million for the
year ended January 2, 1999. Loss from discontinued operations, net of income tax
benefits, for the year ended January 1, 2000 was $0.8 million compared to a loss
of $0.1 million for the year ended January 2, 1999.
Interest expense, net for the year ended January 1, 2000 increased $6.0
million to $17.4 million from $11.4 million for the year ended January 2, 1999.
The increase is principally due to the interest on the debt incurred to acquire
Stuart Hall on August 20, 1998, coupled with interest rate increases.
14
Fiscal 1998 Compared to Fiscal 1997
Net sales for the year ended January 2, 1999 increased by $26.8 million, or
30.5%, to $114.8 million from $88.0 million for the year ended January 3, 1998.
The Company's acquisition of Stuart Hall on August 20, 1998 contributed $11.8
million or 13.4% of the increase. For the Pen-Tab segment, which includes Stuart
Hall, differentiated product and core product sales increased by $10.8 million
and $16.0 million, respectively, for the year ended January 2, 1999 as compared
to the year ended January 3, 1998.
Gross profit for the year ended January 2, 1999 increased by $8.7 million
or 38.0% to $31.6 million from $22.9 million for the year ended January 3, 1998.
The gross profit percentage for year ended January 2, 1999 was 27.5% compared to
26.1% for the year ended January 3, 1998. The 1.4% increase in the gross profit
percentage is principally related to (i) the growth in high margin
differentiated product sales which increased to 37.4% of net sales for the year
ended January 2, 1999 from 36.7% for the year ended January 3, 1998, and (ii)
sales volume increase in 1998 caused an increase in gross margin due to the
increased utilization of fixed factory overhead.
SG&A expenses for the year ended January 2, 1999 increased $5.3 million or
34.9% to $20.5 million from $15.2 million for the year ended January 3, 1998. As
a percentage of net sales, SG&A expenses increased to 17.8% for the year ended
January 2, 1999 from 17.3% for the year ended January 3, 1998. This increase is
principally the result of (i) shipping expenses (primarily freight out)
increased to 8.9% of net sales for the year ended January 2, 1999 from 7.5% of
net sales for the year ended January 3, 1998. The increase was the result of an
increase in direct-to-store customers. Partially offset by (ii) a reduction in
1998 of television and print advertising of $1.2 million or 0.9%.
Discontinued operations includes the operations of the Company's vinyl
packaging segment. Net sales for the vinyl packaging segment for the year ended
January 2, 1999 increased by $0.7 million or 8.1% to $9.3 million from $8.6
million for the year ended January 3, 1998. Loss from discontinued operations,
net of income tax benefits, for the year ended January 2, 1999 was $0.1 million
compared to an income of $0.2 million for the year ended January 3, 1998.
Interest expense, net for the year ended January 2, 1999 increased $3.2
million to $11.4 million from $8.2 million for the year ended January 3, 1998.
The increase is principally due to the interest on the debt incurred to acquire
Stuart Hall on August 20, 1998.
Liquidity and Capital Resources
Net cash used in operating activities for the year ended January 1, 2000
was $7.1 million as compared to net cash provided by operating activities of
$24.9 million for the year ended January 2, 1999. The decrease was primarily
attributable to the timing of the purchase of Stuart Hall as the acquisition
occurred at the seasonal peak in accounts receivable. Hence the 1998 cash
provided by operating activities was benefited by acquired accounts receivable
collections. In addition, merger integration and ERP system implementation
issues led to higher than normal accounts receivable at January 1, 2000.
Net cash used in investing activities for the year ended January 1,
2000 was $2.9 million as compared to $116.1 million for the year ended January
2, 1999. Substantially all of the cash used in investing activities in 1998 was
used to purchase Stuart Hall.
Net cash provided by financing activities for the year ended January 1,
2000 was $10.1 million as compared to $77.6 million for the year ended January
2, 1999. The activity in both years was mainly due to the Stuart Hall
acquisition. During 1999 the Company paid a post closing working capital
purchase price adjustment of approximately $19.9 million which was funded by
proceeds from revolver borrowings.
Net cash provided by operating activities for the year ended January 2,
1999 was $24.9 million as compared to net cash used in operating activities of
$0.8 million for the year ended January 3, 1998. The increase was primarily
attributable to the acquisition of Stuart Hall. The timing of which generated a
$16.4 million decrease in accounts receivable.
Net cash provided by financing activities for the year ended January 2,
1999 was $77.6 million as compared to net cash provided by financing activities
of $15.9 million for the year ended January 3, 1998. The increase is
attributable to a $39.2 million equity contribution from Pen-Tab Holdings and
the proceeds of long-term debt used to acquire Stuart Hall.
Capital expenditures in the fiscal years 1999, 1998, and 1997 were $2.9
million, $2.9 million, and $1.6 million, respectively. The Company expects that
capital expenditure requirements will not exceed $2.0 million for 2000 as
required in the Credit Facility. The Company believes capital expenditure levels
are sufficient to
15
maintain competitiveness and to provide sufficient manufacturing capacity. The
Company expects to fund capital expenditures primarily from cash generated from
operating activities.
In August 1998, in conjunction with the acquisition of Stuart Hall, the
Company entered into a new Credit Facility ("Credit Facility"). The information
below is a summary of the material terms thereof qualified by reference to the
complete text of the documents. The Credit Facility has two parts, a $100
million revolver and a $35 million term loan. Borrowings under the Credit
Facility are available to acquire the capital stock of Stuart Hall Company,
Inc., for working capital and general corporate purposes, including letters of
credit. The $35 million term loan was fully drawn on at August 20, 1998 in
conjunction with the acquisition of Stuart Hall. The Credit Facility is secured
by first priority liens on substantially all of the Company's assets. The Credit
Facility expires on August 20, 2001, unless extended. The interest rate per
annum applicable to the Credit Facility is the prime rate, as announced by the
Bank plus 1.75% or, at the Company's option, the Eurodollar rate plus 3.5%. The
Company is required to pay a commitment fee of 0.65% on the unused portion of
the $100 million revolver. The Credit Facility permits the Company to prepay
loans and to permanently reduce credit commitments or letters of credit, in
whole or in part, at any time in certain minimum amounts.
The availability of the Credit Facility is subject to various conditions
precedent. Advances are made under the revolver portion of the Credit Facility
up to an aggregate $100 million based on a borrowing base comprised of eligible
accounts receivable and inventory at the following advance rates: 85% of the
value of eligible accounts receivable, and 60% of the value of eligible
inventory. The Credit Facility and the Indenture impose certain restrictions on
the Company, including restrictions on its ability to incur indebtedness, pay
dividends, make investments, grant liens, sell its assets and engage in certain
other activities.
The Company's average working capital borrowings under its Credit Agreement
and Credit Facility, since August 20, 1998, for the fiscal years 1999, 1998, and
1997 were $52.8 million, $7.6 million, and $2.5 million, respectively. The
Company's maximum working capital borrowings outstanding were $78.5 million,
$35.3 million, and $10.9 million, respectively for the same fiscal years.
As a result of insufficient third quarter 1999 earnings, the Company was in
default of a covenant based on EBITDA (earnings before interest, taxes,
depreciation, amortization, and certain non-cash charges, as defined in the
agreement) and cash interest and principal payments (fixed charge coverage
ratio) for the twelve months ended October 2, 1999. On November 16, 1999, the
Company amended its credit facility to waive the fixed charge coverage ratio
covenant default. This amendment also provided that the interest rate increase
by 0.625%.
As a result of insufficient fourth quarter 1999 earnings, the Company was
in default of the fixed charge coverage ratio covenant and the minimum net worth
covenant, as defined in the agreement, at and for the twelve months ended
January 1, 2000. In addition, due to the earnings shortfall and ERP system
implementation issues which led to higher than expected inventories and accounts
receivable collection delays, the Company was in default of the annual clean up
provision. The clean up provision requires the Company, for a period of not less
than thirty days between September 30 and November 15, to reduce the outstanding
balance on the revolver to $25 million or less. The Company was also in default
of the borrowing base formula, as defined in the agreement, whereby the balance
outstanding on the revolver was in excess of the borrowing base formula computed
amount. On March 13, 2000, the Company amended its credit facility. The
amendment (i) waived the defaults, (ii) revised the borrowing base definition to
provide for an over advance of up to $16.5 million for the period of March 1,
2000 through July 15, 2000, (iii) increased the interest rate by 0.875% plus
another 0.50% during the over advance period, (iv) revised the annual clean up
provision amount to $27 million from $25 million and revised the clean up period
to be between October 15 and January 15 from between September 30 and November
15, (v) revised the fixed charge coverage ratio to 1.00:1 (from 1.50:1) for the
twelve month periods ended March 31, 2000 and June 30, 2000 and to 1.50:1 (from
1.75:1) thereafter, (vi) limits capital
16
expenditures to $2 million for fiscal 2000 and (vii) requires total debt, as
defined in the agreement, not to exceed $153 million at June 30, 2000. The
Company paid a fee of $0.5 million in conjunction with the Credit Facility
amendment and will amortize such fee over the remaining life of the Credit
Facility (March 2000 through August 2001).
Prior to the amendment discussed in the preceding paragraph and as a result
of the covenant violations described above, the Company was not allowed to
make the required interest payment of approximately $4 million due on February
1, 2000 to the holders of the Company's $75 million 10.875% Senior Subordinated
Notes due 2007. As a condition of the aforementioned amendment, the Company
obtained consent from substantially all of the note holders to accept the
February 1, 2000 interest payment in the form of new notes, in aggregate
principal amount substantially equal to such interest payment, in lieu of a cash
payment. As a result, the Company will be deemed to have made the cash interest
payment and simultaneously issued new notes to existing note holders in exchange
for such cash payment.
Subsequent to January 1, 2000, a major stockholder of Pen-Tab Holdings,
Inc. ("Holdings") purchased approximately $60 million of the $75 million 10.875%
Senior Subordinated Notes in the secondary market.
The Company is currently engaged in discussions with the note holders of
the $75 million 10.875% Senior Subordinated Notes regarding a conversion of
such notes to non-cash interest bearing securities or equity. Such conversion is
required to take place on or before June 30, 2000 in order for the Company to
meet the total debt, as defined in the Credit Facility, covenant threshold.
Management believes that it will be able to accomplish such a conversion and
therefore meet the Credit Facility covenant regarding total debt at June 30,
2000.
Management believes that based on current levels of operations and
anticipated internal growth, cash flow from operations, together with other
available sources of funds including the availability of seasonal borrowings
under the Credit Facility, will be adequate for the foreseeable future to make
required payments on the Company's indebtedness, to fund anticipated capital
expenditures and working capital requirements. The ability of the Company to
meet its debt service obligations and reduce its total debt will be dependent,
however, upon the future performance of the Company which, in turn, will be
subject to general economic conditions and to financial, business and other
factors, including factors beyond the Company's control. The majority of the
debt of the Company bears interest at floating rates; therefore, its financial
condition is and will continue to be affected by changes in prevailing interest
rates.
During November 1997, the Company entered into a swap agreement, which
expires February, 2002, to swap its fixed rate of payment on the $75 million 10
7/8% Senior Subordinated Notes for a floating rate payment. The floating rate is
based upon a basket of LIBORS of three countries plus a spread, and is capped at
12.5%. The interest rate resets every six months and the Company's effective
interest rate under the swap agreement at January 1, 2000 was 10.04%. The
Company can terminate the transaction on any interest reset date at the then
current fair market value of the swap instrument. At January 1, 2000, the
agreement could have been terminated at a loss of $0.7 million.
Inflation
The Company believes that inflation has not had a material impact on its
results of operations for the three years ended January 1, 2000.
Year 2000 compliance.
The company did not experience any significant Year 2000 issues in its
information technology systems nor non-information technology systems through
January 31, 2000. No major business processes, operations or customer deliveries
were disrupted as a result of the Year 2000 issue.
The company had a contingency plan to address the greatest areas of risk of
noncompliance or threats to business operations or company assets related to the
Year 2000 issue.
17
Disclosures Regarding Accounting Standards Issued But Not Yet Adopted
The Financial Accounting Standards Board has issued three new statements
including Statement No. 135 (Recision of Statement No. 75), Statement No. 136
(Transfer of Assets Involving a Not-for-Profit Organization That Raises or Holds
Contributions for Others) and Statement No. 137 (Deferral of Effective Date of
Statement No. 133). Statements No. 135 and 136 have no applicability to the
Company. Statement No. 137, which deferred the effective date of Statement No.
133 (Accounting for Derivative Instruments and Hedging Activities) is not
effective until fiscal year 2001 and the Company did not adopt early. Adoption
of this standard will not materially impact the Company's financial position,
results of operations or cash flows, and any effect, while not yet determined by
the Company, will be limited to the presentation of its disclosures.
The American Institute of Certified Public Accountants has issued three new
statements including SOP 98-9 (Modification of SOP 97-2 on Software Revenue
Recognition), SOP 99-2 (Accounting for and Reporting of Postretirement Medical
Benefit (401(h)) Features of Defined Benefit Pension Plans) and SOP 99-3
(Accounting for and Reporting of Certain Defined Contribution Plan Investments
and Other Disclosure Matters). The aforementioned statements do not have a
material effect on the financial position, results of operations or cash flows
of the Company.
Item 7a. Quantitative and Qualitative Disclosures About Market Risk.
The Company's market risk is impacted by changes in interest rates and
certain commodity prices, namely paper. The Company does not currently hold or
issue derivative instruments, except for the swap disclosed in Note 2, for
trading or hedging purposes related to commodity price fluctuations.
The Company's primary market risk is commodity price exposure. Based upon
past experience, the Company believes it can effectively pass through to its
customers commodity price fluctuations thus assisting the Company in mitigating
exposure related to commodity price fluctuations. In addition, the Company has
market risk related to interest rate exposure on its Credit Facility and swap
agreement. Interest rate swaps may be used to adjust interest rate exposure when
appropriate.
Based on the Company's overall commodity price and interest rate exposure
at January 1, 2000, management believes that a short-term change in any of the
exposures will not have a material effect on the consolidated financial
statements of the Company.
Item 8. Financial Statements and Supplementary Data.
Financial Statements of Pen-Tab Industries, Inc.
Report of Ernst & Young LLP, Independent Auditors.......................... F1
Consolidated Balance Sheets................................................ F2
Consolidated Statements of Operations...................................... F4
Consolidated Statements of Stockholder's Equity............................ F5
Consolidated Statements of Cash Flows...................................... F6
Notes to Consolidated Financial Statements................................. F7
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure.
The Company has not filed a form 8-K reporting a change of independent
auditors or any disagreement with the independent auditors.
Part III
Item 10. Directors and Executive Officers of the Registrant.
The following table sets forth the names, ages as of December 1999, and a
brief account of the business experience of each person who is a director or
executive officer of the Company.
Name Age Position
- ---- --- --------
Marc English 47 Chief Executive Officer
Michael Greenberg 59 Executive Vice President
William Leary 40 Vice President, Chief Financial and
Administrative Officer
Deborah Hodes 47 Senior Vice President/Creative Director and Director
Alan Hodes 56 Director
Thomas McWilliams 56 Director
David Howe 35 Director
James Stevens 63 Director
18
Marc English joined the Company as Chief Executive Office in July 1999.
Mr. English was previously the President and Chief Executive Officer of CSS's
Cleo unit, a consumer products company primarily engaged in the manufacturer and
sale to mass-market retailers of seasonal gift-wrap products. Mr. English's
employment at Cleo spanned 1994 through 1999 and included holding the position
of Senior Vice President of Sales and Marketing. Prior to joining Cleo, Mr.
English spent 15 years at CPS Corp., also in the gift-wrap industry, in various
roles, the most recent of which was Senior Vice President of Marketing and
Sales. Mr. English has a Bachelors degree from the University of Wisconsin.
Michael Greenberg has been Executive Vice President since 1971. Mr.
Greenberg was Vice President of Vinylweld, Inc. the predecessor of the Company's
packaging business, when it was acquired by the Company. He was previously
Manufacturing Manager for Mohawk Tablet Company. Mr. Greenberg graduated from
the University of Illinois with a B.S. degree in Industrial Engineering.
William Leary has been Vice President, Chief Financial and Administrative
Officer of the Company since 1991. Mr. Leary is a certified public accountant.
He was previously employed by Ernst & Young, LLP as a Senior Manager in the
Audit practice. Mr. Leary earned a Bachelors of Business Administration degree
in Accounting in 1982 from Bernard M. Baruch College of the City University of
New York.
Deborah Hodes has been Senior Vice President/Creative Director of the
Company since 1992. Ms. Hodes experience in the fashion related industry
includes a position as Fashion Director for a chain of specialty department
stores and Assistant to a leading clothing and fragrance designer. Ms. Hodes'
education includes the New York School of Interior Design, Parsons School of
Design and Chamberlayne College. Ms. Hodes is married to Alan Hodes.
Alan Hodes has been affiliated with Pen-Tab since 1966. Mr. Hodes and Mr.
Greenberg purchased Pen-Tab in 1982. Mr. Hodes was Chief Executive Officer of
Pen-Tab from 1982 to 1999. Mr. Hodes received his B.S. degree in Accounting from
Brooklyn College. Mr. Hodes is married to Deborah Hodes.
Thomas McWilliams has been affiliated with CVC since 1983 and presently
serves as managing director of CVC as well as a member of CVC's investment
committee. From 1978 until 1983, Mr. McWilliams served as an executive officer,
including as vice president, president and chief operating officer, of Shelter
Resources Corporation, a publicly held holding company with operating
subsidiaries in the manufactured housing industry. From 1967 until 1978, Mr.
McWilliams served in various corporate finance and management positions at
Citibank, N.A. Mr. McWilliams is currently a director of each of Chase Brass
Industries, Inc., Ergo Science Corporation and various privately owned
companies.
David Howe has been employed at CVC since 1993. Prior thereto, he worked at
Butler Capital, a private investment company. He serves on the Board of
Directors of Aetna Industries, Inc., Brake-Pro, Inc., Cable Systems
International, Inc., Copes-Vulcan, Inc., Sinter Metals, Inc., Milk Specialties
Company and American-Italian Pasta Company. He also represents Citicorp on the
Board of Del Monte Foods Company. He is a graduate of Harvard College and
Harvard Business School.
James Stevens is presently a financial consultant and serves a variety of
organizations as a corporate director or as a trustee. From 1987 through 1994,
Mr. Stevens was affiliated with Prudential Insurance Company of America, serving
as Executive Vice President. He was also Chairman and Chief Executive Officer of
the Prudential Asset Management Group (August 1993 through December 1994), the
Senior Officer in charge of the Private Placement Group (October 1987 through
August 1993) and a
19
member of the Operating Council. Mr. Stevens is a former Managing Director of
Dillon, Read & Co. Inc., a former Executive Vice President of Citicorp/Citibank
and a former Chairman of CVC.
Item 11. Executive Compensation
Compensation of Directors
The Company will reimburse directors for any out-of-pocket expenses
incurred by them in connection with services provided in such capacity. In
addition, the Company may compensate directors for services provided in such
capacity.
Compensation of Executive Officers
The following summarizes the principal components of compensation of the
Company's Chief Executive Officer and each officer whose compensation exceeded
$100,000 for fiscal 1999. The compensation set forth below fully reflects
compensation for work performed on behalf of the Company.
Summary Compensation Table
Annual Compensation
--------------------
Salary Bonus
Name and Principal Position Fiscal Year ($) ($)
- --------------------------- ----------- ------ -----
Marc English 1999 330,000 161,000
Chief Executive Officer
Michael Greenberg 1999 235,847 -
Executive Vice President 1998 231,964 -
1997 228,800 -
William Leary 1999 150,000 -
Vice President, Chief Financial and 1998 128,700 50,000
Administrative Officer 1997 117,000 50,000
Deborah Hodes 1999 118,960 -
Senior Vice President, Creative Director 1998 113,300 50,000
1997 103,000 50,000
Alan Hodes 1999 309,239 -
Former Chief Executive Officer 1998 304,148 -
1997 300,000 -
Dan Gallo 1999 231,000 -
Former President 1998 220,000 50,000
1997 220,000 118,000
20
Employment Agreements
Currently, Pen-Tab Holdings, Inc. has an employment agreement with Mr.
Greenberg. The employment agreement provides for (i) payment of a base salary
indexed to inflation, (ii) payment of bonuses of up to fifty percent of base
salary to be awarded at the discretion of the Company's Board of Directors and
(iii) certain fringe benefits. The employment agreement provides that the
executive may be terminated by the Company only with cause, and provides that
the executive will not compete with Holdings or its subsidiaries during the
period of employment and for the three years thereafter. The executive is
entitled to receive a severance payment in the event of a resignation caused by
the relocation of the office at which the executive is employed.
Pen-Tab Industries, Inc. has an employment agreement with Mr. English. The
employment agreement provides for (i) payment of a base salary, (ii) payment of
an annual bonus based upon the executive's performance and the Company's
operating results, and (iii) certain fringe benefits. The employment agreement
provides that the executive will not compete with the Company during the period
of employment and for eighteen months thereafter.
Pension Plan
The Company sponsors a 401(k) plan for all non-union employees meeting the
participation requirements. The Company matches the employee's contribution at a
rate of 50% on the employee's first 5% of wages.
The Company also contributes to union sponsored multi-employer defined
contribution pension plans.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
All of the Company's issued and outstanding capital stock is owned by
Holdings.
Item 13. Certain Relationships and Related Transactions
Subsequent to January 1, 2000, a major stockholder of Pen-Tab Holdings,
Inc. ("Holdings") purchased approximately $60 million of the $75 million 10.875%
Senior Subordinated Notes in the secondary market.
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) The following documents are filed as part of this form 10-K:
1) Financial Statements
Report of Ernst & Young LLP, Independent Auditors
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Stockholder's Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
2) Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts
Financial data schedule
21
3) Exhibits: the exhibits listed on the accompanying exhibit index are filed
as part of this form 10-K.
EXHIBIT INDEX
Exhibit
No. Description
- -------
2.1 Recapitalization Agreement dated as of January 9, 1997 by and among
Citicorp Venture Capital, Ltd., Pen-Tab Industries, Inc., Alan Hodes and
Michael Greenberg.**
3.1 Certificate of Incorporation of Pen-Tab Industries, Inc.**
3.2 By-laws of Pen-Tab Industries, Inc.**
4.1 Indenture dated as of February 1, 1997 between Pen-Tab Industries, Inc.
and United States Trust Company of New York.**
4.2 First Supplemental Indenture, dated as of May 7, 1997, between Pen-Tab
Industries, Inc. and United States Trust Company of New York.**
10.1 Second Amended and Restated Loan and Security Agreement dated as of
February 4, 1997 among Pen-Tab Industries, Inc., Pen-Tab Holdings, Inc.
(formerly known as Pen-Tab Industries, Inc.) and Bank of America
Illinois.**
10.2 Form of Notice of Borrowing.**
10.3 Form of Amended and Restated Revolving Note.**
10.4 Amended and Restated Trademark Agreement dated as of February 4, 1997
among Pen-Tab Industries, Inc., Pen-Tab Holdings, Inc. and Bank of America
Illinois.**
10.5 Pledge Agreement dated as of February 4, 1997 made by Pen-Tab Holdings,
Inc. in favor of Bank of America Illinois.**
10.6 First Amendment to Second Amended and Restated Loan and Security Agreement
dated as of February 4, 1997.***
10.7 Second Amendment and Waiver to Second Amended and Restated Loan and
Security Agreement dated as of June 9, 1997.***
10.8 Third Amendment to Second Amended and Restated Loan and Security Agreement
dated as of February 23, 1998.***
10.11 Shareholders Agreement dated as of February 4, 1997 by and among Pen-Tab
Holdings, Inc., Citicorp Venture Capital, Ltd., Alan Hodes, Michael
Greenberg and each other executive of Pen-Tab Holdings, Inc. or its
subsidiaries who acquires Class A Common Stock from the Company.**
10.12 Registration Rights Agreement dated as of February 4, 1997 by and among
Pen-Tab Industries, Inc., Citicorp Venture Capital, Ltd., Alan Hodes,
Michael Greenberg.**
10.13 Employment Agreement by and among Pen-Tab Holdings, Inc., Pen-Tab
Industries, Inc. and Alan Hodes.**
10.14 Pen-Tab Holdings, Inc. 1997 Stock Option Plan and Form of Agreement
Evidencing a Grant of a Nonqualified Stock Option under 1997 Stock Option
Plan.**
10.15 Employment Agreement by and among Pen-Tab Holdings, Inc., Pen-Tab
Industries, Inc. and Michael Greenberg.**
10.16 First Amendment to Second Amended and Restated Loan and Security
Agreement, dated as of February 4, 1997 by and among Pen-Tab Industries,
Inc., Pen-Tab Holdings, Inc. (formerly known as Pen-Tab Industries, Inc.)
and Bank of America Illinois.**
10.17 Stock Purchase Agreement between Newell Co. and Pen-Tab Holdings, Inc.
dated June 24, 1998.**
10.18 Secured Credit Agreement dated as of August 20, 1998 among Pen-Tab
Industries, Inc., Pen-Tab Holdings, Inc. and Bank of America National
Trust and Savings Association, as Agent and Letter of Credit Issuing Bank,
and The Other Financial Institutions Party Hereto.**
10.19 First Amendment and Waiver to the Secured Credit Agreement dated March 31,
1999.*
10.20 Second Amendment and Waiver to the Secured Credit Agreement dated November
16, 1999.*
10.21 Third Amendment and Waiver to the Secured Credit Agreement date March 13,
2000.*
10.22 Bond Holders Consent and Waiver Agreement dated March 13, 2000.*
22
10.23 Employment Agreement by and among Pen-Tab Holdings, Inc., Pen-Tab
Industries, Inc., and Marc English.*
21.1 Subsidiaries of Pen-Tab Industries, Inc.*
25.1 Statement of Eligibility of Trustee on Form T-1.**
27.1 Financial Data Schedule.*
99 Pen-Tab Safe Harbor Statement.*
Earnings to Fixed Charge Exhibit.***
*Filed herewith.
**Incorporated by reference
***Included in management discussion and analysis
(b) Reports of form 8-K
Form 8-K filed on June 3, 1999, announcing the retirement of Alan
Hodes as Chief Executive Officer and the appointment of Marc English
as the new Chief Executive Officer.
23
Signature
Pursuant to the requirements of Section 13 on 15(d) 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.
Pen-Tab Industries, Inc.
(Registrant)
Date: April 15, 2000 By: /s/ William Leary
- ----------------------- ---------------------
William Leary
Vice President, Chief Financial and
Administrative Officer
(principal financial officer
and accounting officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following person on behalf of the Registrant and in the
capacity and on the date indicated.
Marc English /s/ Marc English Chief Executive Officer April 15, 2000
------------------------
William Leary /s/ William Leary Chief Financial Officer April 15, 2000
------------------------
Deborah Hodes /s/ Deborah Hodes Senior Vice President April 15, 2000
------------------------ And Director
Alan Hodes /s/ Alan Hodes Director April 15, 2000
------------------------
Thomas McWilliams /s/ Thomas McWilliams Director April 15, 2000
------------------------
David Howe /s/ David Howe Director April 15, 2000
------------------------
James Stevens /s/ James Stevens Director April 15, 2000
------------------------
24
Schedule II - Valuation and Qualifying Accounts
Pen-Tab Industries, Inc.
Balance at
Beginning Bad Debts Charge-off Balance at
Description of period Expense Deductions End of period
- ------------------------ --------------- --------------- --------------- --------------
Allowance for
doubtful accounts
for the years ended:
January 1, 2000 $ 306 $ 340 $ (289) $ 357
January 2, 1999 $ 186 $ 286 $ (166) $ 306
January 3, 1998 $ 76 $ 144 $ (34) $ 186
Balance at
Beginning Allowances Charge-off Balance at
Description of period and Credits Deductions End of period
- ------------------------ --------------- --------------- --------------- --------------
Reserve for
allowances and
credits for the
years ended:
January 1, 2000 $1,429 $6,586 $(4,816) $3,199
January 2, 1999 $ 217 $3,041 $(1,829) $1,429
January 3, 1998 $1,299 $ -- $(1,082) $ 217
Balance at
Beginning Balance at
Description of period Additions Subtractions End of period
- ------------------------ --------------- --------------- --------------- --------------
Reserve for lower of
cost or market
inventory adjustments
for the years ended:
January 1, 2000 $2,036 $ - $(2,036) $ -
January 2, 1999 $ - $2,036 $ - $2,036
January 3, 1998 $ - $ - $ - $ -
Balance at
Beginning Balance at
Description of period Additions Subtractions End of period
- ------------------------ --------------- --------------- --------------- --------------
Reserved for excess
and obsolete
inventory for the
years ended:
January 1, 2000 $1,121 $ 879 $ - $2,000
January 2, 1999 $ - $1,121 $ - $1,121
January 3, 1998 $ - $ - $ - $ -
25
Index to Financial Statements and Schedules
Financial Statements of Pen-Tab Industries, Inc.
Report of Ernst & Young LLP, Independent Auditors ...........................F1
Consolidated Balance Sheets as of January 1, 2000 and January 2, 1999 .......F2
Consolidated Statements of Operations for the three years in the period
ended January 1, 2000....................................................F4
Consolidated Statements of Stockholder's Equity for the three years in the
period ended January 1, 2000.............................................F5
Consolidated Statements of Cash Flows for the three years in the period
ended January 1, 2000....................................................F6
Notes to Consolidated Financial Statements...................................F7
The following consolidated financial statement schedule is included in item
14(d):
Schedule II - Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and therefore have been omitted.
F
Report of Ernst & Young LLP, Independent Auditors
Board of Directors
Pen-Tab Industries, Inc.
We have audited the accompanying consolidated balance sheets of Pen-Tab
Industries, Inc. as of January 1, 2000 and January 2, 1999, and the related
consolidated statements of operations, stockholder's equity and cash flows for
each of the three years in the period ended January 1, 2000. Our audits also
included the financial statement schedule listed in the index at Item 14(a).
These consolidated financial statements and schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Pen-Tab
Industries, Inc. at January 1, 2000 and January 2, 1999, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended January 1, 2000, in conformity with generally accepted accounting
principles in the United States. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, present fairly in all material respects the
information set forth therein.
/s/ Ernst & Young LLP
April 14, 2000
McLean, Virginia
F1
Pen-Tab Industries, Inc.
Consolidated Balance Sheets
(Dollars in Thousands)
January 1, January 2,
2000 1999
---------- ----------
Assets
Current assets:
Cash and cash equivalents $ 175 $ 20
Accounts receivable (less allowances for discounts,
credits and doubtful accounts of $3,794 & $2,325) 21,353 15,770
Inventories, net 45,015 40,601
Prepaid expenses and other current assets 810 611
Deferred income taxes 6,871 1,384
-------- --------
Total current assets 74,224 58,386
-------- --------
Property, plant and equipment, at cost:
Land and buildings 16,244 16,206
Machinery and equipment 42,601 42,746
Furniture and fixtures 3,279 1,332
Leasehold improvements 1,504 1,476
-------- --------
64,078 61,760
Less: accumulated depreciation and amortization 21,771 16,222
-------- --------
Total property, plant and equipment 42,307 45,538
-------- --------
Intangibles:
Goodwill, net 73,737 73,680
Debt issue costs, net 3,454 4,339
-------- --------
Total intangibles 77,191 78,019
-------- --------
Total assets $193,722 $181,943
======== ========
See accompanying notes to consolidated financial statements.
F2
Pen-Tab Industries, Inc.
Consolidated Balance Sheets (Continued)
(Dollars in Thousands, except share data)
January 1, January 2,
2000 1999
-------- ---------
Liabilities and stockholder's equity
Current liabilities:
Accounts payable $ 6,211 $ 6,646
Accrued expenses and other current liabilities 10,556 7,382
Due to Newell Co. - 18,546
Accrued interest on subordinated notes 3,065 3,324
Current portion of long-term debt 21,431 4,886
Current portion of capitalized lease obligation 809 924
-------- ---------
Total current liabilities 42,072 41,708
-------- ---------
Long-term debt 134,456 119,339
Capitalized lease obligation 6,473 7,311
Deferred income taxes 6,871 3,068
-------- ---------
Total long-term liabilities 147,800 129,718
-------- ---------
Stockholder's equity:
Common Stock $.01 par value, 1,000 shares,
Authorized; 100 shares issued at January 1,
2000 and January 2, 1999 - -
Additional capital 39,209 39,209
Retained deficit (35,359) (28,692)
-------- ---------
Total stockholder's equity 3,850 10,517
-------- ---------
Total liabilities and stockholder's equity $193,722 $181,943
======== ========
See accompanying notes to consolidated financial statements.
F3
Pen-Tab Industries, Inc.
Consolidated Statements of Operations
(Dollars in Thousands)
Fiscal Year
-------------------------------------------
1999 1998 1997
-------- -------- -------
Net sales $155,403 $114,791 $88,014
Cost of goods sold 110,631 83,228 65,071
-------- -------- -------
Gross profit 44,772 31,563 22,943
-------- -------- -------
Expenses:
Selling, general and administrative 26,681 20,469 15,234
Amortization of goodwill 1,892 578 -
Other:
Interest income - (102) (228)
Interest expense 17,427 11,527 8,420
Reorganization expenses 6,112 - 804
Other income--net (21) (28) -
-------- -------- -------
Total expenses 52,091 32,444 24,230
-------- -------- -------
Loss from continuing operations before
income tax (benefit) provision (7,319) (881) (1,287)
Income tax (benefit) provision (1,492) (290) 1,774
-------- -------- -------
Loss from continuing operations (5,827) (591) (3,061)
-------- -------- -------
Income (loss) from operations of discontinued
segment, net of taxes (750) (90) 216
-------- -------- -------
Net loss $ (6,577) $ (681) $(2,845)
======== ======== =======
Unaudited Pro Forma Data:
Historical loss before income taxes $ (900)
Pro forma tax benefit (338)
-------
Pro forma net loss $ (562)
=======
See accompanying notes to consolidated financial statements.
F4
Pen-Tab Industries, Inc.
Consolidated Statements of Stockholder's Equity
(Dollars in Thousands)
Retained
Common Additional Earnings
Stock Capital (Deficit) Total
-------- -------- -------- --------
Balance December 28, 1996 $ -- $ -- $ 15,052 $ 15,502
Net loss -- -- (2,845) (2,845)
Dividends -- -- (40,212) (40,212)
-------- -------- -------- --------
Balance January 3, 1998 -- -- (28,005) (28,005)
Net loss -- -- (681) (681)
Dividends -- -- (6) (6)
Equity Contributions -- 39,209 -- 39,209
-------- -------- -------- --------
Balance January 2, 1999 39,209 (28,692) 10,517
Net loss -- -- (6,577) (6,577)
Dividends -- -- (90) (90)
-------- -------- -------- --------
Balance January 1, 2000 $ -- $ 39,209 $(35,359) $ 3,850
======== ======== ======== ========
See accompanying notes to consolidated financial statements.
F5
Pen-Tab Industries, Inc.
Consolidated Statements of Cash Flows
(Dollars in Thousands)
Fiscal Year
-----------------------------------
1999 1998 1997
--------- --------- ---------
Operating activities
Net loss $ (6,577) $ (681) $ (2,845)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization 6,085 3,607 2,554
Amortization of goodwill 1,892 578 -
Amortization of debt issue costs 885 707 414
Deferred income taxes (1,492) (290) 1,774
Provision for losses on accounts receivable 340 286 144
Provision for sales allowances and credits 6,586 3,041 -
Provision for reorganization expenses 5,932 - -
Provision for excess and obsolete inventory 879 1,121 -
Changes in operating assets and liabilities:
Accounts receivable (12,509) 16,376 2,232
Inventories (5,293) (3,507) (7,049)
Prepaid expenses and other current assets (199) 461 (507)
Accounts payable (435) 1,230 (103)
Accrued expenses and other liabilities (2,950) 1,957 (712)
Accrued interest on subordinated notes (259) (6) 3,330
--------- --------- ---------
Net cash provided by (used in) operating activities (7,115) 24,880 (768)
--------- --------- ---------
Investing activities
Sale of minority interest in Vinylweld LLC - 125 -
Purchase of property, plant and equipment (2,854) (2,854) (1,562)
Purchase of Stuart Hall, net of cash acquired - (113,357) -
--------- --------- ---------
Net cash used in investing activities (2,854) (116,086) (1,562)
--------- --------- ---------
Financing activities
Proceeds from revolver borrowings 93,500 145,058 18,688
Repayments of revolver borrowings (57,000) (140,058) (35,144)
Proceeds from term loan - 35,000 -
Principal payments on long-term debt (4,838) (1,150) -
Principal payments on capitalized lease obligations (953) (503) -
Proceeds from issuance of senior subordinated notes - - 72,563
Payment to Newell Co. (20,495) - -
Dividends (90) (6) (40,212)
Equity contribution from Holdings - 39,209 -
--------- --------- ---------
Net cash provided by financing activities 10,124 77,550 15,895
--------- --------- ---------
Increase (decrease) in cash and cash equivalents 155 (13,656) 13,565
Cash and cash equivalents at beginning of year 20 13,676 111
--------- --------- ---------
Cash and cash equivalents at end of year $ 175 $ 20 $ 13,676
========= ========= =========
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest $ 16,859 $ 10,028 $ 5,109
--------- --------- ---------
Income taxes $ - $ - $ 512
========= ========= =========
Non-cash transaction:
Services purchased related to the debt offering
and paid for by a reduction of proceeds received $ - $ - $ 2,437
========= ========= =========
See accompanying notes to consolidated financial statements.
F6
Pen-Tab Industries, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
1. Description of Business, Recent Developments and Liquidity
On February 4, 1997, Pen-Tab Industries, Inc., a Virginia corporation, changed
its name to Pen-Tab Holdings, Inc. ("Holdings"). On February 4, 1997 Holdings
formed a wholly owned subsidiary called Pen-Tab Industries, Inc. (the
"Company"), a Delaware corporation. On February 4, 1997, the Company issued $75
million 10 7/8% Senior Subordinated Notes due 2007 and Holdings effected a
recapitalization pursuant to which Holdings repurchased approximately 748 shares
of Class A common stock and 122 shares of Class B common stock from management
shareholders for approximately $47,858, converted an additional 14 shares of
Class A common stock and 358 shares of Class B common stock into redeemable
preferred stock, and sold 37 shares of Class A common stock, 3 shares of Class B
common stock and 125,875 shares of redeemable preferred stock to outside
investors for proceeds of approximately $15,010. Holdings' shareholders
concurrently approved an amendment to Holdings' articles of incorporation to
increase the number of authorized shares to 8,352,500, consisting of 6,000,000
shares of Class A Common Stock, par value $.01 per share, 2,000,000 shares of
Class B Common Stock, par value $.01 per share, and 352,500 shares of redeemable
preferred stock. Following completion of the above transactions, Holdings'
shareholders approved a stock split pursuant to which each share of Holdings'
Class A Common Stock and Class B Common Stock then outstanding was converted
into 60,937.50 shares of such common stock.
On August 20, 1998, the Company acquired all of the capital stock of Stuart Hall
Company, Inc. ("Stuart Hall"). See Note 3 for details.
The Company, a wholly-owned subsidiary of Holdings, is a leading manufacturer of
school, home and office supply products. Its products include legal pads,
wirebound notebooks, envelopes, school supplies, and arts and crafts products.
The Company is a primary supplier of many national discount store chains, office
supply super stores, and wholesale clubs throughout the United States and
Canada. The Company, through Vinylweld L.L.C., is a leading designer and
manufacturer of vinyl packaging products. Sales are made on open account and the
Company generally does not require collateral.
F7
1. Description of Business, Recent Developments and Liquidity (Continued)
Covenant Violations/Amendments to Credit Facility/Note Holder Consent. As a
result of insufficient third quarter 1999 earnings, the Company was in default
of a covenant based on EBITDA (earnings before interest, taxes, depreciation,
amortization, and certain non-cash charges, as defined in the agreement) and
cash interest and principal payments (fixed charge coverage ratio) for the
twelve months ended October 2, 1999. On November 16, 1999, the Company amended
its credit facility to waive the fixed charge coverage ratio covenant default.
This amendment also provided that the interest rate increase by 0.625%.
As a result of insufficient fourth quarter 1999 earnings, the Company was
in default of the fixed charge coverage ratio, annual clean up and the minimum
net worth covenants, as defined in the agreement, at and for the twelve months
ended January 1, 2000. In addition, due to the earnings shortfall and Enterprise
Resource Planning ("ERP") system implementation issues which led to higher than
expected inventories and accounts receivable collection delays, the Company was
in default of the annual revolver clean up provision. The clean up provision
requires the Company, for a period of not less than thirty days between
September 30 and November 15, to reduce the outstanding balance on the revolver
to $25 million or less. The Company was also in default of the borrowing base
formula, as defined in the agreement, whereby the balance outstanding on the
revolver was in excess of the borrowing base formula computed amount. On March
13, 2000, the Company amended its credit facility. The amendment (i) waived the
defaults, (ii) revised the borrowing base definition to provide for an over
advance of up to $16.5 million for the period of March 1, 2000 through July 15,
2000, (iii) increased the interest rate by 0.875% plus another 0.50% during the
over advance period, (iv) revised the annual clean up provision amount to $27
million from $25 million and revised the clean up period to be between October
15 and January 15 from between September 30 and November 15, (v) revised the
fixed charge coverage ratio to 1.00:1 (from 1.50:1) for the twelve month periods
ended March 31, 2000 and June 30, 2000 and to 1.50:1 (from 1.75:1) thereafter,
(vi) limits capital expenditures to $2 million for fiscal 2000 and (vii)
requires total debt, as defined in the agreement, not to exceed $153 million at
June 30, 2000. The Company paid a fee of $0.5 million in conjunction with the
Credit Facility amendment and will amortize such fee over the remaining life of
the Credit Facility (March 2000 through August 2001).
Prior to the amendment discussed in the preceding paragraph and as a result
of the covenant violations described above, the Company was not allowed to make
the required interest payment of approximately $4 million due on February 1,
2000 to the holders of the Company's $75 million 10.875% Senior Subordinated
Notes due 2007. As a condition of the aforementioned amendment, the Company
obtained consent from substantially all of the note holders to accept the
February 1, 2000 interest payment in the form of new notes, in aggregate
principal amount substantially equal to such interest payment, in lieu of a cash
payment. As a result, the Company will be deemed to have made the cash interest
payment and simultaneously issued new notes to existing note holders in exchange
for such cash payment.
Subsequent to January 1, 2000, a majority stockholder of Pen-Tab Holdings,
Inc. ("Holdings") purchased approximately $60 million of the $75 million 10.875%
Senior Subordinated Notes in the secondary market.
Management, in conjunction with its debtors, have reviewed the Company's
fiscal 2000 budget and cash flow forecasts, and believe these plans will allow
the Company to meet the debt covenant requirements of its debt agreements.
F8
2. Summary of Significant Accounting Policies
Method of Accounting
The accompanying consolidated financial statements are prepared on the accrual
basis of accounting in accordance with generally accepted accounting principles.
The 1998 and 1999 fiscal years refer to the fifty-two week periods ended January
2, 1999 and January 1, 2000, respectively, and the 1997 fiscal year refers to
the fifty-three week period ended January 3, 1998.
Principles of Consolidation
The consolidated financial statements include the accounts of the company and
its subsidiaries. All significant inter-company accounts and transactions have
been eliminated.
Revenue Recognition
Sales are recognized upon product shipment (FOB shipping point). All risks and
rewards of ownership pass to the customer upon shipment. Damaged or defective
products may be returned to the Company for replacement or credit. The Company
may offer certain volume rebates, co-op advertising and other discounts and
allowances. The effects of these discounts and allowances are estimated and
recorded at the time of shipment.
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original maturity of
three months or less when purchased to be cash equivalents.
Inventories
Inventories are stated at the lower of cost or market and are valued using the
last-in, first-out (LIFO) method.
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation is computed on
the straight-line method over the estimated useful lives of the related assets.
Leasehold improvements and assets held under capital leases are amortized by the
straight-line method over the shorter of the estimated useful lives or
F9
2. Summary of Significant Accounting Policies (Continued)
the lease term. The principal estimated useful lives are: buildings - 15 to 40
years; machinery and equipment - 3 to 10 years; furniture, fixtures and computer
equipment - 3 to 5 years; leasehold improvements and assets held under capital
leases - 3 to 10 years.
Impairment of Long-Lived Assets
Each year, management determines whether any property and equipment or any other
assets have been impaired based on the criteria established in Statement of
Financial Accounting Standards No. 121 ("SFAS 121"), "Accounting for the
Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of." The
Company made no adjustments to the carrying values of the assets during the
years ended January 1, 2000 and January 2, 1999.
Goodwill
The excess of the purchase cost over the fair value of assets acquired is being
amortized over 40 years. The Company evaluates whether events and circumstances
have occurred that indicate the remaining estimated useful life of goodwill may
warrant revision or that the remaining balance of goodwill may not be
recoverable. When factors indicate that goodwill should be evaluated for
possible impairment, the Company uses an estimate of the undiscounted future
cash flows over the remaining useful life to determine whether goodwill is
recoverable. The Company believes that no material impairment of goodwill
existed at January 1, 2000. The related accumulated amortization at January 1,
2000 and January 2, 1999 was $2,470 and $578, respectively.
Amortization of Debt Issue Costs
Debt issue costs are stated at cost and amortized to interest expense.
Amortization of debt issue costs is computed on the effective interest method
over the maturity of the applicable debt, which range from three years for the
Credit Facility, ten years for the Senior Subordinated Notes and twenty years
for the Industrial Development Revenue Bonds. The Company complies with
Statements of Financial Standards (FAS 121) "Accounting for the Impairment of
Long-Lived Assets" as related to its debt issue costs and other intangibles. The
related accumulated amortization at January 1, 2000 and January 2, 1999 was
$2,025 and $1,140, respectively.
Advertising Costs
The Company expenses the costs of advertising as incurred. Such costs amounted
to approximately $0, $1,596, and $2,658 for fiscal 1999, 1998, and 1997,
respectively.
F10
2. Summary of Significant Accounting Policies (Continued)
Income Taxes
The Company accounts for income taxes and the related assets and liabilities in
accordance with FAS 109, "Accounting for Income Taxes". Provisions for income
taxes are based upon earnings reported for financial statement purposes and may
differ from amounts currently payable or receivable because certain amounts are
recognized for financial reporting purposes in different periods than they are
for income tax purposes. Deferred income taxes, net of any valuation allowance,
result from temporary differences between the financial statement amounts of
assets and liabilities and their respective tax bases. Also see Note 8.
Fair Value of Financial Instruments
The Company considers the recorded value of its cash, cash equivalents, accounts
receivable and accounts payable to approximate the fair value of the respective
assets and liabilities at January 1, 2000 and January 2, 1999.
The fair value of the $75 million Senior Subordinated Notes based on a quoted
market price is 30% of the face value or $22.5 million at January 1, 2000. The
fair value of the swap agreement at January 1, 2000 was a loss of $0.7 million.
The fair value was determined based upon prevailing interest rates at January 1,
2000.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
Derivative Financial Instruments
The Company utilizes derivative financial instruments principally to hedge
interest rates through an interest rate swap agreement. The Company actively
evaluates the credit worthiness of the financial institutions that are
counterparts to derivative financial instruments, and it does not expect any
counterparts to fail to meet their obligation. Premiums paid on the interest
swap agreement are amortized as interest expense over the term of the agreement.
Amounts received or paid under the swap agreement are recorded as a reduction of
or increase in interest expense, respectively.
F11
2. Summary of Significant Accounting Policies (Continued)
Risk and Uncertainties
The Company is potentially subjected to concentrations of credit risk with trade
accounts receivable. Because the Company has a large and diverse customer base,
there was no material concentration of credit risk related to trade accounts
receivable at January 1, 2000, except as discussed in Note 11.
Reclassification
Certain amounts included in prior years' financial statements have been
reclassified.
3. Acquisition of Stuart Hall
On August 20, 1998, Pen-Tab acquired all of the outstanding stock of Stuart
Hall, a wholly-owned subsidiary of Newell Co. for $126.8 million in cash. The
purchase price of the acquisition was funded by an equity contribution of $39.2
million from Holdings and with borrowings under the Company's Credit Facility
(see Note 7 - Long-Term Debt). The transaction was accounted for using the
purchase method. The purchase price was allocated to the assets and liabilities
acquired based on their estimated fair values. In conjunction with the
acquisition, the Company recorded goodwill of approximately $75.8 million. The
operations of Stuart Hall are included in the consolidated financial statements
of the Company beginning August 20, 1998 (date of acquisition).
The following unaudited pro form results of operations assumes that the
acquisition of Stuart Hall had occurred at the beginning of fiscal 1998 and
1997, respectively. These pro forma results give effect to certain adjustments,
including depreciation of property, plant and equipment, amortization of
goodwill and interest expense resulting from the acquisition and related
financing. The pro forma results have been prepared for comparative purposes
only and do not purport to indicate the results of operations that would
actually have occurred had the combination been in effect on the date indicated
or which may occur in the future.
For the Year Ended
-------------------------
Jan 2, 1999 Jan 3, 1998
------------- ------------
Pro forma net sales unaudited.................. $ 193,175 $ 187,570
============= ============
Pro forma net income unaudited................. $ 5,098 $ 3,367
============= ============
F12
4. Unaudited Pro Forma Data
As described further in Note 8, the Company was taxed as an "S" corporation
through February 4, 1997. Upon completion of the recapitalization described in
Note 1, Pen-Tab Industries, Inc. terminated its "S" corporation status. The pro
forma related statement of operations for fiscal 1997 reflects adjustments to
the Company's income tax provision, as if the Company had been taxed as a "C"
corporation for the entire fiscal year of 1997.
5. Inventories
Inventories consist of the following:
January 1, January 2,
2000 1999
------- -------
Raw materials $17,858 $17,242
Work-in-process 1,792 715
Finished goods, net 23,922 22,644
LIFO reserve, net 1,443 -
------- -------
$45,015 $40,601
======= =======
For purposes of comparability, had LIFO inventories been reported at values
approximating current cost, as would have resulted from using the FIFO method,
and if no other assumptions were made as to changes in income, income before
taxes would have been lower in 1999, 1998, and 1997 by approximately $1,443,
$707, and $257, respectively. The Company reports its inventory under the LIFO
method in order to better match its income and expenses. There were no
liquidations of LIFO inventories for the fiscal year ended January 1, 2000.
6. Dividends
Dividends for fiscal years 1999, 1998, and 1997 of $90, $6, and $40,212,
respectively, were paid to the stockholders' of the Company. The dividends for
the fiscal year 1997 included $5,695 paid to the stockholders' of the Company in
the period to February 3, 1997 and $34,517 paid by the Company to Holdings.
F13
7. Long-Term Debt
Long-term debt consisted of the following:
January 1 January 2,
2000 1999
--------- ----------
Credit Facility:
Revolver $ 41,500 $ 5,000
Term Loan 30,750 34,250
Senior Subordinated Notes 75,000 75,000
Industrial development revenue bonds 6,700 7,100
Equipment notes payable 1,937 2,875
Capital lease obligations (see Note 9) 7,282 8,235
-------- --------
163,169 132,460
Less: current portion 22,240 5,810
-------- --------
$140,929 $126,650
======== ========
In conjunction with the acquisition of Stuart Hall on August 20, 1998, the
Company entered into a $135 million Credit Facility ("Credit Facility") with
Bank of America which expires on August 20, 2001. The Credit Facility includes a
$100 million revolver and a $35 million term loan. The $35 million term loan has
aggregate maturities as follows: 1998 $750; 1999 $3,500; 2000 $5,500; 2001
$25,250. The $100 million revolver portion of the Credit Facility provides for
advances based upon a borrowing base comprised of specified percentages of
eligible accounts receivable and inventory. During March 1, 2000 through July
15, 2000 the borrowing base includes an overadvance of up to $16,500. The
interest rate per annum applicable to the Credit Facility is the prime rate, as
announced by the Bank plus 1.75% or at the Company's option, the Eurodollar rate
plus 3.5%. During an overadvance period the interest rate is increased by 0.50%.
The Company is required to pay a commitment fee of 0.65% on the unused portion
of the $100 million revolver. Under the terms of the Credit Facility, the
Company is required to maintain certain financial ratios relating to cash flow
(fixed charge coverage ratio, minimum EBITDA threshold and capital expenditure
limit), annually reduce the principal balance of the revolver to $27 million for
thirty consecutive days during the period between October 15 and January 15,
limit total debt, as defined in the agreement, to $153 million at June 30, 2000
and restrict the amount of dividends that can be paid during the year. Except as
noted below, all assets of the company are pledged as collateral for balances
owing under the Credit Facility. The weighted average borrowing rate was 7.7%,
7.5% and 7.5% for fiscal year 1999, 1998 and 1997, respectively.
F14
7. Long-Term Debt (Continued)
The 10 7/8% Senior Subordinated Notes are due in 2007. The Indenture contains
certain covenants that, among other things, limits the ability of the Company to
incur additional indebtedness. During November 1997, the Company entered into a
swap agreement, which expires February, 2002, to swap its fixed rate of payment
on the $75,000 10 7/8% Senior Subordinated Notes for a floating rate payment.
The floating rate is based upon a basket of the LIBORS of three countries plus a
spread, and is capped at 12.5%. The interest rate resets every six months and at
January 1, 2000, the Company's effective interest rate under the swap agreement
was 10.04%. The Company can terminate the transaction at any time, at the then
current fair market value of the swap instrument. A 1.0% change in the effective
interest rate would result in a $0.7 million change in interest expense.
The industrial development revenue bonds represent 20-year tax-exempt bonds
issued through the Town of Front Royal and the County of Warren, Virginia on
April 1, 1995. Interest is paid monthly, and is calculated using a floating rate
determined every 7 days with reference to a tax-exempt bond index (3.82% as of
January 1, 2000 plus a bank of letter of credit fee of 1.5%). The industrial
development revenue bonds are subject to a mandatory sinking fund redemption
which commenced April 1, 1998, under which Pen-Tab is required to make 17 annual
installments of $400, with a final installment of $700, due in 2015. Repayment
is collateralized by a bank standby letter of credit in the amount of $6.8
million and a first security interest in Pen-Tab's land and buildings in Front
Royal, Virginia. The bonds may be redeemed at the option of Pen-Tab, in whole or
in part, on any interest payment date.
The Company has a series of equipment notes payable with CIT Group/Equipment
Financing Inc. The notes bear interest at various fixed amounts from 8.95% to
10.85% and mature at various dates through 2001. The aggregate maturities are as
follows: 2000 $986; 2001 $951.
8. Income Taxes
The Company elected to be treated as an "S" corporation for federal income tax
purposes until February 4, 1997 under which income, losses, deductions and
credits were allocated to and reported by the company's stockholders based on
their respective ownership interests. Effective February 4, 1997, in conjunction
with the Recapitalization described in Note 1, the Company terminated its "S"
corporation election.
The significant components of these amounts as shown on the Balance Sheet are as
follows:
F15
8. Income Taxes (Continued)
January 1, January 2,
2000 1999
------- -------
Current
- -------
Deferred Tax Assets
Accrued expenses $ 115 $ --
Allowance for bad debts 136 110
Inventory capitalization 304 186
Inventory valuation 760 --
Unused net operating loss 4,041 314
Restructure reserve 2,254 --
LIFO reserve -- 774
------- -------
Current Deferred Tax Asset 7,610 1,384
Valuation allowance (739) --
------- -------
Net Current Deferred Tax Asset $ 6,871 $ 1,384
------- -------
Non-current
- -----------
Deferred Tax Liability
Property, plant and equipment $(3,919) $(1,897)
Goodwill (2,952) (1,171)
------- -------
Net Non-Current Deferred Tax Liability $(6,871) $(3,068)
======= =======
Total Net Deferred Tax $ -- $(1,684)
======= =======
The components of income tax (benefit) provision from continuing operations are:
1999 1998 1997
------- ------- -------
Current
Federal $ -- $ -- $ --
State -- -- (30)
------- ------- -------
-- -- (30)
------- ------- -------
Deferred
Federal (1,337) (263) 1,545
State (155) (27) 259
------- ------- -------
(1,492) (290) 1,804
------- ------- -------
Income tax (benefit) provision $(1,492) $ (290) $ 1,774
======= ======= =======
F16
8. Income Taxes (Continued)
The differences between the (benefit) provision for income taxes and income
taxes computed at the statutory U.S. federal income tax rates are explained as
follows:
1999 1998 1997
------- ------- -------
Income tax benefit computed at the statutory U.S.
federal income tax rates $(2,488) $ (300) $ (438)
State income taxes, net of federal benefit (293) (35) (51)
Valuation allowance 739 -- --
Change in entity status -- -- 2,343
(Income) loss taxed at shareholders level -- -- 108
Other, including permanent differences 550 45 (188)
------- ------- -------
(Benefit) provision for income taxes $(1,492) $ (290) $ 1,774
======= ======= =======
A deferred tax asset valuation allowance of $739 was recorded in 1999. This
valuation allowance reduced the deferred tax asset to an amount, which the
Company believes, based on the Company's estimates of its future taxable
earnings, is realizable. Therefore, the 1999 income tax benefit was reduced by a
provision of $739 related to the valuation allowance. In future periods, the
Company's provision for income taxes may be impacted by adjustments to the
valuation allowance.
The Company has available for federal income tax purposes $10,634 of net
operating losses, which expire substantially in the years 2012 through 2019.
During fiscal 1997, the Company was taxed as an "S" corporation for the period
ended February 3, 1997 and as a "C" corporation for the period thereafter. The
Company recorded a cumulative deferred tax liability of $2,343 upon termination
of the Company's "S" corporation election.
9. Leases and Commitments
The Company leases certain office, manufacturing and warehouse facilities in
California and Chicago under operating leases which expire in May 2002 and
December 2004, respectively. The Company also leases certain office,
manufacturing and warehouse facilities in Kansas City under long-term capital
leases that expire in December 2005, and are included in property, plant and
equipment as buildings. The assets held under capital leases are as follows:
F17
9. Leases and Commitments (Continued)
January 1, January 2,
2000 1999
------ ------
Buildings $8,783 $8,783
Less: Accumulated amortization 1,302 304
------ ------
Total $7,481 $8,479
====== ======
Future minimum lease payments under non-cancelable operating and capital leases
are as follows, as of January 1, 2000:
Fiscal year Operating Capital
----------------------- ----------------- -------------------
2000 1,871 1,582
2001 1,629 1,582
2002 982 1,582
2003 482 1,582
2004 430 1,582
Thereafter 126 1,856
------ --------
Total $5,520 $ 9,766
======
Imputed interest (2,484)
--------
Present value $ 7,282
========
Rent expense was approximately $1,717, $1,353, and $1,197 in fiscal 1999, 1998,
and 1997, respectively. Amortization of the capital lease assets are included in
depreciation expense.
At January 1, 2000 and January 2, 1999, the Company had standby letters of
credit outstanding in the amounts of $197 and $457 issued by a bank on behalf of
Pen-Tab in connection with a license contract and a worker's compensation
insurance program, respectively. See also Note 7.
10. Reorganization Expenses
During fiscal 1999, the Company approved a plan to rationalize its manufacturing
operations. The plan includes a plant consolidation, equipment moves,
plant/product changes, and warehouse consolidation. The reorganization charge of
$6.1 million represents the Company's rationalization plan and includes employee
termination costs, including severance and benefit, cost to exit facilities,
lease termination costs, and property taxes after ceasing operations.
F18
10. Reorganization Expenses (Continued)
During fiscal 1997, the Company reorganized its sales and marketing functions.
The non-recurring charges of $804 for recruitment and acquisition costs of new
sales and marketing executives as well as the severance costs of terminated
sales employees are reported as reorganization expenses in the statements of
income and retained earnings.
11. Concentration of Risk
During fiscal 1999, 1998, and 1997 the Company had two customers each in excess
of 10% of revenues as follows:
1999 1998 1997
---- ---- ----
Customer A 22.8% 18.3% 23.8%
Customer B 12.0% 14.4% 19.1%
---- ---- ----
Total 34.8% 32.7% 42.9%
==== ==== ====
Two customers comprised approximately 35.0% and 34.5% of the net accounts
receivable balance at January 1, 2000 and January 2, 1999, respectively.
Employees covered under collective bargaining agreements represent approximately
65% of the Company's work force. Collective bargaining agreements covering
approximately 24% of the Company's work force have expiration dates within one
year.
12. Defined Contribution Plan
The Company sponsors a 401(k) plan in which nonunion full-time employees meeting
certain age and employment requirements are eligible for participation.
Participating employees can contribute between 2% and 15% of their annual
compensation. The Company matches employee contributions at a rate of 50% of the
employee's annual contributions up to 2.5% of the employee's annual
compensation. Total expense under the plan amounted to $228, $220, and $136 in
fiscal 1999, 1998, and 1997, respectively. The Company also contributes to union
sponsored multi-employer defined contribution pension plans. All union employees
meeting certain employment requirements are covered. Total expense under the
union sponsored plans amounted to $95, $87, and $24 in fiscal 1999, 1998, and
1997, respectively.
13. Discountinued Operations
In March 2000, the Company decided to divest its vinyl packaging business
segment, which operates as Vinylweld L.L.C. The consolidated financial
statements and related footnotes reflect this business as a discontinued
operation. The net sales from this segment amounted to $8,152 in 1999, $9,291 in
1998 and $8,623 in 1997. Income tax (benefits) provisions allocated to this
segment were $(192), $(45) and $171 for the years 1999, 1998 and 1997,
respectively. The assets and liabilities of this segment, consists primarily of
accounts receivable, inventories, property, plant and equipment and accounts
payable.
January 1, January 2,
2000 2000
------------------ ------------------
Net current assets $ 1,088 $ 1,519
================== ==================
Net non-current assets $ 1,139 $ 1,050
================== ==================
14. Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consist of the following:
January 1, January 2,
2000 1999
---------- ----------
Accrued compensation and benefits $ 632 $ 1,135
Accrued reorganization costs 5,932 -
Accrued sales programs 2,538 1,562
Accrued acquisition costs - 3,271
Other accrued expenses 1,454 1,414
---------- ----------
$ 10,556 $ 7,382
========== ==========
F19
15. Segment Information
As described in Note 1, the Company operates in two business segments consisting
of school, home and office products, and vinyl packaging products. The following
table provides certain financial data regarding these two segments.
School, Home Vinyl
And Office Packaging
Products Products Total
------------ --------- -----
1999
Net sales $155,403 $ 8,152 $163,555
Operating earnings (loss) 10,108 (987) 9,121
Interest expense, net 17,337 45 17,382
Identifiable assets 190,415 3,307 193,722
Depreciation and amortization 8,586 276 8,862
Capital expenditures 2,483 371 2,854
1998
Net sales $114,791 $ 9,291 $124,082
Operating earnings (loss) 10,545 (148) 10,397
Interest expense, net 11,413 -- 11,413
Identifiable assets 178,608 3,335 181,943
Depreciation and amortization 4,692 200 4,892
Capital expenditures 2,175 679 2,854
1997
Net sales $ 88,014 $ 8,623 $ 96,637
Operating earnings 6,905 389 7,294
Interest expense, net 8,194 -- 8,194
Identifiable assets 61,578 2,214 63,792
Depreciation and amortization 2,770 198 2,968
Capital expenditures 1,498 64 1,562
For the purposes of the segment information provided above, operating earnings
are defined as net sales less related cost of goods sold, selling, general and
administration expenses, amortization of goodwill, restructure and
reorganization expenses and other income-net. Inter-segment sales are
immaterial.
F20